Regulatory roadblocks and fears of government interference threaten India’s resurgent infrastructure sector
For many observers, last summer’s Commonwealth Games in Delhi – with its collapsing bridges, falling ceilings and substandard accommodation – not only symbolized India’s infrastructure deficit, but also told the world about it. Others thought it was high time a light was shone on a murky part of the country’s economy.
“With various scandals in the limelight, foreign players do consider such factors before making any investment decisions,” says Ravi Bishnoi, a co-founding partner of SRGR Law Offices, a Noida-based law firm with a significant infrastructure practice. “Investors are more cautious now,” he adds.
Fortunately India moved rapidly to make amends. The central government stepped in and brought the Delhi metropolitan administration to heel. After a brief panic, emergency teams shored up the faltering infrastructure, the games were considered a success and India was able to take pride in its revitalized “can-do” attitude.
“The criticism was more aimed at the government mishandling and organizers of the Commonwealth Games and not at the business of infrastructure,” says Raja Sujith, a partner at Majmudar & Co in Bangalore. “The proof is that the Cricket World Cup tournament, which started in February, has attracted huge infrastructure investment.” (For coverage of the infrastructure issues associated with hosting large events, see A sporting challenge, page 24.)
A threat to economic growth
India’s infrastructure issues are certainly not new: recent World Bank Enterprise Surveys, completed in more than 100 countries, found that the three main deterrents to private investment worldwide are complex regulatory environments, lack of access to finance and inadequate infrastructure. While India suffers from all three, the bank learned that more than half of companies report that the lack of reliable electricity is a major constraint to doing business in the country.
In another survey, this time by Pricewaterhouse-Coopers, 88% of Indian chief executive officers said that the inadequacy of basic infrastructure was a threat to the country’s growth.
So the irony is that while investors in other sectors are deterred by inadequate infrastructure, prospective infrastructure investors are staying away on account of overly complex regulations and the lack of attractive financing. As long as this vicious circle is left unbroken, economic growth will inevitably suffer.
Aware of the problems it faces, the Indian government aims to increase investment in infrastructure to more than 9% of GDP by 2012 and spend US$1 trillion on infrastructure during the 12th five-year plan, which will be from 2012 to 2017.
Infrastructure also took centre stage in the recent union budget, announced by the finance minister, Pranab Mukherjee, on 28 February. The government pledged to create infrastructure debt funds and boost infrastructure development with issues of ₹300 billion (US$6.2 billion) in tax-free bonds. Meanwhile, the limit for foreign institutional investors to issue five-year corporate bonds for investment in infrastructure was raised from just US$5 billion to US$25 billion.
Private equity investors, already upbeat about infrastructure, were heartened by Mukherjee’s budget pledge to broaden the definition of the sector. “Capital investment in fertilizer is to be treated as infrastructure investment and infrastructure status will be given to cold storage chains,” says Pradeep Chokhani, a partner in MountHill Investment Advisors, a Chennai-based private equity fund.
Mukherjee also said the government would formulate a comprehensive policy for developing public-private partnerships (PPPs).
“Collaborative structures – particularly PPPs – continue to be the structure of choice for private investment in India’s infrastructure,” says John Sullivan, a partner at Mallesons Stephen Jaques in Sydney. (See Flavour of the month, page 22.)
Nevertheless, private investment has declined slightly in recent months. “The foreign money intake in the Indian infrastructure and energy sectors has slowed down somewhat in the very recent past,” says Manoj Bhargava, a partner in the Singapore office of Jones Day, which is working on five Indian energy and infrastructure transactions.
The slowdown is partly attributable to the recent financial crisis. “The growth of infrastructure is directly proportional to availability of finances, says Ravi Singhania, the managing partner of Singhania & Partners. “The recession had a defining effect. Banks adopted a stringent lending policy regarding loans, and hence funds for infrastructure projects were not easily available to investors.”
Singhania is now seeing signs of an upturn. “Funding, especially private sector and overseas funding, has increased,” he says. “Policymakers in various sectors have continued with reforms and several large projects have managed financial closure. Deals in the private equity market suggest that funds are relatively easily available now, which is a good sign for the infrastructure market.”
The “infrastructure market is showing signs of gradual progress,” concurs Bob Nelson, a partner at Akin Gump Strauss Hauer & Feld. “There has been a good amount of international interest, with a broad range of foreign companies bringing India into their sight.”
Discussing the role that foreign investors should be playing, Nelson says that “the best opportunities come from linking up with strong and transparent Indian partners, whether through joint development, co-investment, or passive investment modes”. He advises investors to look at small and medium-sized projects, where there is less chance of falling foul of public or government opposition or supply chain problems.
Slamming on the brakes
In spite of the immense opportunities and renewed interest by foreign investors, regulatory difficulties all too often act as a deterrent. “The challenges extend to market access barriers, limitations on the repatriation of invested capital, restrictions on offshore lending and governance issues,” says Natalie Kurdian, a senior associate at Mallesons Stephen Jaques.
