infrastructure investment and stressed assets - outlook

Infrastructure investment opportunities and resolution of stressed assets in IndiaNovember 2016

ii | Infrastructure investment opportunities and resolution of stressed assets in India Infrastructure investment opportunities and resolution of stressed assets in India | iii

6th National Summit on Infrastructure Finance: Building a New India

Message from ASSOCHAM

President’s Message

Infrastructure projects are capital-intensive with long gestation periods, requiring strong policy frameworks and structural flexibility to enable capital commitment from the private sector. A major portion of debt funding for infrastructure projects in India is provided by commercial banks, which are constrained by an increasing asset - liability mismatch and regulatory limits on exposure to particular sectors.

The Union Government has articulated the infrastructure vision for India through powerful ideas such as bullet trains, river linking, highway development and port development. To achieve this vision, the Government has undertaken several measures such as introducing electronic toll collection and fast tracking of project approvals to allay concerns of the investor community, and strengthening policy frameworks and encouraging investment.

In this backdrop, ASSOCHAM is organizing the 6th National Summit on Infrastructure Finance and has come out this knowledge paper, prepared jointly by ASSOCHAM and EY, with the objective to contemplate the issues and challenges being faced by various stakeholders and suggest measures that can be taken to optimize their contribution thereto.

We hope this paper will be useful for the stakeholders. Your valuable suggestions/comments are welcome.

D S Rawat

Secretary General, ASSOCHAM

The Indian infrastructure story is at an interesting crossroad. On the one hand, being the world’s fastest growing major economy, India needs to create fresh capacity in its infrastructure to maintain the growth momentum. On the other hand, banks, which have been the main source of funds for infrastructure projects, are saddled with mounting levels of stressed assets which have almost choked their ability to lend. And incidentally, the infrastructure sector accounts for a major chunk of that stressed assets portfolio.

While public-private partnerships (PPPs) had been the mainstay for infrastructure projects in India for quite some time, they have now almost come to a standstill. The risk appetite of the private sector for infrastructure projects is yet to pick up. However, in order to revive the growth momentum, the Government has sped up investments on its own in select sectors such as roads and highways, sped up the process of project clearances, introduced a number of schemes to refinance existing projects and conceptualized new investment vehicles. While the Government needs to be complimented for its efforts, there is still much scope for discussing new and existing concepts from around the world that can be tried out in India to facilitate infrastructure financing. Also, we have remained dependent on bank finance for infrastructure projects for far too long, and it is high time to explore alternative sources for long-term funds.

Thus, the timing for ASSOCHAM’s 6th Infrastructure Summit is very appropriate as it will bring together experts for sharing their thoughts and experience. I am confident that this conference will generate quality ideas and inputs that will help in reviving private sector investments in infrastructure.

Sunil Kanoria

President, ASSOCHAM

iv | Infrastructure investment opportunities and resolution of stressed assets in India Infrastructure investment opportunities and resolution of stressed assets in India | v

Foreword

Revitalizing the infrastructure sector remains crucial to improve the overall investment climate and bring the Indian economy back in the high growth trajectory. India was ranked 81st out of 140 countries for its infrastructure in the World Economic Forum’s Global Competitiveness Report 2015—16. The country needs close to INR31 trillion (~US$455 billion) to be spent on infrastructure development over the next five years, with 70% of the investment needed across the power, roads and urban infrastructure segments.

During the last decade, the Indian infrastructure landscape was characterized by high levels of stressed assets and stalled projects. The number of stalled infrastructure projects increased to 893 as of March 2016 compared to 766 in March 2014. A sharp slowdown in the domestic economy, lack of long-term alternative financing options, regulatory delays in clearances, persistent policy paralysis, build-up of excess capacity, delays due to environmental concerns, and deficiencies in the credit appraisal of the banks are some of the key factors that hampered the smooth implementation of large infrastructure projects.

Despite significant headwinds, notable systematic efforts have been made, especially under the new Government and with the support from regulators and bankers, to both revitalize stalled projects and boost fresh investments. Some of the notable measure taken by the RBI to revive stressed projects include changes in CDR guidelines (taking away provisioning concession offered to CRDs), introduction of Special Mention Accounts (SMAs) (to identify early signs of stress in an account based on tangible events or indicators), strengthening of credit risk management at banks and providing more accountability to promoters. The new Bankruptcy Code and the SDR/S4A guidelines from the RBI are also expected to play a pivotal role in the resolution of stressed infrastructure projects.

As for propelling fresh investments, we believe that one of the most critical aspects that need to be looked at is the development of structured institutional financing framework. While globally, pension and insurance funds are the prime source of long-term financing, regulatory/credit hurdles have prevented such development in India, where historically, banks are the primary source for infrastructure financing. The share of infrastructure finance in gross bank credit increased from 1.6% in FY01 to 15.3% in FY15. Credit has flown into infrastructure sector via NBFCs, mutual funds and capital markets — the source of the bulk of which is bank finance. However, infrastructure financing by banks in India is exposed to challenges, such as a) ALM mismatch, b) long gestation periods of infrastructure projects, c) elevated stress in infrastructure lending books and d) the RBI’s proposal to cut exposure limits. To address these challenges, the Government and the RBI have taken effective measures, including the following:

• Setting up of National Infrastructure and Investment Fund (NIIF) with initial investment of INR200 billion to increase investment flow to infrastructure projects

• Promising to infuse capital to improve banks’ CAR — for example, under Indradhanush, the Government has promised to infuse INR700 billion during FY16—19

• Implementing policy measures such as improving coal and gas availability to power projects and ensuring faster clearances of stalled projects

• The RBI allowing banks to raise long-term infrastructure bonds with no regulatory costs

• Banks being allowed to refinance infrastructure projects under the 5/25 scheme and extend long-term loans of 20—25 years to match the cash flow of projects.

These efforts are noteworthy; however, given the Government’s fiscal constraints and sheer magnitude of financing, there is a greater need to further develop alternative sources of long-term financing, such as bonds and institutional equity support from the private sector. The corporate bond market in India is still underdeveloped and is yet to make a mark. Currently, structured issuances in the bond market are primarily dominated by investment in entities such as the NHAI, PFC, REC and, most recently, the Railways. Finally, it is to be noted that India’s infrastructure challenges cannot be mitigated through improved financial intimidation alone. Systematic and well synced efforts by all the industry participants are the need of hour keeping in mind India’s social, political and economic scenario.

As a global thought leader in turnaround and restructuring of stressed assets, EY has always been at the forefront of assisting borrowers, creditors and policy makers with innovative and effective solutions. This report outlines the current infrastructure investment opportunities and resolution of stressed assets, and puts forth suggestions and recommendations to improve the overall infrastructure financing scenario in the country.

We hope this report will be of value to the regulators, market participants, and government and decision makers.

Warm Regards,

Abizer Diwanji,

Partner and National Leader – Financial Services, EY

Cont

ents

Infrastructure – Building Blocks of a New India . . 1

Power to the people . . . . . . . . . . . . . . . . . . . . . . . 5

Renewing the green pledge . . . . . . . . . . . . . . . . . 8

The road ahead . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Development on track . . . . . . . . . . . . . . . . . . . . 15

Opportunities soaring: . . . . . . . . . . . . . . . . . . . . 18

Coast to Coast: . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Banking on infrastructure . . . . . . . . . . . . . . . . . . 24

New Beginnings . . . . . . . . . . . . . . . . . . . . . . . . . 32

1 | Infrastructure investment opportunities and resolution of stressed assets in India Infrastructure investment opportunities and resolution of stressed assets in India | 2

Infrastructure: building blocks of a new India

After gaining momentum in FY16, where the Indian economy grew by 7.9% in the March quarter, the country’s economic growth decelerated to its slowest level of 7.1% in six quarters in the April 2017 –June 2017 period, thereby making the government’s target of achieving 8% growth this year more overwhelming. The gross fixed capital formation contracted further from negative 1.9% in March 2016 to negative 3.1% in June 2016, signaling weak pick up in private investment activity.

India’s rank on the Ease of Doing Business Index released by the World Bank improved to 130 among 190 countries in 2016 - 2017 as compared to 142 in 2014 - 2015. India also, jumped 32 places in World Economic Forum’s Global Competitive Index 2016-17 to rank 39th amongst 140 countries as compared to rank 71 in 2014-15. However, during the same period, India’s rank on Infrastructure development in the Global competitive index was at 68, improvement of only by 19 places.

At the heart of the growth of Indian economy is the infrastructure sector, responsible for propelling India’s overall development. India needs close to INR 31,000 billion (US$455 billion) to be spent on infrastructure development over the next five years, with 70% of funds needed for power, roads and urban infrastructure segments.

Bridging the gap

The task on infrastructure development in India remains significant despite the progress made over the years.

India needs

Renewable energy and power:

• As of September 2016, the installed power capacity in the country reached 306.36 GW; power consumption is estimated to increase from 1174.07 TWh in 2015 to 1,894.7 TWh in 2022

• The target of 175 GW of renewable power by 2022 which will include 100 GW of solar power, 60 GW from wind power, 10 GW from biomass power and 5 GW from small hydro power.

• India will add 12 GW of new solar power capacity this fiscal year, and 15 GW and 16 GW in FY18 and FY19, respectively. This will also bring the country closer to the government’s commitment of providing 24-hour electricity to all Indians by 2019.

• Renewable energy has already approved the installation of 15 GW of new solar projects, of which 12 GW is likely to be in operation before March 2017.

• According to the 12th Five Year Plan, India is targeting a total of 88.5 GW of power capacity addition by 2017, of which, 72.3 GW constitutes thermal power, 10.8 GW hydro and 5.3 GW nuclear.

Highways:

• NHAI plans to increase both awards and execution in FY17 by four times over the FY16 levels - with target execution of 8000 km (@21.92 km/day) and target awards at 15,000 km

• The length of national highways in India increased from 97,135 km in FY15 to 100,475 km in FY16. As a part of infrastructure reforms, the government plans to double the length of national highways to 2,00,000 km

• The government has proposed to upgrade two-lane national highways into four-lane national highways for which US$65 billion has been allocated. The Ministry of Road Transport and Highways has decided to convert highways with 10,000 passenger car units (PCU) to a four-lane facility against the current norm of 15,000 PCU.

• The government of India plans to invest INR 3,000 billion (US$45 billion) for developing 35,000 km of roads across the country, of which 21,000 km will be economic corridors and 14,000 km will be feeder routes. This is expected to improve freight movement, ease traffic bottlenecks and improve inter-city connectivity in the country.

Railways:

• The government aims to reduce the empty freight wagon return ratio from an abysmal 39% during the current and last fiscal, to 30% by 2020, still missing the global benchmark of 25%.

• Indian Railways will lay 7 km of tracks every day in 2016-17 as against an average of 4.3 km per day in the last six years

• 10,000 route km to be electrified by FY20 and 400 new stations to be redeveloped

• The government of India has unveiled plans to invest approximately Rs.8,500 billion (US$137 billion) in its rail network over the next 5 years.

Ports:

• A target of 3,130 MT port capacity has been set for the year 2020. More than 50% of this capacity is to be created in non-major ports as the traffic handling by these ports is expected to increase to 1,280 MT.

• The target of capacity addition at 12 major ports is 120MT in 2016 -17. These ports had added the highest-ever capacity of 94MT in 2015-16.

Airports:

• The government envisions airport infrastructure investment of USD 11.4 billion under the Twelfth Five Year Plan (2012-17). It has opened the airport sector to private participation, and six airports across major cities are being developed under the PPP model. The Airports Authority of India (AAI) aims to bring around 250 airports under operation across the country by 2020.

• Currently about 125 airports are operational; to boost air connectivity, the government is preparing an action plan to revive 160 airports and airstrips, each of which, will cost about INR 50 crore -100 crore.


