Consolidation is underway in renewable energy, with well-funded developers ramping up asset portfolios by acquiring the operating assets of small-to-mid-sized firms, which are facing a plethora of issues
That India’s infrastructure build-out needs fresh and huge sources of capital has been said enough times.
Good part is, the sector today has a lot more options to choose better capital allocators, which assess risks well, and can therefore accelerate the great build-out.
Between financial year 2013-14 and 2017-18, capital constraints returned, as reflected in credit offtake plummeting to an average 4 per cent from 28 per cent between financial year 2008-09 and financial year 2012-13.
The government stepped up with budgetary support. CRISIL estimates the central and state governments accounted for ~68 per cent of infrastructure investments between financial year 2012-13 and financial year 2016-17, compared with 63 per cent between financial year 2007-08 and financial year 2011-12.
But, the fiscal headroom is narrowing with the government needing to cater to other growth areas.
That means the private sector, whose share in infrastructure spending has fallen to 29 per cent from 35 per cent in financial year 2015-16, needs to start showing better traction.
Lending by non-banking financial companies (NBFCs) is stifled with banks reluctant to extend credit after the recent fiasco at IL&FS Financial Services Ltd. This resultant liquidity crunch has increased the cost of funds for most NBFCs, leading to a slowdown in credit disbursal.
The unmet funding gap in infrastructure has been difficult to fill. To achieve a sustained gross domestic product (GDP) growth of 7 per cent to 8 per cent over the medium to long-term, India needs to invest 6.0 per cent to 6.7 per cent of GDP in infrastructure.
CRISIL estimates the cumulative funding gap/shortfall at ~Rs 19 lakh crore at the end of financial year 2021-22. To bridge this, alternative financing routes are needed.
InvITs are a good alternative
The power sector, which accounts for nearly 27 per cent of the total infrastructure investments, shows the way. With private sector investments in thermal power adversely impacted, the focus is on renewable energy (RE). However, challenges such as keener competition in RE has pinched project internal rates of return and delayed payments from state distribution companies (discoms), have squeezed capital flow.
Consolidation is underway in RE, with well-funded developers ramping up asset portfolios by acquiring the operating assets of small-to-mid-sized RE firms, which are facing a plethora of issues, such as dearth of financing, high competition and low tariffs. Large developers with scalability focus have a competitive edge because of financial prudence, strong balance sheets with multiple funding sources, robust corporate governance and proven execution track record.
Further, there is a need for better and sustainable sources of capital to channel growth on the right path. Traditional sources of equity funding such as the foreign direct investment (FDI) have dried up, while banks have turned reluctant to extend credit over longer term. As a result, the sector needs a better capital allocator that can sustain capital supply.
Infrastructure Investment Trusts (InvITs) are emerging as a credible option, as their structures are better suited for meeting the sector’s financing challenges. Given the massive need for investment and supply-side financing constraints, InvITs can play an important role in channeling right investments by enabling asset recycling and utilising the growth proceeds for further capital supply.
The assets most suited for InvITs include operating assets backed by credible counterparties. We have seen operating inter-state transmission assets with an availability-based payment mechanism being quite amenable. But, RE developers or their sponsors, too, can sell their operational assets to InvITs and unlock capital to reduce leverage and/or use the proceeds as growth capital.
An InvIT is a hybrid product with characteristics of debt and equity. InvITs resemble equities, but are unique due to tax-efficient and mandatory payouts. Their sponsors have an option to choose either a private InvIT, with a handful of institutional investors, or a public InvIT, which raises money through a public offer. Private InvITs are preferred because of the involvement of the “right investors” during valuation. These investors, typically institutional asset managers, understand the products better and play a strategic role in the functioning and value creation of the InvIT. Private InvITs also have more flexibility while investing in under-construction projects, with a mandatory distribution of 90 per cent of distributable cash flow at least once a year (for public InvITs, at least once every six months) and lower disclosure norms. Recent regulatory amendments seek to increase investor participation and provide flexibility in fundraising for InvITs. The key changes include increasing the maximum permissible net consolidated debt for InvITs to 70 per cent from 49 per cent earlier.
Expected loss ratings, a better decision-making tool
The loss-given default rates of RE projects are attractive enough to ensure that expected losses (EL) are lower. Banks should start using EL rating scales to evaluate RE projects, so that they can allocate capital in this space and price risk better. The credit profile of an infrastructure project improves on an EL scale, as stability emerges. Operational infrastructure projects that are fundamentally viable may face short-term liquidity mismatches, constraining ratings on the conventional probability-of-default scale.
EL ratings fill this gap, as they focus on dues recovery over the project lifecycle. For this, they consider refinance/restructuring, residual economic life and the presence of embedded safeguards, such as termination payments. As a result, EL ratings help long-term investors in operational assets, but for their broader usage, regulatory facilitation is required.
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About Sudip Sural
Sudip Sural is Senior Director – Infrastructure and Public Finance at CRISIL Infrastructure Advisory. Prior to CRISIL, he had been associated with Fitch Ratings and Genpact.