Project Number: 31901 Equity Investment Number: 7138-IND Project Number: 38926 Loan Number: 2169-IND December 2011 Equity Investment and Long-Term Loan to Infrastructure Development Finance Company (India) In accordance with ADB’s public communications policy (PCP, 2005), this abbreviated version of the XARR excludes confidential information and ADB’s assessment of project or transaction risk as well as other information referred to in paragraph 126 of the PCP. Extended Annual Review Report
Equity Investment and Long-Term Loan to Infrastructure Development Finance Company (India)
In accordance with ADB’s public communications policy (PCP, 2005), this abbreviated version of the XARR excludes confidential information and ADB’s assessment of project or transaction risk as well as other information referred to in paragraph 126 of the PCP.
Extended Annual Review Report
CURRENCY EQUIVALENTS
Currency Unit – Indian rupee (Rs)
At Appraisal At Project Completion 19 April 2005 31 March 2011
Rs1.00 – $0.02 $0.02 $1.00 – Rs43.73 Rs44.75
ABBREVIATIONS
ADB – Asian Development Bank CAGR – compounded annual growth rate CAR – capital adequacy ratio CSR – corporate social responsibility ECB – external commercial borrowing EMSP – environmental management system and procedure EROIC – economic return on invested capital ESDD – environmental and social due diligence ESG – environmental, social, and corporate governance ESMG – environmental and social management group FI – financial intermediary FID – foreign direct investment GDP – gross domestic product HUF – Hindu undivided families IDFC – Infrastructure Development Finance Company IFC – infrastructure finance company IFI – international financial institution IPO – initial public offering LIBOR – London interbank offered rate NBFI – non-bank financial intermediary NPA – nonperforming asset OCB – overseas corporate body PAI – project administration instructions PAU – project administration unit PB – private bank PPP – public–private partnership PSB – public sector bank QIP – qualified institutional placement RBI – Reserve Bank of India REC – Rural Electrification Corporation ROAA – return on average assets ROAE – return on average equity ROIC – return on invested capital SBI – State Bank of India SBU – strategic business unit SCB – scheduled commercial bank WACC – weighted average cost of capital XARR – extended annual review report
ii
NOTES
(i) The fiscal year of Government of India and most of India’s public and private institutions and corporations runs from 1 April to 31 March. The fiscal year (FY) of Infrastructure Development Finance Company ends on 31 March. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2011 ends on 31 March 2011.
(ii) In this report, "$" refers to US dollars.
Vice-President L. Venkatachalam, Private Sector and Cofinancing Operations Director General P. Erquiaga, Private Sector Operations Department (PSOD) Director R. van Zwieten, Capital Markets and Financial Sectors Division, PSOD Team leader C. Engstrom, Dealing Officer, PSOD Team members C. Abuel, Project Analyst, PSOD
I. Chua, Investment Officer, PSOD
In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.
CONTENTS
Page BASIC DATA i EXECUTIVE SUMMARY ii
I. THE PROJECT 1
A. Project Background 1 B. Key Project Features 2 C. Progress Highlights 2
II. EVALUATION 3
A. Project Rationale and Objectives 3 B. Development Impact 4 C. ADB Investment Profitability 17 D. ADB Work Quality 18 E. ADB’s Additionality 20 F. Overall Evaluation 20
III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS 20
A. Issues and Lessons 20 B. Recommended Follow-Up Actions 21
APPENDICES 1. Project-Related Data 22 2. Private Sector Development Indicators and Ratings: Infrastructure 27 3. Industry and Operations Review 33 4. Financial Statements 37
BASIC DATA Equity Investment: Infrastructure Development Finance Company, Ltd. (7138 - IND)
Key Project Data
As per ADB Equity Investment Documents
($ million) Actual
($ million)
Total project cost ADB investment:
Equity: Committed Disbursed
30.0
30.0 30.0
30.0
30.0 30.0
Key Dates Expected Actual
Board approval First disbursement First disposal Final disposal
1997 1998 2005 2006
1997 30 Mar 1998 29 Aug 2005 15 Sep 2006
Project Administration and Monitoring No. of Missions No. of Person-
ADB = Asian Development Bank, ORM = Office of Risk Management, PSCM = Capital Markets and Financial Sectors Division, XARR = extended annual review report.
ii
BASIC DATA
Loan: Infrastructure Development Finance Company (2169-IND)
Key Project Data
As per ADB Loan Documents ($ million)
Actual ($ million)
Total Project Cost ADB Investment:
Loan: Committed Disbursed
50.0
50.0 50.0
50.0
50.0 50.0
Key Dates Expected Actual
Concept Clearance Approval Board Approval Signing of Loan Agreement First Disbursement Loan Maturity
2004 2005 2007 2007 2017
23 Sep 2004 19 Apr 2005
20 Mar 2007 07 May 2007
( )
Project Administration and Monitoring No. of Missions No. of Person-
( ) = not applicable, ADB = Asian Development Bank, ORM = Office of Risk Management, PSCM = Capital Markets and Financial Sectors Division, XARR = extended annual review report.