• The number of stalled projects in India increased to 893 in March 2016 as compared to 766 in March 2014

• The main reason for stalling is land acquisition, accounting for 17.2% of the value of stalled projects. Promoter apathy accounted for 12.8%. Fuel, feedstock and raw material supply problems accounted for 10.9% of stalled projects. Other issues included lack of environmental and other clearances, unfavorable market conditions and lack of funds.

• During 2014 - 15 and 2015 - 16 only 22% of the outstanding stalled projects revived. And, in 2015 - 16, only 9% revived.

First debt to be re-cast under S4A:Construction major Hindustan Construction Company (HCC) became India’s first firm to get debt recast under RBI’s new Scheme for Sustainable Structuring of Stressed Assets (S4A).

The RBI-mandated Overseeing Committee under the S4A, approved HCC’s INR 5,000-crore debt recast passed by an ICICI Bank-led JLF

Present tense

Despite the real demand for physical infrastructure, the sector is facing significant challenges, as the developers, the financial community and the government grapple with stalled projects, non- performing loans and widening gap between performance and targets.

For the last decade and a half, infrastructure project finance has been led by the commercial banks in India such as State Bank of India, Bank of Baroda, Punjab National Bank, Bank of India, Canara Bank and Union Bank and private/foreign players such as ICICI Bank, Axis Bank and Standard Chartered Bank, had taken large exposures on Indian sponsor groups focused on infrastructure activity – the most common example being an Engineering, Procurement & Construction (EPC) player taking on a Build Own Operate Transfer (BOOT) project under a PPP / PPA driven model.

The factors impacting the performance of the projects are many. The following table details the status of stalled projects in the economy

31.8%

34.5%

22.1%

7.5%

3.0%

0% 10% 20% 30% 40%

Electricity

Manufacturing

Services (other thanFinancial)

Construction and RE

Mining

% Contribution to stalled projects in March 2016

Source: CMIE

The risk landscape for Indian banks has undergone a significant change over the past few years. The stress asset situation of the banks has worsened considerably, primarily on account of poor project evaluation and monitoring, extensive project delays, cost overruns and policy inertia.

The infrastructure sector contributes to 14.2% of the total advances of the Indian banking system; however, its share in restructured standard advances stood at 34.4% of which the power sector accounted for 20.9% (the highest share within the infrastructure sector). Consequent to the continued financial stress, the overall credit growth has remained subdued (9.4% as on June 2016).

Multiple factors have led to the current high level of stressed assets, including macro-economic issues and bottlenecks related to specific sectors. The primary factors being excessive leverage and overinvestment during earlier strong economic phases and regulatory delays in the infrastructure sector.

Companies in the EPC sector are faced with a myriad of issues following a slowdown in the domestic economy. Issues impacting projects right from the planning to the operation stage have made several of them unviable. Significant cost overruns, regulatory bottlenecks and aggressive bidding positions taken by a few market players are some of the key concerns affecting the EPC sector. Another important element synonymous to the sector is the build-up of claims that are receivable from various government entities. These claims could be on account of several factors, such as change of scope of work (quantity variation/extra items), idling of resources (manpower, overheads etc.), compensation beyond original the contract period, change in statute and loss of opportunity, etc. The claims go through an arbitration process that potentially delays the timing of cash flows

In view of the increasing working capital requirements and the resultant increase in leverage, construction players are left with limited opportunity to raise further capital to fuel growth in the current scenario. Private equity funds too are cautious with their new investments because there are limited opportunities to exit as a result of unfavorable capital markets. To revive the construction sector, the Cabinet Committee on Economic Affairs under has approved a series of initiatives which are expected to help in improving the liquidity in the short run and reform the contracting regime in the long run. Given the significant multiplier effect the construction sector has on the economy, these measures are expected to give a major boost to economic growth.

The Indian power sector has witnessed significant distress in the last five years on account of both demand and supply side constraints. On the supply side, issues include fuel shortages and Power Purchase Agreements (PPA) disputes and on the demand side, the biggest issue is the DISCOMs’ curtailment of power purchases due to deterioration of their financial health. The Union Cabinet has approved a new scheme moved by the Ministry of Power - Ujwal DISCOM Assurance Yojna or UDAY. UDAY provides for the financial turnaround and revival of power distribution companies (DISCOMs), and importantly also ensures a sustainable permanent solution to the problem. The government has also taken necessary steps to ensure sufficient coal availability to

already commissioned power plants and significantly increase the domestic coal production to address fuel supply concerns

The RBI, from time to time, has come up with various initiatives to deal with the current banking stress as well as new projects. High level discussions with key stakeholders have led to the resolution of stalled projects. The new Bankruptcy code and the SDR/S4A guidelines from the RBI are expected to revitalize several key projects.

The regulator, through its discussion paper on early identification of distressed assets, has adopted an approach that would lead to early identification of stressed assets to enable credible and timely resolution of such assets.

Can we make the future perfect?

The investment in infrastructure is a national priority. The new regime has been proactive in initiating several measures in encouraging investments in development of sustainable infrastructure - states / PSUs have been encouraged to enter into PPA’s for renewable energy; aggressive plans connectivity through road, rail power and telecom networks, evolution of the hybrid annuity structure for highways, are some of the key developments that are likely to spur investment in the sector.

With greater appreciation of the risks associated with large infrastructure projects, lending institutions are expected to channelize more investment in the sectors. While quality of diligence and project monitoring are rising, domestic banks have been again backing projects – renewables, highways and railway PPP projects showing the way forward.

New financial options and sources are now available to infrastructure projects, and the RBI has also taken various steps to facilitate more investment in the sector, through new investment structures as well as through changes in the existing project lending and ECB guidelines.

“Masala” bonds

Infrastructure investment trusts (InvITs)

Foreign Currency Convertible Bonds FCCBs

Credit enhanced bonds

Infrastructure debt funds

The corporate bond market in India is only just starting to warm up to invest in the Indian infrastructure assets. The need for a vibrant market has been reiterated by all key regulators including the RBI and the Planning Commission.

Masala Bonds Credit Enhanced Bonds

NTPC issued Green Masala Bonds of INR 1300 Crore@ 8.57% for 37 months.

CLP India issued secured, partially-guaranteed, redeemable, bonds of INR 476 crore @9.99% with a maturity of 11 years

Adani Transmission Limited issued Masala Bonds of INR 500 crore @ 9.1% for 60 months

Three solar SPVs of Hindustan Power issued privately placed credit enhanced bonds of INR 380 crore @ 10.05% with a maturity of 10 years

Renew Wind Energy (Jath) Ltd issued credit enhanced bonds of INR 451 crore, partially guaranteed by IIFCL with a maturity of 18 years

As per the Planning Commission (2013)– The need for long-term savings products is the mirror image of the other important need—that of long-term finance for long gestation products, namely physical infrastructure. Without the first, the latter becomes hard.

While globally pension and insurance funds have are the primary sources of long term finance for long gestation infrastructure projects, regulatory / credit hurdles have prevented this from happening in the Indian context.

Indirectly, the bond market has been supporting the infrastructure investments through investments in entities such as NHAI, PFC, REC and most recently the railways.

However, corporate bond issuances, especially for infrastructure projects have yet to make a mark in the segment. It is only recently that structured issuances, backed by partial credit guarantee structures primarily from the renewables sector, a few NHAI annuity projects and certain IDF bond structures have attracted market attention.

Finally, it is important to understand that infrastructure projects, globally have had challenges and risks, which can never be mitigated through improved financial intermediation alone. India’s social, economic and political scenarios add another dimension to the issue. Systemic action has already commenced – including wide ranging changes to the legal system and the tax regime, and the currency cleansing – all of which bode well for the country and the sector. With the recent changes in the global political scenario, India is likely to emerge stronger, on the back of a connected economy of 1.3 billion people.

Some of the recent bond issues via different structures, are depicted below:

Some of the new structures/options available to the sector are:


Power to the people

Overview

India has an installed capacity of ~306 GW including thermal, renewables and nuclear power as of September, 2016. In the 12th plan (2012-17), the power sector accounts for almost a quarter of the projected investment among all the infrastructure sectors. The evolution of the Indian power sector can be broadly classified into the following stages:

Introductory Stage (Before 1956)

Nationalisation Stage (1956-1991)

Liberalisation Era (1991-2003)

Growth Era (2003- Onwards)

• Electricity (Supply) Act 1948

• Establishment of semiautonomous State Electricity Boards (SEBs)

• Industrial Policy Resolution (1956)

• Generation and distribution of power under state ownership

• Power losses, subsidies, infrastructure bottlenecks and resource constraints

• Legislative and policy initiatives (1991)

• Private sector participation in generation

• Electricity Regulatory Commissions Act (1998)

• Electricity Act (2003) and National Tariff Policy (2006)

• Amendments made in Electricity Act

• Implementation of Deen Dayal Upadhyay Gram Jyoti Yojana (DDUGJY) and Ujwal DISCOM Assurance Yojana (UDAY)

Demand-supply and capacity addition

According to the September 2016 data, out of the ~306 GW of installed capacity, ~42% belongs to the private sector with Central and State contributing to 25% and 33% respectively. The power supply scenario has significantly improved over the last year. In September, 2015, there was energy supply of 94,613 MU against a requirement of 97,740 MU implying a deficit of ~3.2%; whereas in September, 2016, the energy supply improved to 98,310 MU against a requirement of 99,021 MU with a deficit of only ~0.7%. The peak demand as of September 2016 stood at 159,243 MW met by a supply of 158,059 MW resulting in a deficit of ~0.7% which was better than the corresponding September, 2015 figure of ~4.0%

22,245 30,53840,245 41,110

62,374 88,537

21,401 16,423 19,015 21,130

54,96488,124

96%

54%47% 51%

88%100%

0%

20%

40%

60%

80%

100%

-10000

10000

30000

50000

70000

90000

7th Plan 8th Plan 9th Plan 10th Plan 11th Plan 12th Plan*(2012-17)

Target (MW) Achievement (MW) % Achievement

Capacity Addition picking up pace *Data till September, 2016

Key Issues in the Sector

• Under-procurement of power by states: In the past, bids for Case I/II thermal power projects have been irregular. In the absence of clear visibility on bids, it is difficult for developers to synchronize their development plans with demand in the sector. This also results in an aggressive bidding pattern, since developers are not sure when the next bids would be announced, especially in Case 1 power supply. Therefore, it is important that a regular pipeline of bids is developed by states and the Central Government.

• ► Fuel concerns: Historically, power projects (based on linkage coal as fuel) have been planned and constructed on the premise that there could be many avenues of power sale in terms of long-term bids, short- and medium-term bids, and merchant sale. However, recent policy interventions that prescribe that linkage coal would be available only to power projects that have a long-term sale arrangement with a distribution utility have resulted in a situation where linkage-based projects without long term, power off-take arrangement are unable to get coal supply and, hence, capacity remains idle. As Coal India Limited (CIL) has restricted coal supplies, generation cost has increased due to mounting dependence on imported coal, e-auction coal. Many projects which were setup on basis of captive coal block also got impacted post Supreme Court ruling whereby all coal blocks allocated to IPPs since 1993, have been deallocated adding to the concerns.

• Financial condition of state discoms: Increasing Aggregate, Technical & Commercial (AT&C) losses and operational inefficiencies have adversely affected the financial health of state discoms, which are currently plagued with humongous out-standing debts. This affects the receivables position of power developers who rely on state discoms to sell power.

• Implementation issues on account of land/environmental clearances: Several projects are facing cost overrun issues due to implementation delays. Financial closure has become difficult due to commercial banks reaching their sectoral lending limits and the cap imposed on cost overrun funding by the RBI. In addition, equity capital from developers has become scarce due to a general slowdown in the economy. As a result, these projects get stuck. Over the last three to four years, the power sector had been adversely impacted by the lack of land availability and environmental clearances. As a result, these projects get stuck. Debt repayment as per schedule becomes difficult, leading to mounting bad loans in the sector.

