Although large marquee projects that require significant investments have been conceptualized, the government still funds most of the projects despite a constraint on the overall spending power.

A stable regulatory model and strong governance mechanism to build investor confidence has been lacking, which has resulted in limited interest from financial institutions in proactively designing new products for infrastructure financing for both the government and private concessionaires.

One of the main reasons for the mismatch between the demand and the supply of infrastructure finance is financiers’ lack of visibility into the long-term pipeline of projects. Infrastructure financing is a complex legal and financial process, requiring significant expertise. Developing this level of expertise is costly, and financial institutions will invest in this only if there is a well-defined pipeline of opportunities. Otherwise, the cost of developing the capabilities will outweigh the benefits that financiers will be aiming to reap by investing in infrastructure over other less complex asset classes. The government will need to define a long-term strategy with strong legal backing that enables a variety of financial institutions to enter the infrastructure market with diverse portfolios without the fear of arbitrary exercise of political power. Developing a national infrastructure pipeline is a step in the right direction and should be supported by stronger financial and legal safeguards for financial investors.

Overcoming the obstacles and maximizing the opportunities

The investment opportunity in India’s transport infrastructure sector is huge and spread across subsegments. Although there are obstacles to realizing the vast potential, these challenges can be overcome with a concerted and coherent strategy across all three groups of stakeholders: government authorities, concessionaires and contractors, and financial institutions.

Government authorities

As authorities design their transport infrastructure development strategies, they will need to focus on identifying the right funding model, ensuring robust cash flow management, and enabling a vibrant ecosystem of concessionaires and contractors.

Robust viability assessment and innovations to enhance project viability

Assessing project cashflows, returns, and viability is one of the most important factors in determining the right funding model for a project. Poorly made detailed project reports, sketchy business case models with generic revenue projections and cost estimates, and limitations in financial risk assessment are some of the major hurdles in developing a robust business case for investment. This can be addressed by creating a strong viability assessment framework for each focus subsector, highlighting clear guiding principles for prioritizing projects within each asset class. The project execution model and the financial model can then be decided based on the project viability.

Apart from the viability assessment, another important tool that can improve project viability and enhance a project’s attractiveness for private participation is innovations in financial and project structuring. Financial innovations and project structuring can make projects more viable, particularly for those on the borderline of IRR thresholds. Innovative project structuring, such as the toll–operate–transfer model (TOT), can be much more attractive for projects with proven returns as opposed to greenfield development, with much more stable cash flows on the revenue and cost sides for private investors.

Another innovation, the hybrid annuity model, aims to lower the capex burden on the concessionaire, as in the case of a pure PPP project, but it also ensures that payouts are linked to performance during the concessions period, thereby addressing the authority’s risk of concessionaire non-performance. This leads to a reduced cash outlay for the government and ensures a steady coupon payment with the concessionaire having skin in the game during the operations and maintenance period. In addition, this model enables authorities to leverage private-sector expertise and efficiencies in construction and operations while at the same time retaining the risks associated with revenue realization with itself.

Another innovation that is finding resounding success across infrastructure projects is asset commercialization, which can significantly impact a project’s business case and make it far more viable than a stand-alone infrastructure project. For example, Indian Railways Stations Development Corporation has begun to tender out station redevelopment projects with a significant share of real estate development on the land parcel by relaxing the norms for floor space. Similarly, the NHAI is planning to monetize its land parcels along highways to offset the high cost of investment required and to improve project viability.

In addition, flexible policies on user fees can improve project viability. For instance, Malaysia recently introduced reforms in its port sector to improve efficiency and viability and prevent anti-competition behaviors while adopting tariff mechanisms to ensure competitiveness and operational capability. Each port has an independent government agency as the port authority, which develops tailored policies while acting as a landlord, regulator, and trade facilitator. The port authority also sets tariff limits in consultation with stakeholders. This helped improve the viability of port operations.