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EXECUTIVE SUMMARY
India began economic reforms in 1991 that liberalized trade and industry, opened up several sectors to foreign and private investment, and increased the role of market forces in the economy to encourage greater participation by the private sector. As the economy grew rapidly in years that followed, the Government of India recognized that huge amounts of investment would be required to develop and rehabilitate the infrastructure sector if the country was to sustain targeted economic growth of 9% a year. India’s financial markets also needed strengthening because the supply of long-term funding to match the longer tenor requirements of infrastructure financing was grossly inadequate. To help meet these challenges and provide impetus to infrastructure development, the government successfully sought the help of ADB and other international financial institutions (IFIs) in the establishment of the Infrastructure Development Finance Company (IDFC) in 1997. With an equity investment of $30 million in IDFC for a 6.1% equity stake, ADB was one of the founding investors in IDFC and helped formulate the company’s business plan and strategy. The presence of nominees of ADB and other IFIs on the IDFC board enhanced IDFC’s lending practices and standards. The IDFC became the premier infrastructure finance company for catalyzing private capital participation in commercially viable infrastructure investments in India. By July 2005, the initial mandate of the ADB and its partner IFIs to help the government establish and nurture the IDFC had been fulfilled and the company’s success had paved the way for it to enter the public equity markets.
Prior to the IPO, ADB approved a $50 million foreign currency loan in 2005 to
supplement the company’s long-term funding requirements through Loan to Infrastructure Development Finance Company (India). ADB’s loan helped the IDFC leverage additional financing from foreign investors and domestic financial institutions. ADB’s presence in IDFC has continued to provide comfort to IDFC’s other creditors and has encouraged commercial banks to participate in infrastructure finance.
The development impact of ADB’s loan and equity investment in IDFC is rated excellent
when evaluated against four criteria: (i) private sector development; (ii) business success; (iii) economic development; and (iv) environment, social, health, and safety performance. This extended annual review report rates overall impact of ADB’s investment on private sector development excellent.
The IDFC today is not only the largest private infrastructure finance company in India but
also highly regarded for innovative products and effectively channeling retail funds into infrastructure projects and for its major contribution to the marked growth in the private sector’s share in infrastructure financing. The IDFC’s financial and business performance remained robust despite the economic slowdown during FY2008. The IDFC’s contribution to overall economic development was also measured by its significant involvement in almost every large infrastructure project in India since 1997 through project financing and advisory services.
ADB’s loan to the IDFC was classified in the financial intermediary category under ADB's
Environment Policy (2002). The IDFC adopted comprehensive environmental management systems and procedures that are consistent with ADB’s and other IFIs’ standards. ADB’s loan was classified as a Category C project for impact on indigenous peoples. No involuntary resettlement of indigenous peoples has resulted from the IDFC's activities. The IDFC employs a robust environmental and social management system and ADB’s loan is rated satisfactory in this regard.
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ADB's work quality is rated excellent based on (i) the screening, appraisal, and structuring of the project; (ii) monitoring and supervision; and (iii) ADB's role and contribution. ADB’s screening, appraisal, and structuring of the equity and the loan projects were excellent because the investments fulfilled their objective of establishing a premier infrastructure finance company in India. ADB’s continuing participation in the IDFC through the existing loan demonstrates ADB’s commitment to expanding infrastructure finance by encouraging more active private sector participation. Monitoring and supervision of the investment is rated satisfactory. The Private Sector Operations Department has periodically monitored the IDFC's compliance with the regulatory agencies’ prudential requirements and ADB’s submission covenants. ADB's role and contribution is also rated excellent as it was instrumental in the successful public listing of IDFC shares. ADB’s presence in the IDFC as an institutional lender provided an opportunity for IDFC to leverage this loan to raise additional long-term funds from many other sources.
As a founding investor, ADB has been able to participate in strategic management
decisions and enhance corporate governance, risk management, and environmental and social management. ADB's additionality is rated satisfactory.
ADB’s overall experience with the IDFC has been highly successful and has greatly
benefitted India’s infrastructure, financial, and private sectors. It is an undertaking that should be replicated in ADB’s other developing member countries.