• Under recovery of costs: Many power projects are facing under recovery in power purchase agreements (PPAs) due to changes in the business environment (such as an increase in the cost of imported fuel due to policy changes in foreign jurisdictions). Many of these projects have applied to SERCs/APTEL/CERC for tariff increases. Such processes are however taking a lot of time, since there is no firm basis for an increase in PPAs. This is again affecting debt servicing as well as ability of existing players to make fresh investments.


Favourable policies

• FDI policy: 100% Foreign direct investment (FDI) is allowed under the automatic route in the power sector for generation from all sources (except atomic energy), transmission and distribution of electric energy and power trading, subject to all the applicable regulations and laws and FDI up to 49% in power exchanges registered under Central Electricity Regulatory Commission (Power Market) Regulations, 2010 under the automatic route, subject to applicable conditions

• Electricity Act, 2003: Elimination of licensing for electricity generation projects, increased competition through international competitive bidding and demarcation of transmission as a separate activity

• National Tariff Policy, 2006: The key objective of the revised Tariff Policy, 2016, the key objectives are to ensure the availability of electricity to consumers at reasonable and competitive rates, ensure financial viability of the sector and attract investments

• Ultra-Mega Power Projects (UMPPs): The government has taken initiative for setting up of UMPPs of 4000MW capacity each to reap the benefits of economies of scale and fast capacity addition. The Ministry of Power identified Power Finance Corporation (PFC) as the nodal agency for the UMPPs

Schemes for Modernization of Transmission and Distribution Network

• Deendayal Upadhyaya Gram Jyoti Yojana (DDUGJY): It was launched in December, 2014, under this scheme, capital subsidy is being provided for feeder separation, electrification of unelectrified villages and households, metering and system strengthening and augmentation of distribution system in rural areas. The erstwhile scheme of RGGVY has been subsumed in DDUGJY as a separate component for rural electrification in the country. REC is the nodal agency for the operationalization of DDUGJY in the country

• Integrated Power Development Scheme (IPDS): Under IPDS Scheme, capital subsidy is being provided for the strengthening and augmentation of the distribution system, metering of distribution transformers/feeders/consumers, and IT enablement in distribution sector in the urban areas. The erstwhile Restructured Accelerated Power Development and Reform Programme (R-APDRP) scheme has been subsumed in the IPDS. PFC is the nodal agency for the operationalization of IPDS in the country

• Ujwal DISCOM Assurance Yojana (UDAY): This scheme was formulated and launched by the government in November,

2015 for the financial and operational turnaround of state owned discoms. The scheme envisages that states shall take over 75% of DISCOM debt as on 30 September 2015 over two years - 50% in FY16 and 25% in FY17.

Renewing the green pledge

OverviewIndia, with installed capacity of 306 GW, has the fifth largest power generation portfolio in the world and the current renewable energy contribution to this portfolio stands at 45.6 GW (or close to 15% as of 30 September 2016).

Currently, India’s 28 GW installed wind power capacity (as of 30 September 2016) is the fifth largest in the world, and its 8.5 GW installed solar power capacity (as of 30 September 2016) is the 11th largest in the world.

Brief history of the renewable energy in India

Renewable energy in India effectively dates back to 1981 when the Commission for Additional Sources of Energy in the Department of Science and Technology was founded. An

independent department– the Department of Non-conventional Energy Sources– was set up in 1982 and was later converted into the Ministry of Non-conventional Energy Sources (MNES) in 1992.

Indian Renewable Energy Development Agency (IREDA) was established in 1987 to finance renewable energy projects. The MNES was renamed to Ministry of Renewable Energy (MNRE) in October 2006.

The development of wind power in India started in the 1990s, but the real growth has been witnessed after 2002, and predominantly since 2010, after the adoption of Feed-in Tariff (FiT) regime and the inflow of FDI in the Indian renewable sector.

The growth of solar energy kick-started effectively from the launch of the Jawahar Lal Nehru National Solar Mission (JNNSM) in 2010. At its launch, JNNSM set a target of 20 GW of solar power by 2022, which has now been revised upward to 100 GW of solar power alone by 2022.

7,0943

1,976 1,185

Upto 10th FYP

17,352941

3,3953,225

Upto 11th FYP

28,082

8,5134,3234,882

Upto Sep 2016

BioPower Small Hydro Power Solar power Wind power

Upto 9th FYP

2 1,438390

1,667

Growth of the Indian renewable capacity (installed capacity in MW)

Growth Potential:

• ► Per capita energy consumption in India as of FY16 is only 1075 kWh compared to a global average of ~4000 kWh indicating huge potential for growth. The demand for electricity is expected to increase at a CAGR of ~7% to 1,894.7 TWh by FY22

• ► The government has taken necessary steps to ensure sufficient coal availability to already commissioned power plants and significantly increasing the domestic coal production to address fuel supply concerns

• ► There is a tangible shift in policy focus on the sources of power. The government is keen on the promotion of hydro and renewables, as well as adoption of clean coal technology (the government has set a target of 175 GW renewable power by 2022)

Investments

• ► The expected investments in the power sector during the 12th Plan (2012–17) is USD 250 billion. The government is targeting capacity addition of around 100 GW under the 13th (2017–22) Five-Year Plan

• ► Total transmission-line investments are likely to be approximately US$50 billion over the next five years.

Investment opportunity


Current capacity and future potential

India’s wind power potential is estimated to be ~302 GW at 100 meter hub height (as estimated by the National Institute of Wind Energy in 2015). Of the 302 GW estimated potential, 153 GW is available in wasteland, 146 GW in cultivable land and 3 GW in forest land. Gujarat has the highest wind potential with 84 GW, followed by Karnataka at 56 GW and Maharashtra with 45 GW.

The current installed capacity wind capacity, as of 30 September 2016, is ~28 GW. The sector has witnessed a compounded average growth rate (CAGR) of 21% since 2002. This is further expected to grow at a CAGR of 14.5% till 2022, by when the government has kept a target of 60 GW wind power installation in the country.

India’s solar power potential is estimated to be ~750 GW (as estimated by the National Institute of Solar Energy in FY 15). Rajasthan leads with the highest solar potential of 142 GW, followed by Jammu and Kashmir at 111 GW, Maharashtra at 64 GW and Madhya Pradesh at 61 GW.

The current installed capacity solar capacity, as of 30 September 2016, is ~8.5 GW, growing at a CAGR of ~60% since 2012. Further the government has kept a target of 100 GW solar power installation by 2022, implying CAGR of ~56% till 2022.

Inclusive of wind and solar power, the government has set a target of 175 GW renewable power by 2022. Of the additional 15 GW, 10 GW of renewable energy is targeted from biomass power with an additional 5 GW to be contributed by small hydro

1,702

FY 2002

28,083

Sep-16

60,000

FY 2022

Wind capacity (in MW)

1,030

FY 2012

8,513

Sep-16

1,00,000

FY 2022

Solar capacity (in MW)

To meet the government’s target of 175 GW in 2022, the renewable energy installation will have to grow at a CAGR of 27.5% or close to 23 GW annually till 2022. This offers huge opportunity for developers, both domestic and international, to enter the highly growing renewable sector.

Key developments and initiatives impacting the Indian renewable sector:Investment-based/financial incentives

• 100% FDI permitted for investment in wind and solar energy projects

• Increase in coal cess (on coal production) from INR 50/ton to INR 100/ton to INR 200/ton to INR 400/ton currently to make a push for investment into renewable energy research and development

• Accelerated depreciation (AD benefits up to 80% in the first year) and generation based Incentives (GBI benefit at INR 0.5 /unit for wind projects of electricity fed into the grid) available to renewable developers over and above the signed PPAs

Policy Initiatives

• Renewable Purchase Obligations (RPO) targets increased to 17% of total consumption of electricity by FY 2022, including minimum 8% provision from solar energy

• Under draft Renewable Act, deemed generation proposed to be accorded to operational renewable project, if the grid is not available for evacuation

• Draft repowering policy for wind issued recently, offering huge incentive for sub MW wind turbine generators to be repowered; further, IREDA will provide loans at lower rates to the repowered projects, while benefits of AD and GBI will continue to be available to the repowered projects. A similar policy is expected for solar sector shortly

Addressing discom-related issues

• UDAY Scheme launched to lower the debt burden and erase losses faced by the ailing state discoms by addressing the operational inefficiencies in the sector and trying to financially turn around the ailing DISCOMs, Under the scheme, states opting for the scheme shall assume 50% of the loans due on 30 September 2015 in FY16, with another 25% debt to be assumed in FY 17, thus freeing the state DISCOMs from the debt trap.

Addressing evacuation issues

• Under the new tariff policy, no inter-state transmission charges/losses to be levied for solar and wind power

• Green corridors being undertaken by the government, in partnership with German agency KfW, to address evacuation of renewable energy. KfW has committed ~USD 1 billion loans at concessional rates for the development of the green corridors in the country.Key Challenges faced by the sector:

1. Discom credit worthiness: Receivables from the respective state DISCOMS remain a major concern for the developers. While states such as Gujarat have high credit ratings and perceived lower risks, there is much higher perceived risk for certain Indian states).

2. Evacuation issues: The power evacuation infrastructure has been unable to keep up pace with the growth of the power generation infrastructure over the years. Power evacuation has been an issue, typically in the south Indian states (Tamil Nadu is an example where grid availability has been a major issue historically).

3. Land availability: Land acquisition in India is beset with the issues of lack of proper guidelines and the local on-ground issues. This, along with the lack of evacuation infrastructure, is the one of the biggest concerns in project delays in the sector. This has also dissuaded many developers in participating in bids in certain states, as a matter of which the bidding has been concentrated to the states with clear policy on land acquisition and evacuation as against resource availability.

4. Issues in signing PPAs: Developers, typically wind developers, are facing issues in signing PPA in many states even though state policy provides for signing PPAs at pre-defined tariff levels. This has affected developers’ ability to start new projects (due to capital stuck in existing projects) and lack of policy clarity.

Government initiatives:

The government and Ministry of New & Renewable Energy (MNRE) have taken various initiatives to address the concerns faced by the developers and fast track the development of renewable energy in the country.


Green field development opportunities available across the following sub sectors:Solar:

• Around 22 GW of identified solar projects bids to come up till FY 2018

• Given the mammoth 750 GW potential, coupled with the lower base (~8.5 GW currently) and the huge 100 GW target (including rooftop), the bids are expected to continue to be floated till FY22 offering. The perfect window of opportunity for solar developers to achieve significant scale and capacity.

Solar rooftop:

• The government has set a massive target of 40 GW by FY 2022 (40% of the total solar installation in the country)

• Several states have offered various incentives – subsidies (Tamil Nadu) and generation based incentives (Delhi) – to encourage domestic solar installations

Wind:

• Wind bidding for 1,000 MW announced by MNRE recently and additional capacity to come up for bidding in the near future , likely to result in accelerated growth in wind installations

• Central bidding, coupled with the ongoing investment in connectivity between the northern and the southern states, would also help the lesser resource privileged states gain access to cheaper renewable energy

Small hydro:

• The government has launched the Small Hydro Power (SHP) Programme, which is one of the thrust areas for MNRE small hydro development; under the SHP Programme, central financial assistance is provided for resource assessment, setting up of new SHP projects and renovation of existing small hydro projects

The road ahead

Overview:

India has the second largest road network in the world at ~5.23 million km. The road network services ~65% of freight and ~86% of passenger traffic in the country. While National Highways constitute only ~2% of the road network in India, they carry 40% of the total road traffic in India.

Strong momentum in expansion of highways:

The government launched the ambitious National Highways Development Programme (NHDP) in 1998 to upgrade and strengthen national highways under the National Highway Authority of India (NHAI), a government agency, responsible for construction, maintenance and development of highways. NHAI targets development of ~50,000 km of national highways to be implemented in seven phases out of which ~30,000 Km of projects have already been awarded by now.