Other challenges arise not from the laws themselves, but from their implementation by India’s sprawling bureaucracy. “Although India has a well-developed legal system, the regulatory environment can be complex,” says Shapna Roy, the head of projects at London-based Wedlake Bell. “There is no single regulator who formulates the policy for all infrastructure projects. Co-ordinating between different sectors’ ministries or regulatory authorities can be complex.”
Vinod Surana, a partner at Chennai-based Surana & Surana, is more forthcoming. “In our experience, anything to do with the government causes delays and uncertainties,” he says bluntly. “Many delays can occur and even government policy can change suddenly, but you have to know how to manage it.”
Despite this, Surana is optimistic and says the government is under tremendous pressure to perform. “People are becoming more aware and there is a realization among the political classes that they have to show results.”
In addition to bureaucratic hurdles, Anand Desai, the managing partner of DSK Legal in Mumbai, believes that the three major obstacles to infrastructure development are related to land acquisition, the system of approvals and dispute resolution.
Land acquisition is a major reason for project delays in India. “In most countries, land is acquired before the bidding for a project begins,” says Desai. “However, in India, the government will – in most cases – put the land acquisition obligation on the developer of the infrastructure project. This makes timely completion of projects difficult.”
India is moving slowly towards a “single-window” approvals system, Desai acknowledges. “However, in the absence of such a system, the consent and approval required from various authorities for development of infrastructure projects creates an impediment.”
In terms of dispute resolution, Desai notes that many problems stem from the enforcement of arbitral awards. While the majority of commercial infrastructure contracts provide for arbitration, the enforcement of decisions is a “time-consuming process in view of the many challenges
brought before Indian courts, causing considerable delays”.
Other observers blame a lack of judicial precedents and the inexperience of Indian lawyers – particularly where PPPs are concerned – for delays in the dispute resolution process. Writing in this month’s Vantage point (page 14), A Balasubramanian, the senior director of project finance at Infrastructure Development Finance Company, warns that Indian lawyers are inexperienced in handling PPPs, and that many lack an understanding of fundamental issues, such as the balancing of public- and private-sector interests.
“Lawyers need to be trained in several areas relating to infrastructure, PPPs and project finance,” he says. “It is vital that they possess a thorough understanding of all the delicate issues that come into play.”
A ghost from the past
Energy is one of the most vibrant areas of India’s infrastructure sector, and also one of the most troublesome.
The debacle over the proposed sale of Cairn India to Vedanta Resources, for example, is a cause of great concern among investors. In August 2010, Cairn Energy, which owns 63.38% of Cairn India, announced that it was to sell 51% of its stake to London-listed Vedanta. However, as state-owned ONGC holds a stake in most of Cairn India’s properties, the government needs to approve the deal. It has so far been dragging its feet on this, partly due to an ongoing dispute between the two companies over the sharing of royalty payments. Reports suggest that a solution is being worked out and the sale should go ahead. But if government approval is not obtained by 15 April, the deal is due to lapse.
All of this has given investors the jitters. For some, it has revived unpleasant memories from the past. “The Cairn-Vedanta matter underscores concerns that reached a high water mark during the Dabhol period,” says Nelson.
Investors in electricity, meanwhile, are bemoaning government interference in the form of new caps on their tariffs. “Due to the social obligations of the government, the revenues in some sensitive projects like power have been capped,” says Jagannadham Thunuguntla, the head of research at SMC Global Securities, a brokerage in Delhi.
“This will obviously deter investment,” says Nelson, “as will the trend to go more to straight price-based bidding situations.”
Other experts doubt that such limits will affect overall investment. “These caps will not in any manner prove to be detrimental to the interest of potential investors,” says Bishnoi at SRGR Law Offices. “These policies are expected to be investor friendly and ceilings will be imposed considering the expectation of the investors.”
Nevertheless, lawyers are also concerned about other difficulties. “There is a lack of clarity in the upstream sector on tax holidays and in the pricing of gas,” says Sumanto Basu, a partner at J Sagar Associates in Gurgaon. “Conventional power projects face issues on coal linkages, gas availability and environmental challenges.”
New sources of energy
Nuclear power has been encouraged by the passage of the Civil Liability for Nuclear Damage Act, 2010. “This has paved the way for India to have a capacity of 20 gigawatts by 2020 and 63 gigawatts by 2032,” says Kumkum Sen, a partner at Bharucha & Partners in Delhi. “However, there are concerns over the provision of liability of the suppliers,” she notes.
The government’s efforts to promote clean energy have met with mixed success. “The hot technology since last year has been solar,” says Basu. “Solar power projects have received a tremendous response because of the Jawaharlal Nehru National Solar Mission.”
The government received bids to develop 5,126 megawatts of solar power production in the first round of the mission. Power trading company NTPC Vidyut is expected to buy the output of the solar plants and bundle it with cheaper coal-fired electricity to be sold to distribution companies as a package.