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I. THE PROJECT
A. Project Background
1. Since India’s partnership with the Asian Development Bank began in 1986, it has since secured $24 billion in ADB loans for over 150 projects in more than 20 states. 2. ADB has been instrumental in supporting India’s policy reforms in the financial sector and capital markets, particularly in improving access to credit and developing long-term financial instruments.1 These projects helped initiate a fundamental restructuring of the country’s financial sector but large investment needs in infrastructure remained unfilled because not enough long-term financing was available. The country’s infrastructure bottleneck in the 1990s was further exacerbated by ineffective governance in India’s cities and states and regulatory uncertainty, both of which impeded the development of infrastructure projects. The Government of India had long been aware that meeting the development requirements of the infrastructure sector was vital to sustaining the country’s economic growth and, in 1997, this awareness led to the establishment of the Infrastructure Development Finance Company (IDFC). 3. To inspire confidence among capital market investors and initiate key infrastructure reforms, the government asked ADB in 1997 to help formulate a strategy for the IDFC and to invest in the company’s equity. After extensive preparation, ADB made a direct equity investment of $30 million in IDFC in 1998, joining several other international investors.2 Foreign investments made up 40% of IDFC equity while the government and government entities retained 48%. The remaining balance in IDFC’s ownership was shared by private domestic financial institutions. By the time of an initial public offering (IPO) in July 2005, the objective of ADB’s equity investment—to help the government establish and nurture premier infrastructure financing company and catalyze private sector infrastructure investments—had been achieved. ADB therefore exited the investment by divesting its share during the IPO and over the following 13 months. 4. India’s rapid economic growth had widened the gap between infrastructure needs and the investments available to meet them. Prior to the IPO and its equity divestment, ADB approved a $50 million foreign currency loan in 2005 to supplement the company’s long-term funding requirements.3 The ratio of infrastructure investment to GDP, historically low, was only about 3% in 2006, although it gradually improved to an average of 5.6% annually during 2007–2011. ADB’s loan responded to India’s need for support from multilateral development banks and foreign commercial banks to fill the large financing gap for long-term infrastructure projects. That need continues. The government estimates that the country will have to spend as much as $1 trillion during 2012–2017 to sustain a targeted annual economic expansion of 9%.4
1 ADB approved a $300 million Financial Sector Program (Loan 1208 IND) on 15 December 1992 to enlarge the
access of the private sector to financial savings, improve the efficiency of financial intermediation, enhance competition and diversity among financial institutions, allow banks greater operational flexibility and autonomy, introduce international standards of accounting and capital adequacy, improve supervision, and develop the market for government securities. Furthermore, ADB approved a $250 million Capital Market Development Program (Loan 1408 IND) on 28 November 1995 to promote the development of India’s long-term debt and equity markets.
2 ADB. 1997. Report and Recommendations of the President to the Board of Directors on a Proposed Equity
Investment in Infrastructure Development Finance Company. Manila. 3 ADB. 2005. Report and Recommendations of the President to the Board of Directors on Proposed Loan to
Infrastructure Development Finance Company. 29 March. Manila. 4 This estimate was cited by Prime Minister Manmohan Singh at a conference on building infrastructure in New Delhi
on 23 March 2010. http://www.livemint.com/2010/03/23213711/Government-plans-1-trillion-s.html
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B. Key Project Features
5. The equity investment approved by ADB in September 1997 of the equivalent to up to $30 million in IDFC’s capital aimed to create a strong infrastructure financing company that would catalyze private capital into commercially viable investments. ADB’s 61 million shares amounted to a 6.1% equity stake. It initially divested 30% of its shareholdings during the IPO in July 2005 and finally sold the balance in September 2006 after the IDFC had been firmly established as a specialized financial institution. 6. Continued ADB support remained necessary as the IDFC embarked on a period of strong business growth. Shortly before the IPO, ADB approved a $50 million foreign-currency denominated loan in March 2005 to support the IDFC’s growing number of infrastructure projects. The loan was fully disbursed on May 2007. Its tenor of 10 years (including a grace period of 3 years) was longer than previous foreign currency loans extended to finance infrastructure projects by other domestic financial institutions in the market. C. Progress Highlights
7. The IDFC was established in January 1997 as a public–private partnership (PPP) to provide long-term financing for sustainable infrastructure projects in India. During its early years, the company focused on project finance and government advisory services to enhance its knowledge base. The IDFC participated in the formulation of policies on removing obstacles to growth in the infrastructure sector. It developed a broad understanding of the risk and opportunities associated with the business and created a market position through innovative products and solutions in infrastructure finance. As the IDFC portfolio grew, it diversified into asset management, loan syndication, corporate advisory, investment banking, and institutional brokerage. This enhanced its competitive strength as a complete solutions provider and its position as one of the top infrastructure financing companies in the country and an important part of infrastructure development in India. 8. To provide an exit for institutional investors, the IDFC entered the capital markets on 15 July 2005 with its IPO of 403,600,000 shares at a price of Rs34 per share through the book building process. The offering included 283,600,000 existing shares and 120,000,000 new shares, which raised over $91 million of fresh capital. The shares were oversubscribed by 37 times and on 12 August 2005 were listed on the National Stock Exchange and the Bombay Stock Exchange. By partially divesting the government shareholdings from 40% to 26%, the IPO facilitated much wider private sector participation in infrastructure development. 9. In July 2007, the IDFC raised $500 million additional capital through a qualified institutional placement (QIP) by issuing 165,354,330 shares at Rs127 each. The proceeds of this offering were used, among other things, to further strengthen IDFC’s capital, support its lending operations, and provide seed capital to some of the private equities that IDFC manages. This effectively reduced government shareholdings to 23%. 10. Following the global financial crisis of 2008–2009, the IDFC scaled down its activities and moderated its growth target in a prudent response to the economic slowdown. Asset quality became its paramount objective. Despite this cautious approach and the economic adversity, its growth in terms of assets during 2008 was 6.1%. It also consolidated its businesses during this period by focusing on improving execution and efficient cost management.