2% 3%

95%

National Highways

State Highways

Rural and MajorDistrict Roads

Evolution of Indian Road Network

Particulars FY03 FY16

Length of National Highways (kms)

58,112 100,475

Passenger vehicle sales (million)

0.71 2.80

NHDP toll collection (USD million)

64.5 1,078.3

Highway projects awarded by NHAI (kms)

677 6,397

Investment opportunities:

MNRE’s Jawaharlal Nehru National Solar Mission (JNNSM) mission, launched in 2010, has been the pioneer of solar bids in India. Solar Energy Corporation of India (SECI) and NTPC have additionally come out with solar bids, providing ample investment opportunities to solar developers in the country. The wind sector is expected to grow rapidly following the introduction of bidding in the sector, in addition to the existing FiT regime in the sector. Given the government’s strong push to renewable energy, the renewable sector in India is currently flooded with opportunities to invest across various sub sectors, open both to global domestic and global players


Golden Quadrilateral (GQ)North South & East West Corridor (NS –EW NHDP Phase I and II)

NHDP Phase III to VII

• It is the highway network that connects four major metropolises; namely, Delhi, Kolkata, Chennai and Mumbai

• Total Length - 5,846km (As of Mar 2016)

• It connects the country’s extreme ends

• Total Length (NS & EW) – 7,142km (As of Mar 2016)

• Construction and improvement of roads in the remaining urban and suburban regions

During FY17, the government of India allocated a budget of USD 8.21 billion for the development of roadways across the country

Key implementation models through PPP:

• Design, Build, Finance, Operate, Transfer (DBFOT) – Toll: The key features of this model are-

• Traffic risk borne entirely by the concessionaire, unless the project is under revenue sharing

• Higher risk – higher return framework

• Design, Build, Finance, Operate, Transfer (DBFOT) – Annuity: highlights of this model are-

• Concessionaire receives semi-annual annuity payments from NHAI

• No traffic risk for the concessionaire

• Lower risk-lower return framework

• Hybrid Annuity Model (HAM): One of the recently introduced contracting models-

• The concessionaire to partly finance, construct, and manage the project and the NHAI to provide capital grant (subject to maximum 40% of the project cost) during construction period and balance as annuity payment during the operational period

• The authority will collect the toll, thereby retaining the traffic risk

• Recommended for projects where PPP Toll in its traditional form is unviable due to high project cost and absence of commensurate revenue streams

• Toll Operate Transfer (TOT): Key features include-

• Brownfield assets to be refinanced by private parties with medium to long term investment horizon (20-25 years) in the operations stage; the tenure of the contract modality to be determined suitably based on project road traffic

• During the concession period the investor/developer to operate, maintain and toll the project road

Key challenges:

• Reduced participation from traditional bidders: Many traditional infrastructure companies have reduced or slowed down their focus on bidding for new PPP highway projects

• Slow moving projects: Execution of many highway projects has been moving at a slower pace due to multiple reasons such as project cost overrun, fund availability issues and delays in timely availability of ROW/ approvals.

• Traffic risk in toll projects: Many PPP Toll highway projects have experienced remarkable drop in actual toll collection, compared to their expectation during the bidding point of time. This has severely impacted the expected project returns of the developers.

• Insufficient equity capital: The availability of capital is currently insufficient for the highway sector industry, especially for acquisition of existing operating projects mainly because of significant capital being stuck in existing projects on account of reasons mentioned earlier.

Favourable policies and government initiatives:

• FDI policy: 100% Foreign direct investment (FDI) is allowed under the automatic route in the road and highways sector, subject to applicable laws and regulation

• Budget outlay: Budget outlay between FY09 and FY17 for road transport and highways increased at a CAGR of 22.8 %, including a major increase in FY17

• Sector policy: Standardised processes for PPP and public funded projects and a clear policy framework relating to bidding and tolling have been developed over the years. Major policy initiatives undertaken by the Ministry of Road, Transport and Highways (MoRTH) during last two years include:

• Mode of delivery - MoRTH is now empowered to decide on mode of delivery of projects-EPC or PPP

• Enhanced inter-ministerial coordination - An Infrastructure Group has been created under chairmanship of the Hon’ble

Minister (Road, Transport & Highways) to resolve approval/clearance issues related to environment & forests, railways and defence, and most of the issues have been resolved.

• Exit policy - Private developers can now exit all operational BOT projects two years from the start of operations (commercial operation date or COD) irrespective of the date of award of the project

• Promoting innovative project implementation models - The hybrid annuity model (HAM) has been developed and adopted for implementation of highway projects. More than 10 projects have already been awarded under this model. Further, the government is also planning to monetize a significant number of TOT model based projects.

• Amendments to the Model Concession Agreement (MCA) for BOT projects - Certain changes in the MCA have been approved by an empowered committee headed by the Cabinet Secretary based on stakeholders feedback. This would facilitate streamlined development and operation of highway projects

• The Government of India has launched major initiatives to upgrade and strengthen highways and expressways in the country including enabling policy measures. MoRTH awarded ~ 7,980 kms of new highways in 2015 and is looking to significantly increase the development work going forward.

• In addition to highway development, focus is also on efficient operations and network management for improving logistics efficiency. This shall give rise to new investment opportunities.

Financial support

• The Union Budget of 2016-17 mentions that the total investment in the central road sector would be USD 8.21 billion, during 2016-17

• The NHAI has been authorized to generate Internal & Extra Budgetary Resource (IEBR) of USD 8.85 billion during 2016-17

• The NHAI/government to provide capital grant (Viability Gap Funding/Cash Support) up to 40% of project cost to enhance viability on a case to case basis

• 100% tax exemption for five years and 30% relief for the next five years, which may be availed of in 20 years

• Duty free import of modern high capacity construction equipment is allowed

Robust expansion plan

• NHAI is planning to bid out ~30,000 km of projects in the next two to three years.

• MoRTH is aiming to expand the National Highway network to 0.2 million km, from the current 0.1 million km, over the next four to five years

• MoRTH has so far approved in-principle for about 38,750 km of State roads as new NHs subject to outcome of their detailed project reports (DPRs)

• Further, about 14,000 km of additional State road stretches are proposed to be upgraded under the “Bharatmala Pariyojana”

Highways sector; on a growth trajectory and a significant contributor to national GDP

• Overall annual freight traffic in the country is estimated to reach around 13,000 billion tonne km (btkm) by 2030 from about 2,000 btkm in 2011-12. Overall annual passenger traffic is estimated to reach around 168,000 billion passenger km (bpkm) by 2030 from about 10,000 bpkm in 2011-12. For both of the above, road transport is likely to cater to around 50% of the traffic.

Investment opportunity:


Development on track

Overview

India has the fourth largest railway network in the world covering 29 states and 3 union territories, including 8,500 stations. It runs nearly 21,000 trains; ~13,000 passenger trains that carry more than 23mn passengers and ~ 8,000 freight trains that carry around 3mn tonnes of freight per day.

Journey from 1951 to 2016

Nationalized in 1951, the Indian Railways (‘IR’) employs over 1.4million employees making it the world’s seventh largest employer. IR has come a long way from the time it was nationalized. While it carried ~73.2mn tonne of freight in FY1953, today it carries more than 1 billion tonne of freight traffic annually making it a part of a select club of countries such as China, Russia and USA.

Journey of Indian Railways

Particulars FY 1953 FY 2016Total Revenues (USD mn)

59 25,190

Passenger Revenue (USD mn)

22 6,932

Freight Traffic (MN tonne)

73.2 1,107

Number of stations 5,976 8,500Running Track (km) 59,315 90,803

Source: Ministry of Railways *Data for FY 15

Despite the overall growth, IR continues to face significant challenges to keep up with India’s growing passenger and cargo movement. Going forward, IR is focused on addressing issues around increasing capacity, improving productivity, widening network and making safety & technological improvements.

Network and rolling stock strength

At the end of FY15, the total route length under IR was 66,030 km out of which ~58,200 km is on the Broad Gauge, ~26,269 km is electrified. IR has been slow to effect electrification of its tracks, which is not only environment-friendly but also serves as a cheaper alternative to fossil fuels. However, the government has, recently, accelerated efforts on electrification with a view to reduce India’s dependence on imported petroleum based energy, make the IR system more eco- friendly and cost effective.

IR has a total holding of 10,773 locomotives, comprising of 5,714 diesel, 5,016 electric and 43 steam locomotives (as at end of March 2015). These locomotives are maintained across 71 sheds.

In addition to upgrading in-house manufacturing facilities, PPP’s are being formed for the expansion of rolling stock fleet by the procurement of locomotives. The Bibek Debroy committee set up to suggest ways to reform IR, also, emphasized on increased participation of private players in locomotive manufacturing. Also, according to a report of the ‘National Transport Development Policy Committee’, IR would require 28,000 electric locomotives by 2032. By the end of FY15, IR held a fleet of ~5,000 electric locomotives.

0 100 200 300 400 500 600 700

196 2602011

216 3132012

293 3302013

335 3022014

350 2502015

Diesel Electric

To meet the expected demand, IR would need to procure more than 1,000 locomotives per year over next two decades compared to a gross addition of 250-300 electric locomotives historically .

Key developments and initiatives impacting Indian Railways:

• 100% FDI is allowed in the railway infrastructure segment under the automatic route

• The government of India has unveiled plans to invest ~Rs.8.5 trillion (USD 137 billion) in its rail network over the next 5 yrs

• World Bank has approved a ~Rs. 42 billion (or USD650 million) debt funding for a part of the eastern arm of the Dedicated Freight Corridor (DFC) project in India

• The government approved the redevelopment of 400 railway stations across the country

• The government has increased the scope of PPP to beyond maintenance and other such supporting roles

• Metro rail projects are being envisaged across many cities over the next ten years

Key challenges faced by IR:

1. Capacity constraints: As freight and passenger traffic increases with a growing economy, IR will have a challenging task ahead transporting the incremental traffic because of line and terminal capacity constrain. There is, thus, a need for significant investment in the rail network, especially high-density routes and its’ feeder and other important routes.

2. High Operating Ratio: IR’s operating ratio has been consistently over 90%, which leaves little resources for capital expenditures

3. Mobilization of capital: The Indian Railways has set an investment plan of ~INR 8,500 billion over the period 2015-19. Such a massive investment plan can not only be financed only through budgetary support and internal accruals of the IR.

4. High Freight Yields: Due to cross subsidization of low passenger fares, freight yields in India are the highest among the countries with the largest railway network; China, USA and Russia.

Government initiatives:

The government has placed special focus on modernization of Indian Railways. The government’s stated four focus areas in the next five years are as follows:

a. Expand Capacity & Modernise Infrastructure

b. Enhance Customer Experience

c. Improve safety in rail travel

d. Make railways financially self-sustainable

Proposed Investment Plan 2015-19 INR bn

Network Decongestion 1,993

Network Expansion 1,930

National Projects 390

Safety 1,270

Information Technology/Research 50

Rolling Stock (Locos, coaches, wagons) 1,020

Passenger Amenities 125

High Speed Rail, Elevated corridor 650

Station redevelopment and logistic parks 1,000

Others 132

Total 8,560

Source: Indian Railways Annual Report & Accounts

Source: Indian Railways Budget Document, FY2016.


