Sanjeev Prasad, Akhilesh Tilotia & Sunita Baldawa
We believe India may have to approach the next investment cycle differently with respect to (1) the type of projects, (2) financing of projects and (3) institutional frameworks for investment. The traditional sectors of power, roads and telecom may not provide the necessary impetus to the investment cycle. India will require new sectors to lead the next investment cycle.
We see a potential decline in investment after the next 18-24 months unless the Indian government can conceptualise and award new investment projects quickly. Ongoing capex is still reasonably strong and reflects investments in projects that had been conceived a few years ago and in which construction had commenced over the past 1-3 years. We highlight the following points to support our somewhat contentious view.
RBIs data on project sanctions by banks suggest a sharp decline in capex. RBIs data on project costs for projects that received financial assistance from banks and financial institutions show a sharp decline in financial assistance in FY2012 compared with FY2010-11 figures (see Graph 1). This would suggest a slowdown in capex after 1-2 years when ongoing projects (that received financial sanctions over FY2008-11) are completed in the next 24-36 months. In our view, the Planning Commissions projections of $1 trillion of investment in the infrastructure segment during the Twelfth Five Year Plan (FY2013-17) appear quite optimistic. We view the three-fold increase in investment in the telecom sector and two-fold increase in the power sector compared to the Eleventh Five Year Plan period (FY2008-12) as difficult to achieve, given a likely slowdown in capex in both sectors.
Telecom capex was spurred in FY2009-11 by the start of operations by new players subsequent to the granting of new 2G licenses and expansion by incumbent operators into new markets (semi-urban and rural). New subscriber additions have slowed subsequently with penetration reaching reasonably high levels (74.7% in August 2012).
In the power sector, India may achieve its Twelfth Plan target of 88 GW though the bigger challenge may be to ensure viable operations of recently commissioned and forthcoming power plants given lack of adequate fuel (coal or gas). The Twelfth Plan figure of $322 billion appears high in the context of 88 GW of new power-generation projects and commensurate investments in transmission and distribution segments. We expect this to result in an investment of about $200 billion.
In our view, India may need to conceptualise and award new projects that can sustain or accelerate the investment cycle once ongoing projects are completed over the next 2-3 years and meet certain long-term objectives.
India can develop its abundant coal reserves and hydro potential better and explore new energy options (nuclear seems to be the only alternative to coal and hydro for large-scale power generation) to meet the energy requirements of a fast-growing country and tackle burgeoning fuel imports and a current account deficit (CAD). Better internal connectivity (railways, roadways, waterways) will result in higher productivity and national integration, too. Improving the quality of urban infrastructure would entail investment in housing, mass-rapid transit systems, roads and water/sewage. This is a vast area given the poor quality of urban infrastructure in India in general. We also suggest a more transparent system to monitor projects under the PPP model. We have seen large slippages in several projects. We also advocate greater participation of the government in some of the new projects. The institutional framework for public-private partnership (PPP) is quite robust for sectors such as power, roads and telecom but some of the new projects, proposed by us and others, may require a greater role of the government (ownership). Many of the new projects would require acquisition of vast tracts of land (hydroelectricity, railways) and interaction with the local community affected by the projects.
In our view, the government may be in the best position to deal with the sensitive areas of land acquisition and rehabilitation and resettlement (R&R). The government has proposed a Land Acquisition Bill, which may be introduced in the forthcoming winter session of Parliament; industry has voiced concerns about certain provisions in the bill related to the cost of land acquisition and R&R activities. In addition, we suggest new financing options: (1) Government equity or funding of the viability gap for projects through special taxes, divestment proceeds, tax on unaccounted money through voluntary disclosure schemes, (2) long-term corporate bonds, which would entail development of a deep and liquid corporate bond market and (3) greater participation of insurance and pension funds in infrastructure projects. In our view, banks are not adequately equipped to finance long-term projects because of (a) asset-liability mismatches and (b) their limited ability to price the risk of long-gestation projects properly.
We believe any discussion on investment in infrastructure projects must cover the important issue of returns on such investments (financial and social). We see investment in infrastructure as important to improve productivity in the economy and address specific challenges. For a growing country such as India with its large infrastructure deficit, any investment will be welcome. However, it is important for investors in infrastructure projects to recoup their investments.
Returns on investment on basic infrastructure projects are hard to quantify given their direct and indirect impact on productivity and society. Such improvements in productivity may be hard to measure immediately given the long-term nature of such projects (50- to 100-year life of airports, highways, ports, railway networks). Besides, the impact on society is hard to measure in the short term.
India has only recently started its experiments with the participation of the private sector in infrastructure development under a PPP model. The results, when measured against deliverable outputs such as (1) timeliness of project execution, (2) project IRR and (3) social impact, have been mixed. Several projects have seen timely completion and good project IRR (initial road projects), some have seen timely completion but have resulted in poor financials for operators (airports), some have seen long delays and will likely see poor financials (urban infrastructure) and finally, some have been mired in controversies with allegations of impropriety in award and execution of projects (several power projects).
We believe the current PPP model requires fine-tuning to ensure that the desired outputsfinancial impact and social impactare delivered concurrently. The basic tenets and institutional frameworks of the PPP model are legally sound. Private-sector entities are completely free to participate in PPP projects based on their appreciation of the financials of the project. We would like to see a stricter schedule for implementation, low tolerance for deviations from the initial agreements between the government (as representative of the public) and private-sector entities executing the project and stricter penalties for entities indulging in bad practices (corruption, delays beyond acceptable limits, re-negotiation of contracts for financial benefits). In our view, the policy and regulatory framework for most infrastructure sectors are quite evolved. The role of the government as legislator, owner, operator and regulator has diminished considerably with the framing of proper regulations in most sectors (some through legislations and some through executive decisions), the establishment of independent regulators in various sectors and the participation of private-sector players in most infrastructure sectors.
The policy and regulatory framework vary from complete pricing freedom in telecom to regulated returns in the case of major ports. Even within the same sector, regulations and models may vary. For example, the power (generation) sector encompasses a range of modelspower plants that earn specified regulated returns to plants that have full pricing freedom (merchant tariffs) without commitment on volumes to customers. This reflects legacy issues; almost all infrastructure businesses operated on cost-plus basis previously. More important, there is a gradual transition to market-linked regulations and market-determined pricing of products and services.
However, we see an urgent need to frame transparent methodologies to allocate natural resources, particularly in the area of mining (coal and mineral ores). The ministry of coal had circulated draft guidelines for allocation of coal blocks in April 2011. It had suggested four variants of competitive bidding. We havent seen any progress over the past 18 months though it is possible that the government may be studying the proposals. The process of allocation of natural resources has become fairly controversial with allegations of corruption in the awarding processes for 2G spectrum and coal blocks. Competitive bidding processes may be the best approach to allocate natural resources.
Sanjeev Prasad is senior executive director & co-head, Kotak Institutional Equities. AkhileshTilotia and Sunita Baldawa are analysts at Kotak Institutional Equities (Excerpted from the Kotak Institutional Equities report The coming investment cliff (and how to avoid it)