3
11. Sustained economic growth in India provided a positive investment climate for infrastructure developers at the start of FY2010. The infrastructure investment-to-GDP ratio in India grew steadily during the year by 5.5%, up from 3.0% during FY2009, which signaled that implementation of past infrastructure projects was continuing. The IDFC’s loan portfolio expanded 50.2% in FY2011, carrying on the momentum built in the second half of FY2010.
12. To support its growing lending activities, the IDFC raised additional capital equivalent to $750 million through QIP and issuance of compulsory convertible preference shares in June 2010. This was the largest QIP in the country since an aluminum producer raised $600 million in November 2009. 5 The deal was launched at a fixed price of Rs168.25 per share. The compulsory convertible preference share has a 6% cash dividend per annum and can be converted anytime to equity shares during the next 18 months at a conversion price of Rs176 per share. The second QIP reduced the government shareholding to 18%.
13. In keeping with the IDFC’s mission of nation building, the company established the nonprofit IDFC Foundation in 2011, which consolidated the functions of its policy advisory group and its department of corporate social responsibility (CSR). The foundation’s mandate is to lead private capital to infrastructure projects by providing thrust to the rationalization of policy and regulatory frameworks, promoting public–private-partnership models, policy advocacy, and direct CSR activities.6 It formed sector advisory boards that are helping to develop the energy, transport, urban, rail services, health care, and education sectors. Through the efforts of the IDFC, the annual India Infrastructure Report is being published by IDFC in collaboration with the Indian Institute of Management in Ahmedabad and the Indian Institute of Technology in Kanpur.7 In each new report, several authors address a specific infrastructure theme as well as current experience and critical issues in the sector as a whole. The report aims to stimulate fresh thinking that can translate into courses of action by infrastructure stakeholders and has become the standard reference source for information on the sector in India. 14. The IDFC initiated a capacity building program in 2008 through its investment in the India PPP Capacity Building Trust (I-Cap) and the India Infrastructure Initiative Trust (Triple-I). Using an initial grant from KfW and support from consultants from the World Bank, the investment aims to train 10,000 government officials in 14 states in preparing and managing PPP projects.
II. EVALUATION
A. Project Rationale and Objectives 15. ADB’s direct equity investment in the IDFC sought to help the government establish a specialized financial institution that would inspire confidence among private investors and encourage them to provide long-term funds for commercially viable infrastructure projects. The project was consistent with ADB’s operational strategy for India at the time, which supported efforts to achieve economic growth through infrastructure development, private sector development, good governance, and environmental protection.8 ADB’s involvement in the initial phase of the IDFC’s operation, along with that of other international financial institutions (IFIs)
6 IDFC. 2010. Thirteenth Annual Report 09-10.Building One Firm. Mumbai.
7 IDFC together with the chairman of Council of Environment, Power, and Water in India released the 2010 India
Infrastructure report on 20 October 2010. http://www.idfc.com/foundation/policy/india_infrastructure_report.htm 8 ADB. 1996. Country Operational Strategy Study: India. July 1996. Manila; ADB. 2003. Country Strategy and
Program: India, 2003–2006. Manila.