Capacity expansion:

• The government plans to invest US$153 billion during the 12th Five-Year Plan

• Investments expected in metro rail networks in India are US$137 billion by 2020

Technology:

• Centrally managed Railway Display Network in over 2,000 stations is planned by 2017

• Satellite railway terminals are planned for major cities

• There are plans to implement a technology infrastructure enabling unreserved passengers to purchase tickets within 5 minutes under the government’s Operation Five Minutes plan

Dedicated freight corridor

• The plan is to construct dedicated freight lines along the eastern (1,856 km route length) and western (1,504 km route length) parts of India

• Freight traffic via DFC to increase at a CAGR of 5.4% to 182MT in 2021–22 from 140MT in 2016–17

• Two dedicated freight corridors, Eastern and Western, would be operational by FY20

• Due to the DFC, added capacity and efficiency of new infrastructure would result in an increased share of the railway network to 87% in 2021–22 from 84 % projected in 2016–17

Revamping:

• ►There are plans to increase the speed of nine railway corridors from 110-130kmph to 160-200kmph

• ►The railways plan to increase the average speed of freight trains to 100kmph (unloaded) and 75kmph (loaded trains)

• ►Diamond Quadrilateral network of high-speed rail to connect major metro cities

• ►Introduction of bullet trains and semi-high speed trains

• Railways to monetise land on tracks by leasing out for horticulture

Opportunities soaring

Overview

India is currently the ninth1 largest civil aviation market in the world. India’s civil aviation sector has been reporting sustained growth due to factors such as de-regularization of the aviation sector leading to the participation of private sector airlines, sustained efforts to increase capacity at metro and non-metro airports, the launch of low-cost carriers (LCCs), liberalized FDI policy and the rise in tourism and business travelers.

According to the forecast by International Air Transport Agency (IATA), the sector has the potential of being among the global top three in terms of passenger traffic. In 2015-16, the passenger traffic reached 224 million, which is 17.6% higher as compared to the previous year. During first half of 2016-17 (April to September), the passenger traffic witnessed a growth of 19.2% over the same period a year ago.

Particulars 2000 2016Scheduled airlines: distance flown in million km

199 1071

No. of aircrafts 225 1657Passenger handling capacity at airports

66 million 270 million

No. of airports 50 130

Evolution of the Indian aviation sector2

Airport infrastructure in India consists of ~450 airports/airstrips. Among these, the Airport Authority of India (AAI) owns and manages 125 airports (95 of which are operational with 71 having scheduled commercial operations). In terms of growth, the sector has witnessed a significant growth during 2000-2016, as can be seen from the data below:

Source: IATA

Source: AAI, MOSPI, MoCA


Indian Railways started the PPP mode of funding and has already awarded projects amounting to around US$1.7 billion in the first seven months of FY16. Some other avenues, outlined by the government that provide attractive Investment opportunities are as follows:


• During FY06 - FY16 passenger traffic in India has grown at CAGR of 11.8%. Domestic traffic during FY06 - FY16 has grew at CAGR of 22.4%, increasing from 22.37 million in FY06 to 168.89 million in FY16. Growth in passenger traffic has been strong since the new millennium, especially with rising incomes and low-cost aviation

73.3596.49

116.87108.88 123.76 143.43 162.31 159.4 169.03 190.1

223.6

22%32%

21%

-7%

14% 16% 13%

-2%6%

12%18%

-10%0%

10%20%30%40%

050

100150200250

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Passenger Traffic in Mn

Passengers Growth

• Freight traffic in India has grown at healthy CAGR of 8% from 1.4 million tonnes in 2006 to 2.7 million tonnes in 2016 with international freight contributing about 60-65% over last decade

Government Initiatives:

The Government of India has recently issued the National Civil Aviation Policy 2016 with the following key objectives being:

a. Integrated eco-system to enable growth of the civil aviation sector b) Enhancement of regional connectivity c) Policy level support to enhance viability of airports and d) Promote other allied activities including cargo, MRO, general aviation, aerospace manufacturing and skill development.

Key FDI changes impacting Indian airports sector:

• 100% FDI allowed in the existing projects (up to 74% under the automatic route, approval route beyond 74%)

• 100% FDI allowed in maintenance and repair organizations, flying institutes and technical training institutes under the automatic route

• 100% FDI is allowed in ground handling services subject to sectoral regulations and security clearance

Key features of National Civil Aviation Policy 2016:

• Waived the five year rule for local airlines before they can fly overseas

• Targets domestic ticketing to reach 300 million by 2022 and 500 million by 2027

• Targets international ticketing to reach 200 million by 2027

• To promote regional air connectivity and policy proposes capping of airfares at INR 2,500 for an hour-long flight (500-600km)

• Plans to revive un-utilized air-strips to develop no-frills airports at an indicative cost of INR 50 – 100 Crore

• Waiver of airport charges under the Regional Connectivity Scheme

Airports development:

• The government has already granted in-principle approval for several greenfield airports in various states including Andhra Pradesh, Telangana, Maharashtra, Karnataka, Kerala, Madhya Pradesh, Sikkim, Puducherry, Gujarat and Uttar Pradesh. These airports offer a combined investment opportunity of more than ~ US$6 billion.

• The bidding process for Bhogapuram and Dagadarthi airports is already underway.

• The process for upgrading and modernizing the Nagpur Airport is under progress by Government of Maharashtra.

Maintenance, repair and overhaul:

• At present, the MRO business of Indian carriers is around US$750 million, most of which is spent outside India

• With India’s technology and skill base, the government is aiming to develop India as an MRO hub in Asia, catering to foreign airlines as well

• Further, given a strong thrust on capacity addition in the airport infrastructure and growing fleet of domestic airlines, a strong growth is expected to be realized in this segment


Until liberalization of the airport development sector, AAI was the only major player involved in developing and upgrading airports. India’s airports sector has started the PPP mode of project development since 2004, with a total of five airports under this model currently; Delhi, Mumbai, Bengaluru, Hyderabad and Cochin. In August 2016, GMR emerged as the preferred bidder for development of a greenfield airport at Mopa, Goa. Further, project award process for Navi Mumbai is at advanced stage. Some other avenues, outlined by the government, which provide attractive Investment Opportunities are as follows:


Coast to Coast

Overview

India has an extensive coastline of about 7,500 km (covering 12 states and union territories) and 14500 km of navigable waterways with 13 major ports (jurisdiction of the central government) and around 180 minor ports; however, only one-third of the minor ports are operational.

About 95% by volume and 72% by value of the country’s international trade is handled through the country’s ports.

Traffic handled

Indian ports handled around 1,072 MT of traffic in FY16, an increase of 6% CAGR from 579 MT in FY06.

There has been a significant shift in traffic handled at the major and minor Ports. Traffic at major ports has increased at a CAGR of 3% from FY06 to FY16 while traffic at the minor ports has increased at a CAGR of 11% during the same period. Consequently, the share of traffic handled at the minor ports has increased from 25% in FY 06 to ~43% in FY 16.

579 650 726 744 850 885 914 934 972 1,053 1,072

11.1%12.3% 11.7%

2.5%

14.2%

4.1% 3.3%2.2%

4.1%

8.3%

1.9%

0.0%

5.0%

10.0%

15.0%

- 200 400 600 800

1,000 1,200

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Traffic (Mn Tons) Y-o-Y Growth

433 464 519 531 561 570 560 546 555 581 606

146 186 206 213 289 315 354 388 417 471 466

579 650

726 744 850 885 914 934 972

1,053 1,072

-

200

400

600

800

1,000

1,200

FY 06 FY 07 FY08 FY09 FY10 FY11 FY12 FY 13 FY 14 FY 15 FY 16

Major Port Traffic Minor Port Traffic Total Traffic

Cargo profileCargo (MTPA) FY 06 FY 16 CAGR FY 06- 16 Share of FY 16 TrafficPOL 212 377 6% 35%Iron Ore 108 32 -11% 3%Coal 73 270 14% 25%Fertilizers 18 30 5% 3%Containers 66 173 10% 16%Others 101 190 7% 18%Total 579 1072 6% 100%

POL and coal represent 60% of the traffic handled in FY16. Growth in the last 10 years has been led by increasing containerization (10% CAGR) and coal imports (14% CAGR). Consequently, the share of coal traffic increased from 13% to 25% and that of container traffic has increased from 11% to 16% between FY06 to FY16.

Key challenges faced by Indian ports:

1. Operational efficiency: Indian ports lag behind global counterparts in terms of operational efficiency. For example, Turnaround time at major ports was 4 days in 2014-15 whereas the global benchmark is one to two days

2. Lower draft: Lower draft (<12-14m) at Indian ports limits the size of vessels that can be handled thereby increasing per unit handling costs

3. Last mile connectivity: Almost 94% of Indian freight transport is either road or rail for transportation of goods. A significant share of this cargo experiences “idle time” during its transit to the ports due to capacity constraints on railways and highways

4. Insufficient use of internal waterways: Water borne transport constitutes only 6% of India’s modal split as compared to 47% for China. Significant savings can be achieved by shifting movement of commodities to coastal and inland waterways

5. Model of port governance: The ports in India, essentially the major-ports, widely follow a hybrid format of the long obsolete service port model and the preferred landlord model. The hybrid approach has resulted in a conflict of interest between the port trusts and the private sector.

Government initiatives and investment opportunities:

As part of the Sagarmala Programme, a National perspective plan for the comprehensive development of India’s coastline and maritime sector has been developed. More than 150 projects have been identified across the four program objectives with a total infrastructure spend of ~ US$60 – 70 billion.


Port Modernization Connectivity Port-led Industrialization Coastal community development

Port- led Development

► 53 projects► 1000 MMTPA of new

capacity► 6 new mega port

locations ► USD 15 billion

investment

► 83 projects► 10,000 km of new

connectivity infrastructure

► 7 new dry ports► USD 30 billion

investment

► 27 industrial clusters ► $15 billion

infrastructure investment

► 8 projects► Setting up of Coastal

community development fund

150 + projects USD 60 billion Investment

Source: Draft National Perspective Plan (NPP) for Sagarmala, Ministry of Shipping

Banking on infrastructure

At the heart of the growth of Indian economy is the Infrastructure sector, responsible for propelling India’s overall development. India needs close to INR 31,000 billion (USD 455 billion) to be spent on infrastructure development over the next five years, with 70% of funds needed for power, roads and urban infrastructure segments. Despite the real demand for physical infrastructure, the sector is facing significant challenges, as the developers, the financial community and the government grapple with stalled projects, non- performing loans and widening gap between performance and targets. Unfortunately, with the overall economic slowdown, the India banking system is under pressure.

The risk landscape for the Indian scheduled commercial banks (SCBs) has undergone a significant change over the past few years resulting from the considerable worsening of the stressed assets situation primarily on account of poor project evaluation and monitoring, extensive project delays, cost overruns and policy inertia.

The stressed assets [gross non- performing asset (GNPA) + restructured advances (RA)] as a percentage of gross advances for the banking sector stood at 7.6% at March 2012 and moved up sharply to 11.5% by March 2016.

2.3% 2.9% 3.4% 4.1% 4.6%7.6%3.5%

4.7% 5.8% 5.9% 6.4%3.9%

0.0%

5.0%

10.0%

15.0%

FY11 FY12 FY13 FY14 FY15 FY16

GNPA Restructured standard advances (RA)

Stressed assets as a percentage of total advances

Source: RBI Financial Stability Report June 2016


21.9%

16.0% 13.2% 9.5% 9.4%0.0%10.0%20.0%30.0%

Mar

-11

May

-11

Jul-1

1

Sep-

11

Nov

-11

Jan-

12

Mar

-12

May

-12

Jul-1

2

Sep-

12

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-1

3

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-1

4

Sep-

14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-1

5

Sep-

15

Nov

-15

Jan-

16

Mar

-16

May

-16

SCBs - Annual Growth Rates %

Consequent to the continued financial stress, the overall credit growth has remained subdued.

To assess the situation of elevated stressed accounts, the RBI initiated the AQR exercise in December 2015 for banks to clean up bad loans and improve the quality of their balance sheets by March 20171. Following the AQR, banks reported a ~70% surge in NPAs. Gross NPAs increased from INR 3,490 billion in September 2015 to INR 5,910 billion in March 2016. PSBs suffered a cumulative loss of INR179.95 billion in FY16 as they reported a steep rise in bad loans and had to increase their provisioning as a result of the impact of AQR2

Elevated levels of NPAs, coupled with weak capital positions have dented overall credit growth of the Indian banking system. Therefore, in the current scenario, it is imperative for banks to clean up their balance sheets and support lending to the productive sectors as the investment cycle revives in the Indian economy.

