India is one of the world’s fastest-growing economies in the world, and as a result of increased spending on infrastructure, it now ranks 44th on the World Bank’s Logistics Performance Index 2018 (LPI). The country has surpassed France and the United Kingdom to become the world’s fifth-largest economy in terms of its GDP, achieving a higher growth rate than earlier projections. Sustained improvement and investment in infrastructure are the key to fuel India’s growth ambitions.
Demand for capital in infrastructure
The Government has set an investment target of ₹111 lac crores in the infrastructure space over the next five years. India has been able to spend ₹9.5 lakh crores per annum, compared to the requirement of ₹22.2 lakh crores per annum, which implies that the country needs more capital.
Supply of capital
In the past, banks and non-banking financial institutions (NBFCs) were the major sources of capital for infrastructure projects. The rise in non-performing assets in the infrastructure space has resulted in commercial banks and NBFCs re-evaluating their exposure to infrastructure projects. Consequently, the share of credit (to the total advances) of banks and NBFCs has reduced substantially since 2013.
Other large institutional pools of capital—insurance and pension funds—have limited exposure to infrastructure projects because of regulatory and credit quality-related constraints. Moreover, the depth and liquidity of debt capital markets is low, and infrastructure IPOs have not set these markets on fire in recent years.
In short, supply of capital in the infrastructure sector is a real concern, and India needs a more creative solution to attract investors to the sector. One way that lenders, investors, public sector enterprises and Government institutions can entice infrastructure investors is by recycling operational assets to institutional yield-seeking investors.
Infrastructure Investment Trusts or InvITs, designed to incentivise infrastructure players to swap their operating assets onto a platform that enables capital to be raised, which is akin to equity at the cost of debt, can be a solution to address liquidity-related requirements in the infrastructure space.
Infrastructure Investment Trust (InvIT)
InvITs are trusts, registered with the SEBI, which can hold the operational infrastructure projects of sponsors with long concession periods and stable cash flows. Once registered, InvITs can raise funds via public or private placement and issue units to investors. In return, investors obtain a share of the annual distribution of dividends and interests. Listed InvITs are required to maintain a maximum-leverage ratio of 49.0%, which can be increased to 70.0%, subject to a track record of six (6) continuous distributions to unit-holders (post listing), an AAA-rating, additional disclosure and compliance requirements, and end-use restrictions. The constraint on leverage in listed InvITs may limit its use, as infrastructure projects are leveraged higher than 49%. However, the private unlisted InvIT regime provides a high level of flexibility and relaxations under SEBI’s guidelines to sponsors, to raise money from investors, without the need to to list the InvIT platform. The 49% leverage requirement is however not applicable to private unlisted InvITs. This makes it popular among sponsors and investors.
In 2020, India has seven infrastructure investment trusts, of which two are publically listed. In terms of assets, three (3) InvITs are in roads, and one (1) each in power transmission, gas transmission and telecom towers. There are several renewable companies exploring the registration of InvITs for renewable generating assets.
Infrastructure investment trusts offer several benefits to investors and sponsors and are gaining in popularity.
- Low risk and high-quality assets: InvITs house infrastructure assets with a low demand and price-related risks, i.e., assured annuity cash flows such as roads, power transmission, renewable, telecom towers and gas distribution. At least 80% of these assets should be operational. This would make the risk of a portfolio low.
- Near-assured returns: InvITs are required to distribute 90% of their cash earnings (on a semi-annual basis), and are ideal for long-term yield-seeking investors.
- Strong corporate governance: The SEBI has institutionalised strong corporate governance requirements for infrastructure investment trusts, such as an independent trustee, a minimum 50% of independent directors on the Board, independent valuers conducting yearly or half-yearly valuations and stringent disclosure norms to ensure transparency and prudent management norms. Strong governance results in the enhanced trust of investors.
- Attractive yields: The yields in InvITs can be ~ 11–12%, (US$-yield is ~ 7–8%), which is close to five-year Sensex returns, and higher than a 6-8% return on fixed income. Unit holders in InvITs benefit from assured cash flows on a semi-annual basis, and the credit quality of the assets is superior. Publically listed InvITs offer a degree of liquidity and listed InvITs provide a concessional Capital Gains tax rate incentive to non-resident investors.
- Tax-free distributions: Distribution of dividends by an InvIT from underlying Special Purpose Vehicles (SPVs) are exempt from tax if a project is claiming a tax holiday or other deductions. Similarly, distribution of interest received from SPVs and paid to non-resident unit holders is subject to a lower tax rate of 5.46% (including cess and surcharge).
In the long run, high-quality assets, reasonable yields, a degree of liquidity and an attractive tax regime make InvITs an attractive platform for various types of investors such as long-term institutional to retail investors.
However, InvITs do face their share of challenges. Two key challenges are as follows:
- InvITs are sensitive to changes in regulatory and tax law, and a slight change in regulations can upset their price- and yield-related expectations. For instance, a recent change in a tax law, which partly withdrew the dividend distribution exemption on InvIT distribution, has shaken the confidence of the investor community on this platform.
- Since proceeds from infrastructure assets are not inflation-linked in India, the real yields of InvITs are affected by high inflation. At such times, InvITs may not seem an attractive investment option.
Infrastructure plays a key role in shaping and scripting India’s growth story. Consequently, the momentum of investments in infrastructure needs to accelerate substantially, and as domestic financial institutions struggle with liquidity and perception challenges, sponsors can utilise InvITs to create a steady stream of re-cycled capital. In this scenario, sponsors with operating InvIT platforms as a safe exit route will be able to recycle and raise fresh capital to fund their growth. Not just private investors, but the Government of India and public sector institutions and enterprises, such as NHAI and Power Grid, may find InvITs an attractive option to raise fresh capital to fuel greenfield investments in a cash-strapped infrastructure space.
(Prerna Mehndiratta is Partner, Deals and Sandeep Kumar Mohanty is a Director at PwC India. Views are personal. To know more about the series ‘Future of Infrastructure Investments’, watch here )