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and multilateral development banks, enhanced the company’s credibility in the market. As a dedicated infrastructure finance company, the IDFC augmented the resources needed to support India’s large funding requirement for infrastructure investment. Existing financial institutions were constrained by the size of their balance sheets and prudential limits on the funding they could allocate for infrastructure financing. 16. India’s long-term debt market is still in the early stage of development. IDFC’s infrastructure bonds will pave the way towards the development of a domestic long-term debt market. A successful IDFC will encourage growth of private capital through credit enhancements and introduction of innovative products that assure lenders and investors of stable and fair returns. IDFC’s involvement through sector representation provides an avenue for policy advocacy, capacity building programs, and government advisory services that will catalyze institutional development in infrastructure finance (paras. 27−32). ADB’s exit in 2005 concluded these objectives. 17. ADB’s $50 million foreign currency denominated loan to the IDFC in 2005 is a confirmation of ADB’s continued support to the company. The loan facility was aimed to support the significant investment requirements in infrastructure that would help India achieve its economic growth targets. The loan would enable the IDFC to provide dollar subloans to eligible subprojects with dollar-based revenues and thus improve their cost and maturity profiles. B. Development Impact 18. The development impact of ADB’s equity investment and loan to IDFC is rated excellent. It was evaluated on four criteria: (i) private sector development, (ii) business success, (iii) economic sustainability, and (iv) environment, social, health, and safety performance.
1. Private Sector Development
a. Overall Assessment of Private Sector Development 19. ADB’s development objectives for both its equity investment and its loan to IDFC have been achieved. The IDFC today is the premier infrastructure financing company in India. It has successfully entered the capital markets, which has contributed to wider private sector participation in infrastructure development. On this basis, ADB’s contribution to private sector development is rated excellent.
b. Beyond Company Impact
20. Objective 1. The first objective of the projects was to support the government by establishing a premier infrastructure financing company that would catalyze private capital investments in commercially viable infrastructure projects. Prior to the IDFC’s formation, ADB provided inputs to a government-appointed expert group on commercialization of infrastructure projects, which recommended the establishment of IDFC.9 After the government’s request that ADB help prepare a strategy for the IDFC and participate in its equity, ADB conducted due diligence missions in March and April of 1997. ADB worked with a multifunctional task force to ascertain the extent of support for the IDFC and to formulate an operating strategy and
9 In October 1994, the government appointed the group to review the condition of the country’s infrastructure,
recommend a new approach to accelerate private investment in infrastructure, and promote PPPs.
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preparation of a business plan.10 ADB’s deep involvement at the very early stage of the IDFC’s development and equity participation as a founding investor has demonstrated ADB’s commitment to support the government in establishing a premier infrastructure finance company. 21. IDFC initially focused on the core business of project finance and government advisory to enhance its existing knowledge base and deepen its understanding of risks and opportunities in infrastructure finance. It devised innovative products and financing structures that provided good value propositions to its customer base and revolutionized the infrastructure financing sphere. After its initial growth, the IDFC accelerated project financing by mobilizing private equity funds to support infrastructure projects. The IDFC engaged in the brokerage and asset management business to facilitate the financing of infrastructure projects that were capital intensive and therefore would provide lower returns to shareholders on a stand-alone basis. Through these businesses, the IDFC achieved its mandate of catalyzing private capital for infrastructure projects while maintaining lower capital requirements and ensuring higher returns to shareholders.
22. Private equity funds provide equity-based risk capital for the early stages of development of infrastructure projects. As of the end of FY2011, total assets under IDFC private equity management amounted to $1.1 billion (Table 1).
Table 1: Infrastructure Development Finance Company Private Equity Funds
Item India Development
Fund Private Equity
Fund II Private Equity
Fund III Year launched 2004 2006 2008 Amount raised ($ million) $190 million $440 million $644 million Investors composition 100% domestic Mixed
a Mixed
a Foreign investors comprised 70% of the fund, which include the Government of Singapore Investment
Corporation, Credit Suisse, and ADB, among others. Source: Infrastructure Development Finance Company.
23. In 2007, to attract private capital investments in the operating assets of infrastructure projects, the IDFC formed the IDFC Project Equity Company, a wholly owned subsidiary. The IDFC Project Equity Company Limited is the investment manager of the India Infrastructure Fund (IIF). The IIF is focused on long-term equity investments in a diversified portfolio of infrastructure projects in India in sectors such as power, roads, ports, airports, electricity and gas transmission, and distribution networks. The IIF seeks to achieve attractive risk-adjusted returns over the long term by investing in infrastructure projects in India that exhibit strong, predictable and stable cash flows in the form of dividend distributions with low volatility of returns and have potential for capital growth. It raised a total of $930 million in June 2009 for direct equity investment in infrastructure projects. 24. The IDFC continues to evolve and in July 2010 became the first non-bank financial intermediary (NBFI) to be accorded the status of an infrastructure finance company (IFC) by the Reserve Bank of India (RBI). There are only six IFCs in India, three of which are major financial institutions with balance sheets of over $7 billion: (i) IDFC, (ii) Power Finance Corporation and (iii) Rural Electrification Corporation. IDFC is a privately held company while Power Finance Corporation and Rural Electrification Corporation are owned by the government. The other three IFCs are small players: L&T Infrastructure Finance, Power Trading Corporation India Financial Services, and Shrei Infrastructure Limited. The IDFC’s new status as an IFC has widened its
10
Footnote 2.