Public sector banks are the highest contributors to the pool of gross NPA with a significantly high stressed asset ratio. The infrastructure sector contributes to 14.2% of the total advances; however, its share in restructured standard advances stood at 34.4% of which power sector constituted 20.9% (the highest share within the infrastructure sector).

1. RBI Quarterly Order Books, Inventories and Capacity Utilization Survey (OBICUS) for Q1:2016-172. RBI’s asset quality review: Deep surgery starting to show results”, The Indian Express, 7 June 2016 ; “Fresh asset quality review of banks unlikely soon, says RBI deputy

governor”, The Economic Times, 21 June 2016 3. RBI - https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=37368

Table 1: Sectoral credit risk: Infrastructure

Sector Infrastructure Of which: Power

Of which : Transport

Share in total advances

14.2% 7.8% 2.9%

Share in restructured atandard advances

34.4% 20.9% 8.6%

Share in GNPAs 13.9% 5.9% 4.3%Sectoral restructured standard advances ratio

9.7% 10.7% 12.1%

System's restructured standard advances ratio

4.0% 4.0% 4.0%

Source: RBI Financial Stability Report June 2016

Multiple factors have led to the current high level of stressed assets, including macro-economic issues and bottlenecks related to specific sectors.

a . Excessive leverage and over investment during earlier strong economic phases

Indian banks resorted to aggressive lending practices during the boom period (from FY04 to mid FY09). Consequently, the corporate sector acquired excessive leverage to finance aggressive capacity addition. Also, it was widely perceived that the impact of the global financial crisis on the Indian economy was not significant. Consequently, the banks continued lending aggressively to capital intensive sectors during FY09-11. There was a significant investment capacity expansion across infrastructure sector. Besides easy availability of credit, Indian corporates were also tempted by cheap valuation of assets in overseas markets amid the global slowdown.

b . Regulatory delays in the infrastructure sector

In a PPP model, the responsibility for both construction and operation of the project are bundled together, which incentivize infrastructure developers to optimize resource allocation over the lifetime of the concession, with the potential to reduce overall costs. The project is implemented through a special purpose vehicle (SPV) with a project sponsor, usually a private sector developer or construction company. The government through a project authority, enters into a concession agreement with the SPV as the concessionaire. The concession agreement provides specifications of the project and services to be rendered as well as revenue sources of the SPV. For example, in the case of a road project, revenue would be in the form of toll collection or semi-annual availability payments (annuities) from National NHAI. The concession agreement is usually long term, given the long economic life of many infrastructure assets.

However, there are more fundamental problems with PPP projects which cannot be resolved only through financial intermediation. Gains from PPP projects come by enhancing project viability by sharing of risks between the government and the private partner.

Infrastructure projects in India carry significant risks largely outside the control of private parties. For example, in the case of power generation projects, the two major sources of risk are the poor financial and operating condition of the largely state controlled DISCOMS and the inability of the public sector Coal India to enter into long term Fuel Supply Agreements (FSAs). The major issues impeding the renewables sector include evacuation issues, land availability and issues in signing PPAs. Similarly, road projects face serious construction risk because of problems related to land acquisition and environmental clearances and in the post completion phase there are political problems related to toll collections and periodic revisions as per concession contracts. Issues pertaining to ports sector include operational efficiency, lower draft, last-mile connectivity, insufficient use of internal waterways and model of port governance.

c . Economic slowdown post FY11 impacted corporate demand

The Indian economy emerged largely unscathed from the global financial crisis. However, stress in the banking system could be attributed to the economic slowdown after FY10. This is indicated by the fact that the double digit growth witnessed in IIP during the boom period had weakened significantly. This in turn negatively impacted demand in several key industrial sectors denting capacity utilization. Overall industrial capacity utilization declined from 78% during March 2013 to 72.9% for 1Q 2016-17.

d . Easy access to the external debt market and rupee depreciation adding to the debt woes

Higher corporate leverage levels can also be attributed to increased access to the external debt market. A dovish monetary policy environment in developed markets after the financial crises led to Indian non-government external debt as a percentage of GDP to increase from 13.6% in FY10 to 19.2% in FY163

(provisional). High levels of external borrowings exposed Indian corporates to exchange rate vulnerability. Depreciation of the rupee against major currencies such as the US dollar and euro increased debt obligation in rupee terms for the companies exposed to foreign currency loans.

Capacity utilization

78.0%

76.1%

73.5% 74.0%72.9%

70.0%

72.0%

74.0%

76.0%

78.0%

80.0%

FY13 FY14 FY15 FY16 Jun-16

Non-government debt (% of GDP)

13.6% 13.7%15.8%

17.8% 19.2% 19.3% 19.2%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

FY10 FY11 FY12 FY13 FY14 FY15 FY16*

Source: RBI Quarterly Order Books, Inventories and Capacity Utilization Survey (OBICUS) for Q1:2016-17

*Provisional Source: RBI – India’s External Debt

SCBs – overall credit growth rates %: Q-o-Q basis

Source: RBI database 2016


Engineering, procurement and construction (EPC) sector:

Companies in the EPC sector are faced with a myriad of issues following a slowdown in the domestic economy. Issues impacting projects right from planning to operation stage have made several of them unviable.

Significant cost overruns, regulatory bottlenecks and aggressive bidding positions taken by a few market players are some of the key concerns affecting the EPC sector. Another important element synonymous to the sector is the build-up of claims that are receivable from various government entities. These claims could be on account of several factors such as change of scope of work (quantity variation/extra items), idling of resources (manpower, overheads etc.), compensation beyond the original contract period, change in statute, loss of opportunity, etc. The claims go through an arbitration process that potentially delays the timing of cash flows.

In view of the increasing working capital requirements and the resultant increase in leverage, the construction players are left with limited opportunity to raise further capital to fuel growth in the current scenario. Private equity funds too are cautious with their new investments, since there are limited opportunities to exit due to unfavorable capital markets. Therefore, the sector is reeling under significant liquidity constraints.

To revive the construction sector, the Cabinet Committee on Economic Affairs under has approved a series of initiatives as follows:

• PSUs/departments may seek the consent of the contractors/ concessionaires to transfer the arbitration cases initiated under the pre-amended Arbitration Act to the amended Arbitration Act, wherever possible;

• In case of claims where the PSU/departments has challenged the Arbitral Award, 75% of the award amount may be paid by the PSU to the contractor/ concessionaire against margin free bank guarantee;

• All PSUs/departments issuing public contracts may consider setting up Conciliation Committees/ Councils comprising independent subject experts in order to ensure speedy disposal of pending or new cases;

• Item-rate contracts, may be substituted by EPC (turnkey) contracts, and PSUs/ Departments may adopt the Model EPC contracts for construction works; and

• Department of Financial Services, in consultation with RBI, is formulating a one-time package for the construction sector which is expected to be announced shortly.

EY’s view is that these initiatives are expected to infuse appropriate liquidity into the construction sector and other infrastructure projects which have been stranded and support the entire process of dispute resolution in relation to construction and real estate. Given the significant multiplier effect the construction sector has on the economy, these measures are expected to give a major boost to economic growth.

Power generation sector: overcapacity is the principal cause for stress

The Indian power sector has witnessed significant distress in the last five years on account of both demand and supply side constraints. On the supply side, issues include fuel shortages and Power Purchase Agreements (PPA) disputes and on the demand side, the biggest issue includes discoms’ curtailment of power purchases due to deterioration of their financial health.

Significant overhang of the capacity is the biggest cause of stress within the power sector. India’s power generation capacity increased by almost 1.7x during FY11-FY16 implying a CAGR of 10.7%. This is largely due to the significant investment committed in capacity addition during the boom period. On the other hand, demand for power has remained subdued largely due to inability of state electricity boards (SEBs) to purchase power at higher tariffs coupled with slack in industrial demand amid weak economic growth. The mismatch between demand and supply has resulted in lower plant load factors (PLFs) for power generation companies, negatively impacting the profitability of many generation companies.

173.6199.9

223.3 243267.6

288 306.3

122.3 130 135.5 135.9 148.2 153.4 159.2

050

100150200250300350

FY 11 FY 12 FY 13 FY 14 FY 15 FY 16 FY 17*

Capacity and demand mismatch

Capacity GW Peak Demand GW

Source: Ministry of Power website

*Provisional (As on September, 2016)

77.2%72.1% 68.7%

70.0% 69.6% 65.5% 64.4% 60.8%77.5% 75.1% 73.3%

69.9%65.6% 64.5% 62.3% 59.0%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

FY 10 FY 11 FY 12 FY 13 FY 14 FY 15 FY 16 FY 17*

All India Thermal PLF (%)

Target Actual

5.2

3.6 3.5 3.52.8

3.52.7

0123456

FY10 FY11 FY12 FY13 FY14 FY15 FY16

Merchant Price (INR/Unit)

Source: Ministry of Power website*Provisional (As on September, 2016)

Source: Ministry of Power website

*Provisional (As on September, 2016)

Aggregate PLFs of thermal power plants declined to ~62% in FY16 from a long-term average of ~72% and the peak in of ~78% in FY09

Going forward, an uptick in economic recovery could stabilize PLFs of the power generation companies. However, the recovery is expected to be gradual as capacity utilization is expected to remain at current levels.

According to CRISIL estimates, debt to weak power generation projects stands at INR 2,100 billion. This includes INR1,600 billion of loans to coal-based facilities that are either stalled or operating below optimal capacity and INR500 billion to gas-based plants that are at risk due to the lack of gas availability. The coal-based capacities are inoperative for three reasons:

a. Off-take risks: These projects are yet to sign PPAs and/ or have high generation and distribution costs, making them unviable for DISCOMS to purchase. The debt to projects that have an offtake risk is ~INR120 billion.

b. Aggressive pricing: These are projects that have signed long-term PPAs for 20-25 years at a low price of INR 2.7 per unit. Their cost of generating power has increased substantially due to the changes in regulatory norms for imported coal or increase in prices of domestic coal. The debt outstanding to such operationally unviable power projects stands at a massive INR810 billion.

c. Fuel shortage: Projects that are stalled, non-operational or running below optimal capacity due to a shortage of fuel availability have a debt of INR 660 billion.

There are a moderate to high chances of reviving projects that have off-take risk or are in trouble due to non-availability of coal or gas. Raw material supply has improved substantially following government’s initiatives with regard to coal block allocation, imported gas availability and tariff revision. Thus, such projects can be revived with a reasonable haircut to their EV to account for project delay and increased debt levels.

The weak financial position of discoms meant that they could not sign long-term PPAs with power-generation companies, forcing them to buy power in the spot market at a higher price. This negatively impacted their profitability. Further, they were unable to invest in distribution infrastructure to curtail T&D losses amid weak profitability, which, in turn, resulted in a buildup of stressed loans on bank balance sheets.

The Union Cabinet has approved a new scheme moved by the Ministry of Power - Ujwal DISCOM Assurance Yojna (UDAY). UDAY provides for the financial turnaround and revival of discoms, and importantly also ensures a sustainable permanent solution to the problem.


► Theft of power and illegal connects► Illegal use of subsidized power meant

for agriculture

2

3

1

► Non-metering and temperedmeters

► Outdated technologies

► 20% of power consumed is by agriculture sector while only 7% of total revenues contribution at all-India level

► Loss due to inefficient T&D infrastructure and high cost of operation due to high workforce and overheads

Analyzing the key issues and challenges of discom

Analyzing thekey issues andchallenges of

discom

A quick glance at UDAY

• ► 14 states had signed an MoU till July, 2016

• ► 75% of discom debt as on 30 September 2015 to be taken over by states over two years (50% before March 2016 and 25% in FY17)

• ► States to issue non-SLR, including SDL bonds, in the market or directly to the respective banks/financial institutions (FIs) holding the DISCOM debt to the appropriate extent @GSEC rate + 50bps

Key reforms target

• ► Reduction of AT&C loss to 15% in 2018—19

• ► Reduction in the gap between the average revenue realized (ARR) and the average cost of supply (ACS) to zero by 2018—19

While the impact of UDAY on the banking sector in the long run is expected to be positive, it could have a negative impact in the near term. Conversion of 75% debt into state bonds, and the pricing of these bonds between 8% and 9% will entail a haircut on the interest income received by banks. Currently, these loans are priced at ~12%—13% and thus may result in a 350—400 bps reduction in the income accrued.

