The government must limit its role to being an investor and enabler if the NIIF is to be a success
With infrastructure being an immediate priority for the government, the National Investment and Infrastructure Fund (NIIF) is a step in the right direction. Announced in Union Budget 2015-16, NIIF is proposed to be established as an Alternative Investment Fund to provide long tenor capital for infrastructure projects. The government plans to commit Rs 20,000 crore to the fund and raise an equal amount of external capital.
Given that India’s infrastructure spending at ~ 6% of GDP is much lower than that of other emerging economies (China spends 9% of its GDP on infrastructure), NIIF will provide much needed capital to the sector. Traditionally, public sector banks have been at the forefront of providing long term financing to infrastructure. This has put strain on their balance sheets, given the mismatch between maturity tenures of deposits and loans disbursed to long gestation infrastructure projects. Going forward, banks will be constrained due to the increase in stressed loans, RBI’s focus on reducing NPAs in the system and the breach of sectoral and single borrower limits for infrastructure players.
On the equity side, given the sheer quantum of the sector’s requirements, domestic sources alone are not enough. On the other hand, international investors have been constrained by factors like aversion to development risk, inability to find diversified portfolios with good assets, valuation mismatches, etc.
In view of this, an alternate pool of capital that provides long gestation capital will be welcome for the sector. Further, if NIIF is able to provide capital for greenfield projects and at costs that are closer to those generated by infrastructure as an asset class (vis-à-vis say 20%+ returns expected by PE investors), then it can make a significant impact.
At the same time, the NIIF will need to be structured as a commercially oriented enterprise operating at an arm’s length from the government. Suitable oversight through the Ministry of Finance or other institutions may be established to ensure accountability, but the role of the government would have to be limited to an investor & an enabler.
The key determinant of NIIF’s success will be its ability to garner capital commitments from large institutions that have hitherto shied away from the Indian infrastructure space. The target set of investors will be sovereign wealth funds, pension funds, multilateral investors and the not yet talked about large ‘family offices’. In my view, the
NIIF should make a compelling case for all these investors because (a) this will be an opportunity to deploy large cheque sizes, (b) over a diversified set of assets, (c) which will have a stable cash flow profile and (d) cash flow generation will be over a long period of time.
However, that alone will not suffice. NIIF will also need to ensure that the investment proposition is a viable one. This will entail (i) appointment of a good fund manager, (ii) clear investment principles and ensuring discipline around these, (iii) complete autonomy, and (iv) suitable return benchmarks. While making returns will have to be the key objective of the fund, the hurdle rates will have to be at a level that they can be deployed in the sector. The hurdle rate will have to be in line with the returns potential of the sector and yet be lucrative enough to attract large financial investors.
The mandate of NIIF will also need to be clearly decided to ensure capital goes into the right projects. There will have to be guidelines for deployment, say funding only for PPP projects or specific allocation for sectors such as urban infrastructure that have had limited access to private capital. So, unlike the NIIF Framework released by the Ministry of Finance which states that the scope could include “Manufacturing-if commercially viable”, its scope will have to be very specific.
To maximise the impact of NIIF, the investment criteria will have to be in line with the sector’s realities. By way of an example, NIIF will need to provide longer term capital (say 7 to 10 years) vis-à-vis the standard 3 to 5 years that sector agnostic financial investors provide. Similarly, a part of the corpus could be earmarked for bonds of infrastructure projects and firms—as infrastructure companies are normally rated only investment grade or so, these bonds have not been been able to attract traditional investors. So, NIIF could help create a bond market for the sector.
As part of the fund raising, NIIF will have to evaluate the conditions attached with fund commitments. For example, large sovereign backed international investors should not mandate any sourcing restrictions on the investee companies. Also, any such commitments should not compete with/discourage direct investment opportunities that the participating funds may want to consider. For example, several large institutional investors are keen to participate in NHAI’s Toll-Operate-Transfer (TOT) programme and an investment in NIIF should not take away these investors from TOT.
With such a tall order set for NIIF, the launch of the Indian Renewable Energy Fund (IREF) is a good way to test waters. The government can use the IREF for analysing the target market, adoption of global best practices and developing a team of experts and key processes to prepare for the launch of the NIIF.
To sum up, while NIIF is a step in the right direction, its execution in terms of fund raising and allocation of funds is going to be key to its success. It has been tried and tested internationally with success, so this untrodden path definitely holds promise.
By Srishti Ahuja
The author is Director-Infrastructure Practice, Ernst & Young. The views are personal.