6
ability to tap both domestic and international capital markets. The creation of the IDFC has proved an inflection point in catalyzing greater participation by private capital in commercially viable infrastructure investments in India. 25. Objective 2. ADB’s projects also sought to help the government meet the infrastructure development requirements for sustained economic growth. Growth in infrastructure correlates directly with sustainability of growth and a country’s overall economic development. Early in 2011, the government estimated that India needs to spend $1 trillion on infrastructure for the Twelfth Five Year Plan (2012−2017) if it is to sustain an annual GDP growth rate of 9%. In 2006, India was investing only 3% of its GDP in infrastructure projects, compared with 14% by the People’s Republic of China. The investments came primarily from government budgets and public sector firms financed by state-owned banks.11
26. The IDFC is unique in India in that it is a private entity but was organized as a government initiative and still retains strong government support. By collaborating with government agencies in addressing sector policy issues and maintaining partnerships with foreign investors to assure continuous funding, the IDFC helps the government achieve its infrastructure targets. During 2007–2011, investments in infrastructure projects increased markedly in the energy generation, transport, and telecommunication sectors, among others. The ratio of infrastructure spending to GDP averaged 5.6% during this period, compared with only 3% in 2006 (Table 2).
Table 2: India’s Gross Domestic Product and Infrastructure Spending
Item 2007 2008 2009 2010 2011 Nominal GDP ($ billion) 1,187.3 1,261.9 1,364.5 1,728.5 1,956.4 Real GDP growth (%) 9.7 9.0 6.7 8.0 8.5 Infrastructure spending to GDP (%)
8.3 5.8 3.0 5.5 5.6
GDP = gross domestic product. Sources: Economist Intelligence Unit. 2011. Country Report: India. September. Mumbai; Government of India,
Finance Ministry, Central Statistics Office.
27. The implementation starting in 1991 of government reforms in financial, regulatory, and administrative policies had a pervasive impact on infrastructure and have boosted India’s economic growth. To ensure the effective performance of the IDFC’s core finance function, the IDFC’s development strategy is now complemented by four key areas of development: (i) policy advocacy, (ii) capacity building initiatives, (iii) government transactions advisory services, and (iii) CSR. 28. The IDFC has been involved in almost all endeavors on policy formulation related to infrastructure.12 As of the end of FY2011, the IDFC had been nominated to transport sector, power distribution, urban water and sanitation sector government committees, as well as financial sector reform committees.13 The IDFC played a pivotal role in providing advice to the government in the development of legal and regulatory frameworks that promote sustainable growth in the infrastructure sectors. The IDFC has advisory boards composed of prominent and knowledgeable persons who provide advice on private financing issues and advocate policies that help remove impediments to growth in the respective sectors. The IDFC’s policy advisory
11
Finance Asia . 2011. Infrastructure Alchemists. May. 12
Back-to-office report of ADB nominee’s mission, dated 15 March 2004, based on account of an IDFC board meeting.
function is independent from its financing activities. Best practices for each of the sectors in infrastructure are determined and integrated into policies and regulations for use by various stakeholders. The two most active boards are the following:
(i) Energy advisory board. In FY2011, India expected an energy deficit of 8.8% and peak power shortages of 10.2%. The country needs to increase energy generation to address the perennial power shortages in the sector, which is beset by difficulties in logistics and the deteriorating viability of energy distribution. Through the workings of the energy advisory board, public policy was crafted that streamlined the regulatory framework for land acquisition and environmental clearance for coal-based power projects, including logistical support assurance for large power projects like port privatization, road building, and upgrading and expansion of India’s rail network, which ensures delivery of coal and natural gas to these projects.14 The establishment of special land acquisition units at the state level in FY2010 doubled the rate of acquisition compared to the average annual acquisition during the most recent 3-year period (FY2007−FY2009). The power sector launched a national campaign for enhanced energy efficiency in FY2011 that promotes energy efficient processes, products, and services. To increase awareness of renewable energy, the streamlined regulatory framework is creating a market for renewable energy to boost investment in clean energy through renewable energy certificates.