Dealing with banking stress — key initiatives by the RBI and the government

The RBI, from time to time, has come up with various initiatives to deal with the current banking stress. The regulator, through its discussion paper on early identification of distressed assets, has adopted an approach that would lead to early identification of stressed assets to enable credible and timely resolution of such assets.

While the RBI has also stressed on a review of the credit appraisal system with a focus on additional necessary due diligence, many of the restructured assets in India are a result of:

• ► A sharp slowdown in the domestic economy over the past few years led by the global slowdown.

• ► Projects stalled at various stages because of delays in clearances and issues in fuel linkages.

• ► Persistent policy paralysis delaying structural reform.

• ► Significant build-up of excess capacity financed mainly through excessive leverage.

• ► Inadequate focus on core competencies and overpriced overseas acquisitions.

• ► Infrastructure projects blocked at various stages because of heightened environmental concerns.

• ► Sharp slowdown of consumption in the domestic economy.

• ► Under-developed institutional equity market.

• ► Deficiencies in the credit appraisal and due diligence processes, particularly at PSU banks.

• ► Failure of Indian banks to take corrective action at the appropriate time.

Some of the prominent measures taken by the RBI are as follows:

• ► Focus on early warning signals

The RBI has asked banks to create a new asset classification called SMAs to identify early signs of stress in an account based on tangible events or indicators. This move will improve transparency and increase the accountability of banks and promoters alike. Early warnings and resolutions will also result in a higher probability of consolidation, turnaround or timely asset sell-off.

While these guidelines will put a large procedural burden on banks in terms of monitoring and reporting requirements, they will also result in greater transparency and timely resolution plans to recover loans and enable rationalization in the industry.

• ► Strengthening of credit risk management at banks

Banks have been asked to pay special attention to the source and quality of promoter equity contribution and be particularly aware when debt raised by a parent company is infused as equity in subsidiaries. Banks have also been asked to engage auditors for specific certification of end use of funds.

• ► Accountability of promoters

Under the RBI guidelines, promoters have to infuse more equity or issue new shares before an account can be restructured. The guidelines also provide for promoters transferring their holdings to an escrow account to enable lenders to institute management change. Increasingly the banks are stipulating that the promoters divest the non-core assets.

• ► Strategic debt restructuring (SDR)

Until the introduction of the SDR in June 2015, the Reserve Bank of India (RBI) had largely stayed away from devising a mechanism that enabled the banks/lenders to play a direct role in the turnaround of stressed borrowers. SDR is a tool for lenders to acquire majority ownership in a borrower by converting a part of the outstanding loan (including overdue interest) into equity.

Most importantly, SDR aimed to provide the lenders an option to initiate a comprehensive turnaround by taking control; giving them a fair shot at reviving these companies by partnering with a more capable promoter. There has been limited will, though, from banks to take on management of companies through the SDR route. Along with an apprehension that the existing legal system would not allow a change of management to take place smoothly, banks were skeptical of lack of protection from existing and imminent litigations.

Since the introduction of SDR provision, the lenders have invoked SDR in case of 21 companies. Lack of willingness of the banks to “right size” the debt and provide the “new” buyer with an appropriate capital structure to turnaround the assets has also impacted the success of SDR. Successful SDR implementation has happened Gammon India.

• ► Scheme for sustainable structuring of stressed assets (S4A):

The lack of a positive response to SDR from banks have forced RBI to devise other measures such as S4A in June 2016. S4A is a reversal from the ‘creditor in control’ stance taken by the RBI. Under S4A, control remains with the existing promoter as long as 50% of their debt is “sustainable.” While the efficacy of the S4A is yet to be evaluated, it has found limited eligibility as it prescribes a short-term cash-flow visibility and does not allow change in repayment terms. Even as these challenges are being addressed, the lack of emphasis on a comprehensive turnaround could possibly result in the problem just being postponed. Corporate stress needs a quick and decisive revival strategy rather than an indefinite deferral of the problem. If comprehensive turnaround plans had been implemented in a timely manner, the size of the problem could have been mitigated. Limited will from lenders to engender such a strategy and a judicial framework that did not entirely support them have hampered the efforts in this direction.

Construction major Hindustan Construction Company (HCC) became India’s first firm to get debt recast under the S4A.

Recently, the RBI-mandated Overseeing Committee (OC) under the S4A approved HCC’s INR 5,000-crore debt recast passed by an ICICI Bank-led joint lender forum.

Under this debt recast of HCC:

• 52.5% of the debt (nearly INR 2,600 crore) was assessed to be sustainable which can be serviced from its business as per original terms and conditions, including interest rate and tenure.

• Out of the remaining 47.5% (INR 2,400 crore) debt, approximately INR 1,000 crore debt will be converted into equity of HCC for banks, which could give them approximately 25% stake in the company’s post-scheme equity capital.

• The remaining balance debt of say around INR 1,400 crore would get converted into optionally convertible debentures to the lenders. These measures would now go for approval from HCC’s shareholders.

• The company is likely to benefit from the proposed release of the claims as per the recent NITI Aayog directive, which will enable to repay its debt.


• ► Asset reconstruction companies (ARCs):

ARCs were created as a result of the passage of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, (SARFAESI Act) to maximize recovery from NPL assets through dedicated and experienced work-out skills.

Last 14 years have seen 22 entities being licensed by the RBI, however, despite the number of entities the current capacity of balance sheets of the ARCs is insufficient to absorb material levels of distressed assets from the banking system. ARCs interest was muted during FY16, with select transactions that were closed out.

However, the recent changes proposed in the Union Budget 2016-17 allowing for 100% FDI in the ARC space will bring in the much needed capital for ARCs and provide a fillip to the industry. Additionally, the recent guidelines introduced by RBI aim to bring in more transparency in the asset sale process to ARCs, and facilitate true sale of NPLs rather than banks holding majority stake in these assets. All of these changes are aimed to incentivize ARCs to improve recoveries from troubled assets.

• ► Bankruptcy and Insolvency Code 2016

Until the Code, there was no single legislation that governed corporate insolvency and bankruptcy proceedings in India. Lenders had limited muscle when faced with default and promoters stayed in control. Only one element of a bankruptcy framework has been put into place to a limited extent, banks are able to repossess fixed assets which were pledged with them.

According to the Bankruptcy Law Reforms Committee (BLRC), “Corporate bankruptcy and insolvency is covered in a complex of multiple laws, some for collective action and some for debt recovery”. The significant number of legislations and the complex interplay between them have made the recovery of debts cumbersome for lenders. Different acts define the powers of lenders and borrowers in the case of an insolvency. The lack of clarity on jurisdiction and lack of commercial understanding have allowed stakeholders to manipulate the situation and stall progress.

Apart from Prime Minister Narendra Modi’s commitment that India will be among the top 50 countries in terms of ease of doing business within three years, the Code acquired urgency because of the stressed assets in the Indian banking system, heightened focus on the resolution of the problem by the RBI and the Supreme Court and a dire need of capital today – not just for stressed companies but for growth in general. It is not the most opportune time to tap capital markets nor are banks willing to provide liquidity; and most promoters are not in a position to infuse capital. Private capital would need to flow in and a strong legal framework would be a pre-requisite.

The Code makes a clear distinction between insolvency and bankruptcy - the former is a short-term inability to meet liabilities during the normal course of business, while the latter is a longer term view on the business. As all businesses cannot succeed, it is perfectly normal for some businesses to fail, making it important to emphasize on corrective action. The Code amply clarifies that insolvency or bankruptcy is a commercial issue, backed by law to enforce transparency and objectivity. It is not another law behind which the inevitable can be delayed.

Such a framework can incentivize all stakeholders to behave rationally in negotiations towards determination of viability, or in bankruptcy resolution. In turn, this will result in shorter recovery timeframes and better recovery, and greater certainty on lenders’ rights leading to the development of a robust corporate debt market and unlocking the flow of capital, an impending requirement of the infrastructure sector.

New Beginnings

All stakeholders of the Indian economy unanimously agree on the importance of continued investments in adding to and upgrading the infrastructure sector. An estimated US$1.5 trillion may be required to be invested in the sector over the next 10 years to unlock the potential of India’s young population.

However, over the last half a decade, the sector has been stuck in a quagmire of stressed assets, regulatory challenges and restrained investments. Myriad problems including cost overruns,

5,21,393 6,29,991 7,29,721 8,36,356 9,24,531 9,64,811

37.2% 20.8% 15.8% 14.6% 10.5% 4.4%0.0%10.0%20.0%30.0%40.0%

5,00,000

10,00,000

15,00,000

2010-11 2011-12 2012-13 2013-14 2014-15 2015-16

Banks Exposure in Infrastructure (Source: RBI)

Credit Growth in Infrastructure Sector

Exposure Growth rate in Credit

project delays, lack of diligence and project monitoring have led to the Indian domestic banks shying away from lending to the sector. The monthly credit growth in the sector according to the RBI has slowed from 19.1% in June 2013 to less than ~4.5% in FY2015-16.

It is thus imperative for the sector’s rejuvenation that there is a collective effort in facilitating new debt capital infusion in the sector, through traditional means as well as through new innovative financial structures.


Regulatory interventions

The critical problems in most large infrastructure projects, and all PPP projects cannot be solved through better or innovative financial intermediation. Infrastructure projects in India continue to carry significant risks which are largely out of the control of the private sector. For example problems of land acquisition, fuel linkages, health of state electricity bodies, environment clearances, local problems in tolling are some of the factors that have severely hampered key infrastructure investments across subsectors.

A key step has been the government’s efforts on reviving stalled projects. Even before the change of regime in the centre, the government had formed a special Project Management Group (PMG) in January 2013 to address issues faced by stalled projects worth more than INR 10 billion or critical public sector projects. While the data may indicate that the number of stalled investment plans reached an all-time high of 12.3% of all projects in March 2016, it is relevant to note that in the last one year, the PMG could resolve 170 projects worth more than INR 6,000 billion.

The silver lining is that the trend of stalled projects may have reached the much desired inflexion point. The government has also been pro-active in engaging with the financial community to address some of the risks that cannot be managed only by financial solutions only. The hybrid annuity model adopted by NHAI and several state highway authorities have found flavor with the lenders. Railways completed land acquisition for their marquis locomotive plants under the PPP model months in advance of the agreed deadlines.

Overall, the positive vibes from the government have sent the right signals to both developers and their lenders, encouraging the next round of much needed investment in the sector.

On the financing side, the RBI has also initiated several measures to facilitate greater investment flexibility for infrastructure, and allow financing structures to meet the long term financing needs of the sector.

5/25 Masala Bonds Credit Enhancement Short term tenor ECB for Infra CIC Holding

Flexible Structuring of Existing Long Term Project Loans to Infrastructure and Core Industries

ECB Policy - Issuance of Rupee denominated bonds overseas

Partial Credit Enhancements to Corporate Bonds

ECB-Revised Framework

Regulatory Framework for Core Investment Companies(CICs)

• ► Lenders are allowed to fix longer amortization period for project loans in the infrastructure and core industries sector, based on the project economic life or concession period, with periodic refinancing

• ► Benefits infrastructure projects that have a shorter loan period (12-15 years) as compared to their life cycle (25-30 years), which puts a strain on the company’s cash flows

• ► Framework to facilitate Rupee denominated borrowing from overseas

• ► The bond offers investors an opportunity to participate in emerging market Indian Credit without taking convertibility/ regulatory risk associated with emerging markets.