However, concern has been expressed over the low bids – just ₹12-22 per kilowatt hour – submitted by distribution utilities. “There is some concern as to the viability of solar projects at [such] lower-than-expected tariffs,” says Basu, who adds that the Indian wind-power sector continues to grow and mature.
On the move
“Transport sectors like roads and railways have a lot to offer prospective investors for years to come,” observes Priyabrat Tripathy, the in-house counsel at Isolux Corsán in Mumbai. Indeed, with only 47% of India’s 3.38 million kilometres of road currently paved, the country’s highway building project holds enormous potential.
“India’s highways development project is cited as the world’s largest PPP project and has attracted US$41 billion, including foreign direct investment,” says Roy at Wedlake Bell.
Railways have been another success story, led by the Delhi Metro, and fuelled by those under construction in Mumbai, Bangalore and Hyderabad.
Things are also looking up in the aviation sector. India is now the ninth largest civil aviation market in the world and saw overall growth of 18.3% in its domestic airlines during 2010. “The Airport Authority of India has plans for modernizing 35-40 non-metro airports across the country and 25 more airports are on the verge of completion,” says Sujith at Majmudar & Co.
The airports are facing limits on the fees they can charge airlines. “In the case of airports, the lack of competition makes the business susceptible to monopolistic tendencies, and to discourage those, the revenues of airports have also been rightly capped,” says Thunuguntla. “This certainly raises concerns in the mind of potential investors.”
The ports sector, meanwhile, is poised for significant growth driven by new manufacturing and power projects and higher cargo traffic at ports. “An increase in containerized trade, coupled with the government’s initiatives to develop the Indian ports sector is expected to further boost growth,” says Shardul Thacker, a partner at Mulla & Mulla & Craigie Blunt & Caroe in Mumbai.
Thacker notes that as a by-product of the infrastructure boom, significant investment is flowing into ancillary “soft infrastructure” areas, such as computer software and hardware, environmental technologies, education and training, design and planning services, and – not least – financial, advisory and other professional services.
India’s infrastructure finance environment has been expanding along with individual subsectors. However, infrastructure projects are characterized by non-recourse or limited recourse financing, where lenders are dependent on project-generated cash flows. “This has deterred foreign investors from tying up capital in long-term infrastructure projects in India,” says Prabjot Bhullar, a partner at Khaitan & Co in Mumbai.
Bhullar also cites the mix of financial and contractual arrangements among several stakeholders; the risks pertaining to the design, construction and operation of the project; and the inherent market, economic, regulatory and political risks as potentially discouraging to foreign investment.
Foreign lawyers agree: “Most of the financings to date have been domestic-led, with the likes of State Bank of India at the top of the rankings,” says Bill McCormack, a partner at Shearman & Sterling, who leads the firm’s infrastructure work in Asia. “But there are recent indications that there is some interest in US dollar debt from offshore banks.” McCormack cites Hong Kong-based CLP’s 1,320 megawatt Jhajjar electricity generation project in Haryana as an example.
Boom time for lawyers?
Law firms play a crucial role in determining a project’s success. “The first and most important task of international and domestic firms is to try to help clients to find suitable onshore and offshore partners for projects,” says Nelson.
Indian law firms provide opinions on the bidding process and on entering into definitive agreements and contracts on winning the bid. “This also involves negotiating and reviewing each contract clause – such as arbitration, indemnity or insurance – in accordance with the prevailing Indian laws,” says Sujith. They also weigh the legal risks of a project by conducting due diligence, he adds.
Another key function of Indian law firms is to assist foreign investors in their dealings with government authorities. “In the event of excesses by the state, the law firm can protect its clients by challenging the decisions before the appropriate courts or arbitrators,” says Singhania.
The key challenge for international law firms is to find a role alongside their domestic counterparts. “The likes of Amarchand and Luthra & Luthra have had huge successes advising on the financings of large India projects,” says McCormack. “To the extent we see an opening up of the financings to international commercial banks, ECAs [export credit agencies] and development banks then a greater role may emerge for a global firm with expertise in project and structured finance.”
Offshore law firms are also looking for a piece of the infrastructure pie. A significant number of infrastructure transactions in India are financed by foreign investors, many of whom prefer to make their investment through offshore centres.
“There are two main reasons for this,” says Craig Fulton, the head of Conyers Dill & Pearman’s office in Ebene Cybercity, Mauritius. “The first is that quite often these investments are made by way of a pooled investment arrangement such as an investment fund or joint venture company.”
Fulton says it is generally preferable to set up such a fund or joint venture company in a neutral, well-regulated jurisdiction with a developed and effective legal system.
“This is where offshore law firms are able to assist,” he adds. “The second reason is that a number of offshore jurisdictions have favourable tax treaties with India and hence by having an offshore law firm assist you in structuring your investment through a vehicle in one of these jurisdictions the investment in the infrastructure transaction can be made in a tax efficient way.”