(ii) Urban advisory board. About Rs2 trillion is needed each year to finance the huge backlog in urban infrastructure requirements, according to the IDFC’s policy advisory group. This includes projects for urban roads, water supply, sewerage, and solid waste management. The IDFC’s advisory contribution in FY2011 to a so-called high-level government-appointed expert committee report provided insights into the current status of urban infrastructure and an opportunity to advocate change. The report highlighted development problems in the government’s largest urban infrastructure development project, the Jawaharlal Nehru National Urban Renewal Mission, including weak governance and poor finances that were obstructing growth in urban infrastructure. As a reform measure, the expert committee recommended the launching of a PPP urban infrastructure fund to promote capacity building, project development, and financing support from private capital.
29. RBI created the IFC subcategory of NBFIs in February 2010. The IFCs have more liberal borrowing limits than normal banks, automatic access to external commercial borrowings up to 50% of net owned funds, and the ability to issue tax-free, long-term infrastructure bonds.15
30. The IDFC is helping building capacity for 10,000 government officials through its investment in I-Cap and its training programs (para. 14). Trainers were selected from a list of faculty members from India’s technological institutes. I-Cap was launched in December 2010 and was appointed by the Ministry of Finance as the executing agency for implementing a national capacity building program for training officials of state governments, urban local bodies, and selected central government departments through existing institutes of public administration across 14 states. I-Cap was appointed by Ministry of Urban Development as the regional capacity building hub for elected representatives and municipal officials under the Jawaharlal Nehru National Urban renewal mission for mission cities in three regions (para. 28(ii)).
14
Footnote 11. 15
To encourage a greater flow of capital from the private sector and in response to a request of the NBFIs, the RBI in 2010 amended its 2007 regulations to introduce the special category.
8
31. The IDFC provides advisory services to governments and agencies to enable them to provide better services to users of public infrastructure. The IDFC Foundation has joint advisory ventures with governments of Karnataka, Uttarakhand, and Delhi states that promote private sector engagement in infrastructure development that substantially benefit from the flow of private capital and management expertise. This program’s successes have included the following projects:
(i) With the support of these advisory activities in Infrastructure Development Corporation (Karnataka) Limited and Uttarakhand Infrastructure Development Company Limited, private sector funding has flowed into such infrastructure projects as state highways in Bihar, Karnataka, and Gujarat states, bus concessions in Delhi, tourism properties on the Andaman and Nicobar islands, and integrated solid waste management facilities in Hardwar district of Uttarakhand.
(ii) The Delhi Integrated Multi-Modal Transit System Limited implemented a state-of-the-art transport monitoring and intelligent-signaling system, which manages the issuance of driving licenses and a GPS-based vehicle tracking system for all public buses in Delhi.
32. Part of the IDFC’s goal is to support socially relevant initiatives in infrastructure development. The IDFC endeavors to make its internal operations more environmentally sustainable, to support projects that are responsive to the needs of the general public, and to thereby provide an example for other IFCs. 33. Objective 3. ADB’s investments aimed to support the government’s strategy to encourage private sector participation in infrastructure development and develop the long-term debt market. In 2006, private sector-funded infrastructure projects in India accounted for about 20.0% of total infrastructure spending. This was concentrated mostly in the telecommunication and power sectors.16 During 2008−2010, the private sector’s share increased to an average of 34.3% of total infrastructure investments. 17 The rise can be ascribed to the IDFC’s policy advocacy, which played a major role in shaping the government’s policy framework on infrastructure. The IDFC’s support for these reform measures helped open the way for an expanding flow of significant private investments in infrastructure projects. The government supported these needed reforms in 2011 by (i) reducing the withholding tax rate from 20% to 5% on income derived by foreign institutional investors from infrastructure debt funds, and (ii) increasing the limit from $5 billion to $25 billion for investments in corporate bonds of infrastructure companies with a residual maturity of over 5 years.
34. The decision by RBI in February 2010 to introduce the IFCs as a new category of NBFIs was an effort to increase the flow of private capital to infrastructure investments (paras. 21 and 24). The advantages of designation as an IFC included
(i) a lower risk weight on an IFC’s bank borrowings compared to other NBFIs, from 100% to as low as 20% for AAA borrowers;
(ii) an increase in an institution’s borrowing from the 15% of the bank’s capital funds earmarked for the NBFIs to 20% for IFCs, provided that such on-lending is used in the infrastructure sector;
16
Footnote 11. 17
Footnote 13.