• ►► Banks may provide credit enhancement as a subordinated loan facility, subject to the maximum extent permitted, of the total credit enhanced senior bond.

• ► Benefits bond holders by considerable reduction in loss given default during both construction and operation phases and improvement in debt service coverage ratio of the senior bond.

• ►► Taking in account long term lending and critical needs of infrastructure sector, companies in infrastructure will also be eligible to raise ECB under Track I of the framework with minimum average maturity period of 5 years, subject to 100% hedging.

• ► Companies which have their assets predominantly as investments in shares for holding stake in group companies

• ► Permitted to raise ECB’s for Infrastructure projects:

• ► ECB availed should be within the ceiling of leverage stipulated for CICs, i.e., their outside liabilities including ECB cannot be more than 2.5 times of their adjusted net worth

RBI initiatives

Rejuvenating InvestmentsIndia’s tryst with core project financing institutions started with the incorporation of the 3 large state owned entities – IDBI, ICICI and IFCI. From the start of the century, with ICICI and IDBI opting to move to a bank platform, Indian domestic banks have been the major source of project finance in India, be it infrastructure or otherwise.

Infrastructure project financing has its own challenges in India from a financing perspective. Logically, infrastructure projects that have inherently long gestation need long term financing solutions best met through long term savings products, primarily insurance and pension plans. However, regulations on such long term products do not facilitate financing “under construction projects” leaving the task to the Indian domestic banks.

Banks face their own constraints in providing long term debt given the perceived asset liability mismatches and also implications with respect to the Basel III norms. The RBI has a counter view on this issue – while banks do rely extensively on their short term retail deposits to fund their advance books, on a portfolio level these short term deposits are actually quite stable enabling the banks to take on longer maturities.

The government and the RBI have continued to support banks in this critical activity, through resolution of stalled projects, improved delivery from public entities on PPP commitments and better PPP structures addressing the lacunae that has been haunting banks and developers alike over the last few years.

From the perspective of the banks, despite the problems facing the infrastructure sector it remains a key driver for growth in corporate advances, especially given the significant investment plans for the sector over the next 5 years. The likely change may be in the credit and diligence processes which would ensure that the mistakes of the past are not repeated.

The RBI has also attempted to channelize ECBs by liberalizing the regulations governing ECB investments. Some of the key measures that are likely to have a positive impact on the infrastructure sector are policies around interest and tenor resets on ECBs within the overall caps prescribed by the RBI, guidelines on ECBs to CICs and permissibility of a 5:25 scheme on an ECB provided by an Indian lender.

A key challenge in the ECB domain is the issue around currency hedging. Excluding ports and airports, infrastructure projects rarely have a natural currency hedge. Long term financing through the ECB route becomes a challenge as currency hedging costs rise sharply based on the tenor, with only customized options available for hedges beyond 10 years.

The RBI’s policy enables Indian companies to pass on the risk to global financial institutions which may have better financial capability to understand and price the risk vis-à-vis an Indian corporate trying to seek a hedge for a single loan.


NTPC issued green masala bonds of INR 1300 Crore@ 8 .57% for 37 months .

CLP India issued secured, partially-guaranteed, redeemable,

bonds of Rs . 476 crore @9 .99% with a maturity of 11 years

Three solar SPVs of Hindustan Power issued privately placed

credit enhanced bonds of Rs . 380 crore @ 10 .05% with a maturity of

10 years

Renew Wind Energy (Jath) Ltd issued credit enhanced bonds

of Rs . 451 crore, partially guaranteed by IIFCL with a

maturity of 18 years

Adani Transmission Limited issued masala bonds of INR 500 crore @ 9 .1% for

60 months

TThe corporate bond market in India, is only just starting to warm up to invest in the Indian infrastructure assets. The need for a vibrant market has been reiterated by all key regulators including the RBI and the Planning Commission.

According to the Planning Commission (2013) –

The need for long-term savings products is the mirror image of the other important need—that of long-term finance for long gestation products, namely physical infrastructure. Without the first, the latter becomes hard.

The corporate bond market has been out of reach of the infrastructure projects, primarily on account of ratings. Standalone infrastructure projects during construction and even initially post commissioning are usually are rated in the BBB category at best, whereas life insurance companies in India are restricted to rating categories of AA and above.

While mutual funds have the flexibility to invest in lower rated instruments, most of the funds by policy tend to avoid green-field projects. Anyway the profile of the investment maturity of mutual funds is also not commensurate with the long term financing tenor needs of infrastructure projects.

Several recent developments initiated by the RBI as well as multilateral organizations such as the ADB include programs to attract life insurance and pension funds for investment in infrastructure projects.

The partial credit guarantee scheme developed jointly by ADB and IIFCL has seen success – several borrowers are opting for the structured guarantee scheme to refinance debt of operational projects including conventional energy, renewables and highways. The RBI’s partial credit guarantee scheme also enables banks to provide guarantees for infrastructure projects. In brief, the PCG solution is based on providing an additional credit support, in the form of a “First Loss” guarantee, which moves the credit rating of an operational project from the BBB – A categories to a AA – AAA Structured Obligation rating – AA (SO) – AAA (S0). The quantum of guarantee is limited to 50% of the total outstanding debt.

The structure enables operational infrastructure projects to reach the required rating category for participation by insurance and pension funds. The choice of the “Partial Guarantee” structure also ensures that the insurance and pension funds, simply do not rely on the guarantee but also understand the overall project risks before investing.

The guidelines on infrastructure debt funds also introduced new sources of investment, either directly or through the corporate bond market for infrastructure projects. Several IDFs have been set up with a clear focus on financing both operational and under construction projects. Several alternative structures is

possible with the IDF including bullet maturity instruments allow borrower’s ability to leverage on the project’s overall profitability to absorb the refinance risk.

The current trend in the corporate bond market does bring in some cheer for the sector, albeit indirectly.

Total debt issuances : Corporate Bond Market ( Rs Crore )

Rs Crore 2013 2014 2015 2016

All industries 1,61,879 2,07,017 2,47,231 2,70,353

Non- financial 45,599 53,747 64,989 60,626

Manufacturing 12,954 9,458 13,880 9,732

Chemicals & chemical products 2,065 350 2,660 2,155

Construction Materials 200 2,335 700 1,425

Metals & metal products 6,492 2,385 2,930 2,000

Transport equipment 2,157 1,800 691 1,875

Mining 50 1,500 2,000 1,250

Electricity 13,255 17,395 21,496 13,411

Services (other than financial) 12,383 15,408 15,162 28,950

Wholesale & retail trading 1,480 3,100 675 3,339

Transport Services 8,220 4,804 3,300 14,450

Communication Services 500 2,500 7,562 6,300

Misc. Services 1,242 4,690 2,789 4,531

Construction & real estate 6,957 9,987 12,452 7,283

Financial Services 1,16,281 1,52,768 1,82,242 2,09,727

Source: Care Ratings Report dated November 3, 2016

The table above gives the shares of various segments in total debt issuances in the corporate bond market across four years. The issuances in the transport services sectors has grown around four fold in the last one year from INR 3,300 crore in FY15 to INR 14,450 crore in FY2016. This increase augurs well for the Highways, Railways and other transportation sectors. The share of electricity, though steady during 2013-2015 period has dipped in 2016. Electricity growth has been steady at 5.1% during the first five months of the year compared with 4.5% last year. With the power sector reforms being implemented by several states, there could be a lag before which demand for new investment fructifies.

However, the corporate bond market still depends heavily on underwritten private placements rather than public issuances. It is the private sector banks like Axis Bank, ICICI Bank, HDFC Bank, IndusInd Bank and Yes Bank that the infrastructure corporates are approaching for the bond placements.

The development of a primary bond market, like the primary share market is still some way off. While government interventions like that of stipulating higher mandatory investment limits for insurance companies to invest in infrastructure companies may ease the market access, the insurance companies themselves need to shore up their internal credit processes to understand and address the risks involved in long gestation infrastructure / PPP projects.


Another option available for the investors is the infrastructure investment trust (InvIT) structure, which is specifically designed to attract long term foreign investments through the bond market.

• SEBI notified the framework for InvITs in India via SEBI (Infrastructure Investment Trusts) Regulations, 2014 in September 2014, thereby paving the way for introduction of an internationally accepted investment structure in India.

• InvITs are trust vehicles that can raise funds from investors, acquire income yielding infrastructure assets, manage such assets and distribute such income to their unit holder.

• A typical InvIT structure has been represented below for a better understanding:

• The following is an overview of beneficial tax provisions as introduced under the Income Tax Act, 1961:

• Capital gains at the time of exchange of shares of a SPV with units of InvIT is exempt from tax; However, capital gains at the time of exchange of assets with units of InvIT shall be subject to capital gains tax

• Finance Act, 2016 exempted from dividend distribution tax (DDT), dividend payments by SPVs to the InvITs where the InvITs hold the entire nominal value of the equity share capital.

• Interest paid to InvIT shall be allowed as a deduction to SPV. No taxes will be withheld

• Dividend and interest received by InvIT from SPV shall be exempt from tax in the hands of InvIT

• The dividend and capital gains component of the income distributed by InvIT to the unit holders will be exempt in the hands of the unit holders

Journey Ahead

The relationship between the lenders and large infrastructure borrowers has gone through a tumultuous phase – mistakes have been made by all stakeholders. However, India’s demand for infrastructure in India is real. With India embracing market forces, it is inevitable that investments in the sector will resume. The vision of building a new India depends on the success of the government, the developers and financial community working together to meet India’s infrastructure ambitions.

Sponsor(s) Unit holders

Manager TrusteeManagement agreement

≥ 50%

InvIT

LLPSPV 1

References

Citation from reports/ research papers:

• ► RBI Financial Stability Reports

• ► Research Paper by Sidharth Sinha, Indian Institute of Management Ahmedabad on “Long Term Financing of Infrastructure”

• ► Care Ratings Report on Trends in Corporate bond market dated November 3, 2016

• ► EY Report on “ARCs – at the crossroads of making a paradigm shift” dated July 2016

• ► EY Report on “Interpreting the Code-Corporate Insolvency in India” Dt: November 2016

Citation from websites:

• ► Airports Authority of India (AAI) http://www.aai.aero/public_notices/aaisite_test/main_new.jsp

• ► International Air Transport Association (IATA) www.iata.org/

• ► Ministry of Statistics and Programme Implementation www.mospi.gov.in/

• ► Ministry of Civil Aviation http://www.civilaviation.gov.in/

• ► Ministry of Power powermin.nic.in/en

• ► Ministry of New and Renewable Energy www.mnre.gov.in/

• ► “RBI’s asset quality review: Deep surgery starting to show results”, The Indian Express, 7 June 2016 ; “Fresh asset quality review of banks unlikely soon, says RBI deputy governor”, The Economic Times, 21 June 2016

• ► http://www.livemint.com/Money/Vfc2yrxfzZMBIF8Vc2ytYP/Corporate-profit-to-GDP-are-we-bottoming-out-this-year.html

Citation from press release/ databases:

• ► RBI - https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=37368

• ► Centre for Monitoring Indian Economy Pvt. Ltd. (CMIE) database |https://www.cmie.com/

• ► RBI Quarterly Order Books, Inventories and Capacity Utilization Survey (OBICUS) for Q1:2016-17


Team

Abizer Diwanji Partner and Head – Financial Services, EY Email: [email protected]

Shailendra Ajmera Partner - Restructuring and Turnaround, EY Email: [email protected]

Partha Guha Executive Director - Debt Advisory, EY Email: [email protected]

Nitin Jain Executive Director-Restructuring and Turnaround, EY Email: [email protected]

Editorial Team

Mukul Dalmia Senior Associate - Debt Advisory, EY

Prateek Somani Associate - Restructuring and Turnaround, EY

Achal Bhalla Analyst - Debt Advisory, EY


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