Channel: Corporate Finance

07 February, 2011
FII investment cap in infra bonds up 5 fold
 
 

 

India seems to be gearing up for more foreign funds. As the FDI inflows have been less than impressive in the last fiscal, the capital inflows pose a real risk to the funding requirements of India. Though government is well aware that hot money may not be the best option in the long term but at the same time there is unanimity about not losing the current opportunity from FII.The increase in FII investment cap in Infra bonds is a very well indication of that.

 

Following up on finance minister Pranab Mukherjee's budget announcement, the Securities & Exchange Board of India (Sebi) on allowed foreign institutional investors (FIIs) to invest $25 billion a year in bonds issued by infrastructure companies as against $5 billion. As per new regulation, FIIs can now invest $40 billion annually in corporate bonds.The FII investment into bonds(see table 1) have touched an all time high figure of $ 10 bn for year 2010.

 

The minimum tenor of the investment in listed corporate bonds would be five years. Also,these investments are now permissible in unlisted instruments.However these investments will have a locking period of three years.During the lock-in period, FIIs will be allowed to trade among themselves but the investment cannot be sold to domestic investors. To facilitate trading by FIIs, exchanges will provide a special window on the same lines as equities in companies where the overall FII investment reaches the maximum limit.

 

The companies in the infrastructure space that are borrowing are SPVs that depend on project financing and their rating is quite low. Unless there is a framework where institutions can provide guarantees for infra companies' debt, it will become difficult for these companies to issue bonds. So while, the announcement is unlikely to result in any significant change in allocation for India immediately, over the next few years this could help the Infrastructure companies and developers of roads, ports, airports and power plants access to more foreign funds. With few takers for bonds, infrastructure providers often find it tough to raise debt as there are restrictions on the amount of loans that banks can extend to a company or a sector.

 

The government is trying to increase the availability of funds for infrastructure projects as it hasbeen estimated that $1 trillion would be required to be invested in the sector to bridge the deficit that is seen as one of the biggest drags on stepping up economic growth. The Economic Survey that preceded the budget was more specific and forecasts that over the next five years (Eleventh Plan), an investment of $ 320 billion will be required for investment in the core infrastructure areas.This translates into a mind-boggling average annual expenditure of $65 billion in the Eleventh Plan commencing 2007-08.Obviously, the Government cannot provide all the funds needed even though, under the present circumstances, it will continue to play a dominant role.

 

So Infrastructure in India will be built only using a public-private partnership model. In some sectors like telecom, airports and power, the model has been tested and achieved encouraging result. In some others like ports, roads, railways and urban transportation, the models are evolving and have had moderate success. The problem for some time will remain in sectors like water, sanitation, waste management and urban infrastructure where all models have failed. Unfortunately these are the sectors that most glaringly showcase India in a poor light to visiting foreigners restraining them from looking at the avenues a worth investing.

 

The inability of government to provide fund for infrastructure projects is quite evident as for a long time to come social infrastructure such as education and health and to a large extent rural infrastructure will engage the Government's attention. Hence the only way out is innovative solutions to raise resources for a wide range of infrastructure sectors such as telecom, ports, roads, airports and even railways. Some of these have shown considerable progress recently.

 

To meet the growing need of external funding government has been very keen on allowing more access of foreign funds. The increase in limit in bonds is a clear vindication of that.The changes are so clearly visible that Indian market which allowed only $ 3.5 bn FII investment in corporate bond(see table 2) till 2006, now allows $ 50 bn investment in bond by FIIs.

 

To attract foreign funds into the infrastructure sector, the government also plans to create infrastructure debt funds and to cut withholding tax to 5 percent from the current 20 percent.

 

So while regulations have been eased there is a very remote possibility that it will result into glut of funds for Infrastructure sector in India.The factors like maturity period, credit guaranteeand innovative market models still don’t match the expectation of the investor and so there is need for more comprehensive approach to solve India’s infrastructure woes. Clearly India has a long way to go before it catches up with its global peers but the steps like increasing limit for FII into Infra bonds are definitely a milestone for the sector.

 
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