After a substantial increase in capital expenditure this fiscal year — nearly double that seen in previous years — the Railway Minister plans to step up capex for the coming fiscal too.
From an estimated (budgeted) ₹1 lakh crore in 2015-16, the capital expenditure is expected to go up to ₹1.2 lakh crore in 2016-17. Given that the internal resource generation this fiscal has not met the budgeted estimates, there is a need to find new and innovative ways to source funds to support such capex plans.
LIC agreeing to invest ₹1.5 lakh crore over five years on extremely favourable terms is a positive move, one that can help take some load off government finances. In 2015-16, the Centre has extended ₹32,000 crore through budgetary support to the Railways.
Long-term funds Raising funds for very long-term infrastructure projects has always been a challenge. Banks for one have been reluctant to fund such projects of more than 10-12 years, given the inability to raise funds for such a long tenure.
Even if banks are able to lend for the long term, projects still face interest rate risks, as banks reset rates periodically.
LIC investing in rail projects can not only help address the issue of raising funds for the long term but also bring in more predictability in rates.
LIC funds “LIC has a lot of disposable funds and it is one of the very few institutions that is rightly positioned to take infrastructure project risks at this point in time. Usually infra projects have a longer economic life (30-40 years), but shorter debt life (10 years). LIC can thus offer financing for a very long tenure,” says R Venkataraman, Director – Infrastructure, India Ratings and Research.
Most infra projects face interest rate risks in the initial phase.
Hence, they require softer rates or certainty in rates. This can help plan the cash flows over a longer period, he adds.
“Banks usually reset rates periodically and interest rate risk becomes huge. This impedes projects especially during the ramping up phase. If LIC lends, then interest rate can be at a fixed rate. This can help projects mitigate financing related risks when operational risks would be critical for the projects,” says Venkataraman.
The Railway Budget indicated that the financing from LIC will be on very friendly terms.
New structures But raising of funds for such projects also needs to go beyond the plain vanilla lending that banks and financial institutions do.
LIC can help evolve newer structures for financing. Developing the mezzanine or sub-ordinated debt market can go a long way in financing long-term infra projects. Repayment of mezzanine debt comes after debt provided by senior lenders such as banks.
“A portion of the funds that LIC lends can be mezzanine financing. If a project is facing challenges, the subordinated debt can cushion the stress, while the senior debt still gets serviced. As cash flows improve, the subordinated debt can be repaid, too,” says Venkataraman.
LIC can also do credit enhancements on similar lines as banks. This can help enhance the credit rating of bonds issued, enabling companies to access funds from the bond market on better terms.
“LIC can have a separate policy for credit enhancement. This would mean a separate credit appraisal system for handling infra projects. Through credit enhancements, LIC can help deepen infra debt markets besides direct lending,” says Venkataraman.
Other routes The Indian Railway Finance Corporation (IRFC), the borrowing arm of the Indian Railways, has also been exploring options such as floating rupee-denominated bonds in the international market to raise funds.
These bonds are issued in the overseas market but in the currency of the home country.
Currency risk Hence, the currency risk lies with the investor and not the issuer. This can help Indian companies reduce their cost of borrowings substantially.