Infrastructure and its financing in India

Infrastructure is where growth, public finance and banking meet, which is why the topic is a favourite for the RBI. In the 2000s, banks lent heavily to power, roads and steel projects. Many stalled over land, clearances, fuel supply and over-optimistic traffic forecasts. The loans turned bad, and the Economic Survey 2016–17 called the result the "twin balance sheet problem": stressed companies and stressed banks. So an ESI answer on infrastructure is really an answer about how to finance long-lived assets without breaking the banking system.

What counts as infrastructure

The government's Harmonised Master List of Infrastructure Sub-sectors groups infrastructure into five categories: transport and logistics, energy, water and sanitation, communication, and social and commercial infrastructure (such as hospitals, education institutions and affordable housing). Being on the list matters: it opens access to longer-tenure loans, infrastructure bonds and specialised lenders.

Economists also separate:

• Economic infrastructure: roads, railways, ports, airports, power, telecom, logistics.
• Social infrastructure: schools, hospitals, water supply, sanitation, housing.

Why infrastructure matters

• Lower costs: reliable power and faster freight cut costs for every firm, which improves export competitiveness.
• Market integration: roads and rail connect farms and factories to larger markets.
• Crowding in: public investment can trigger private investment in nearby industry and services.
• Multiplier: construction spending creates jobs and demand in the short run.
• Quality of life and inclusion: water, sanitation and connectivity reach people directly.

Why financing is hard

Infrastructure projects have four features that ordinary lending handles badly:

1. Large, lumpy capital up front.
2. Long gestation: little revenue during construction.
3. Long payback: revenues stretch over 15–30 years.
4. Risks outside the lender's control: land acquisition, environmental clearances, regulated tariffs and demand risk.

The asset–liability mismatch

Banks fund themselves mainly with deposits, most of which have short maturities. A 15-year road loan financed with one- to three-year deposits exposes the bank to liquidity risk (deposits must be rolled over) and interest rate risk (deposit costs can rise while the loan rate is fixed or slow to reset). Concentration in a few large borrowers adds credit risk. This is why banks alone cannot finance infrastructure at scale.

A lender's test: debt service coverage

Lenders judge a project by its debt service coverage ratio (DSCR):

• DSCR = cash flow available for debt service ÷ (interest + principal due in the period)

Example (illustrative): a toll road earns ₹180 crore in a year and spends ₹50 crore on operations and maintenance, leaving ₹130 crore. Its debt service is ₹100 crore. DSCR = 130/100 = 1.3. If traffic is 20% below forecast, revenue falls to ₹144 crore and cash flow to 144 − 50 = ₹94 crore. DSCR = 0.94: the project cannot meet its debt service without support. This is exactly what happened to many projects bid on optimistic traffic forecasts.

Sources of finance

Two tools deal directly with the maturity problem. Take-out financing lets a bank lend during construction and then sell the loan to a long-term lender once the project operates. The RBI's flexible structuring (5/25) scheme of 2014 allowed long project loans to be amortised over up to 25 years with refinancing every five years, better matching the project's life.

Public–private partnership models

Viability gap funding (2006 scheme) supports PPP projects that are economically justified but not commercially viable: the Centre can fund up to 20% of project cost, and the sponsoring authority can add up to another 20%.

The Kelkar Committee on revisiting and revitalising the PPP model (2015) recommended better risk allocation, renegotiation frameworks for stressed contracts, an independent regulator, and not using PPPs merely to shift costs off budget.

Recent initiatives

• National Infrastructure Pipeline (2019–25): a project pipeline of about ₹111 lakh crore, compiled by a task force.
• PM Gati Shakti National Master Plan (2021): a GIS-based digital platform so that ministries plan roads, rail, ports, gas pipelines and fibre together.
• National Logistics Policy (2022): aims to cut logistics costs and improve coordination.
• National Monetisation Pipeline (2021): about ₹6 lakh crore over 2021–22 to 2024–25 from leasing operating public assets (roads, transmission lines, stations) to private operators, without selling ownership, and recycling the money into new assets.
• Higher public capital expenditure: central budgets have raised capex as a share of GDP since 2020–21 and given states long-term interest-free capex loans.

Model answer outline (15 marks)

Question: Why has infrastructure financing been difficult in India? Suggest reforms to make it sustainable.

1. Opening: infrastructure's role in growth; the twin balance sheet episode.
2. Nature of the problem: lumpy capital, long gestation, regulatory and demand risk.
3. Bank-specific issues: asset–liability mismatch, concentration, weak DSCR on optimistic forecasts.
4. Market gaps: shallow bond market, limited long-term institutional money, weak municipal finances.
5. Reforms so far: NaBFID, InvITs, HAM, VGF, take-out finance, asset monetisation, Gati Shakti.
6. Way forward: deeper bond markets and credit enhancement, faster land and clearance processes, dispute resolution, independent regulators, realistic bidding.
7. Conclusion: the aim is to move infrastructure debt from bank balance sheets to long-term investors once projects are operating.

Short model answer (10 marks)

Question: Explain the hybrid annuity model. Why was it introduced?

The hybrid annuity model, adopted for highway projects in 2016, combines features of EPC and BOT. The government pays 40% of the project cost during construction, in instalments linked to progress. The private developer raises the remaining 60% through equity and debt. After completion, the government pays the developer annuities with interest over the operating period, and the developer maintains the road. Toll collection and traffic risk stay with the government.

It was introduced because the BOT toll model had stalled. Developers had bid on aggressive traffic forecasts, faced delays in land acquisition and clearances, and could not raise equity when traffic fell short. Banks, already carrying stressed infrastructure loans, stopped lending to such projects.

HAM shares risk more fairly. The government's construction support lowers the developer's financing need, and annuities remove traffic risk, making the project easier to finance. The cost is a larger fiscal commitment and continued reliance on the government's balance sheet.

Practice questions

1. How many categories does the Harmonised Master List of Infrastructure have?
   • Five.
2. If cash available for debt service is ₹90 crore and debt service is ₹75 crore, what is the DSCR?
   • 1.2.
3. Under HAM, what share of project cost does the government pay during construction?
   • 40%.
4. What is the maximum viability gap funding from the Centre under the 2006 scheme?
   • 20% of project cost.
5. Which regulator frames the rules for InvITs?
   • SEBI.
6. Under which PPP model does the private developer bear traffic risk?
   • BOT toll.

What to do next

• Draw the PPP table from memory and mark who bears each risk.
• Note the latest capex allocation and NaBFID's progress from official sources.
• Revise with the fiscal policy guide and the MSME guide.