Managing the funding requirement

Infrastructure projects are largely executed by the government through the EPC mode. Raising the upfront capital required to execute infrastructure projects without upsetting government finances is a delicate balance. This coupled with the fact that revenues from transportation infrastructure projects are spread over 20 to 30 years after the project is completed poses a significant cash-flow management challenge. Relying solely on the budgetary resources will constrain the government’s ability to plan and execute large infrastructure programs. Alternate and innovative sources of raising capital are the need of the hour. For example, the Airport Authority of India is looking at an investment of $25 billion over the next 10 years to meet targets laid out by the National Civil Aviation Policy of 2016, but it had internal resources and a government scheme allocation of only about $0.6 billion in 2019.¹³ The gap is simply too wide to bridge using only budgetary allocation. However, with a debt–equity ratio of less than 0.1 in 2019, the Airport Authority of India’s balance sheet is underleveraged for an infrastructure development authority building airports—one of the more viable asset classes within transport infrastructure. Government authorities are exploring options to bridge the gap between the required capital and the available resources, such as borrowing through bonds and loans, rotating assets, and land value capture financing to capitalize on the increased value of land as a result of infrastructure development.

There is a significant opportunity to raise additional capital through bonds by leveraging government agencies’ balance sheets. For instance, Indian Railways recently raised $20 billion through bonds issued by Indian Railway Finance Corporation from the Life Insurance Corporation of India (LIC). Similarly, the NHAI raised $3.5 billion from LIC through bonds in the past year. In addition to raising finances for EPC projects, the government should also put in place the right mechanisms for selecting and phasing projects. This will enable enough revenue generation and phased capital deployment to meet the obligations of debt repayment. Although there is significant leeway to increase the debt on the balance sheet of infrastructure development agencies, structuring the terms of the debt (interest rate, moratorium, and tenure) to closely match the project’s cash flow is crucial to limit any short-term cash shortfall and ensure robust debt serviceability throughout the life cycle of the asset.

Asset rotation, where the revenue from completed projects is capitalized by transferring the rights to levy user fees to private investors, is being explored to finance new projects. The TOT model eliminates the construction risk for the financial investor while providing a significant return on the investment through expected traffic growth. Such an asset class is well-suited for infrastructure-focused private equity and sovereign wealth funds as the construction risk is eliminated and the base traffic is already established, minimizing the revenue risk. A case in point is the first round of TOT auctions completed by the Ministry of Road Transport and Highways, which fetched about $1.3 billion—1.5 times the expected value. However, the second round did not get the desired response from the market as projects were not bundled appropriately. Based on the lessons learned from the second phase and from engaging with stakeholders, the third phase was successful.

The key imperative for successful asset rotation is prioritizing assets to be put on block and phasing them to ensure regular cash flows. In addition, ensuring the availability of good quality data to the interested bidders is essential to enable successful bidding and discovery of a fair price for the assets. Governments will need to proactively open communication channels with potential bidders to solve their deal-related queries to evince interest from domestic and global investors. The TOT model was refined to allow varying concession periods based on project features to attract a variety of investors.

The government is also bringing in new models to manage the financing requirement and create investment avenues for private investors. The infrastructure investment trust model is being used to monetize operational assets in the power and roads sectors. The NHAI is also exploring a project-based funding model to set up special purpose vehicles that would invest in developing a particular road stretch and operating it for a specified amount of time to get a return on the equity component and repay the debt obligations.

This would help the authority tap into additional resources for developing highways. More government agencies are opting for land monetization. Delhi Metro Rail Corporation has been involved in leasing land parcels and developing and leasing an IT park in Delhi. Similarly, the Airport Authority of India is leasing out land for hotel chains, car parks, and city-side developments. The Rail Land Development Authority is working on commercializing excess land available with Indian Railways. Funds from such proceeds can be poured back into ongoing projects to ease the funding requirements.

Authorities are also exploring ways to capture the value of increased real estate activity with the development of major urban infrastructure projects. For instance, the stamp duty in the influence area of 500 meters along Nagpur Metro has increased by 1 percentage point, and the surcharge is being shared equally between Nagpur Metro Rail Corporation Limited and Nagpur Municipal Corporation. Successful implementation of value capture financing through a higher stamp duty or other related mechanisms requires coordinated action with all concerned stakeholders: the infrastructure development authority, state governments, and urban local bodies.

The financial models will have to be supported by the right operating model framework—clearly defining the roles and responsibilities of all stakeholders: government authorities, private concessionaires, and financial institutions. Specifically, in the context of railways, there are four operating models globally (see figure 9).