Source: National Bank of Azerbaijan
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(iii) higher external commercial borrowing (ECB) for infrastructure financing of up to 50% of owned funds, subject to compliance with the applicable prudential guidelines and hedging of currency risk in full; and
(iv) an increase in the single borrower exposure limit to 25% of net owned funds from the 20% for other NBFIs and in the industry concentration limit to 40% of net owned funds from 35% imposed on the other NBFIs.
35. The IDFC raised Rs14.5 billion in FY2011 from over 730,000 domestic retail investors through the issuance of long-term bonds to the public. The IDFC’s direct bond issue tapped market opportunities by leveraging the Rs20,000 income tax exemption under the Income Tax Act of 1961 for individuals who are making an investment in long-term infrastructure bonds. The tax incentives helped efficiently utilized India’s high domestic savings by channeling individual financial resources into the long-term debt market. Notwithstanding the relatively high cost of retail bond distribution, the IDFC’s bond issue opened a window for diversifying its funding sources and contributed to the development of long-term debt market.
36. India’s debt market in FY2003 was composed largely of government securities, which made up about 75% of outstanding debt. Total corporate debt raised in the primary market during the year was Rs531 billion, mostly with maturities of 60, 84, and 120 months. US dollar-denominated syndicated loans totaled only $1.6 billion, with very few issues maturing beyond 5 years.18 ADB’s loan to IDFC in 2005 had a 10-year term. In the years following ADB’s loan disbursement to IDFC, the Indian debt market grew significantly due to government reforms that encouraged wider private sector participation in long-term financing of infrastructure projects. During 2006–2011, private corporate bonds and debentures held by commercial banks grew by a compounded annual growth rate (CAGR) of 20.1% to Rs1.1 trillion, while net inflow of funds from foreign institutional investors grew by a CAGR of 24.3% to $29.4 billion. The demonstration effects of the viable long-term loans from ADB and other foreign institutional investors have helped India’s long-term debt market gradually develop (Table 3).19
Table 3: India’s Debt Market
Item 2006 2007 2008 2009 2010 2011 Bonds/debentures held by banks (Rs billions) 447.0 454.3 519.3 642.0 709.7 1,116.4 Bonds issued by private corporations (Rs billions) 295.5 276.4 287.0 331.3 400.7 660.3 Bonds issued by other FIs (Rs billions)
151.5 177.9 232.3 310.7 309.0 456.1
Net inflow of funds from FIIs ($ billion) 9.9 3.2 20.3 -15.0 29.0 29.4
FI = financial institutions, FIIs = foreign institutional investors Source: Reserve Bank of India.
c. Direct Company Impact 37. The IDFC has grown since its establishment in 1997 into the largest privately held infrastructure finance company in India. Its balance sheet has expanded since inception at a compounded annual rate of 30% and reached $11 billion at the end of FY2011. The company continues use the large foreign participation in its equity and debt capital to attract investments
18
Footnote 3. 19
Footnote 3.
10
and loans from domestic commercial banks and other financial institutions. In 2010, the IDFC became the first NBFI to be accorded IFC status by the RBI. Through the participation of ADB and other foreign institutions, the IDFC has evolved into a diversified private infrastructure company with one of the highest standards of corporate governance, risk management, and environmental and social management in India. 38. Objective 4. ADB’s presence in IDFC helped attract foreign equity participation from international banks and insurance companies, and provided comfort to investors in IDFC bonds. At the government’s request, ADB made the investment in IDFC in 1998 along with several international institutions, banks, and insurance companies (para. 3). ADB’s presence as a shareholder gave confidence to other international investors during the company’s early growth years. 39. Since the IPO, foreign equity participation in IDFC equity has gradually increased, rising from Rs4,987 million in 2006 to Rs7,464.9 million in 2011 (Table 4).20 This translates to a CAGR of 8.4%. Through the IPO and qualified institutional placements in 2007 and 2010, government shareholding was effectively reduced from 40% to 18% during 1997–2011, giving the private sector greater equity. Foreign ownership of IDFC’s total capital as of the end of FY 2011 was 51%, up from 40% at inception. ADB’s active participation in IDFC helped in the marketing of the IPO to institutional investors. Had the IPO not been successful, ADB’s objective of encouraging private sector participation and attracting more foreign capital might have been significantly weakened.
Table 4: Infrastructure Development Finance Company’s Shareholding Structure
FDI = Foreign direct investment, FI = financial institution, FII = foreign institutional investor, IC = insurance company. Source: Infrastructure Development Finance Company’s annual reports, 2006–2011.
40. ADB approved a long-term loan to the IDFC in March 2005 even before ADB divested its shareholding in 2006. ADB’s continued presence in the IDFC as a creditor helped secure investor support when the IDFC launched its first bond issuance in September 2010 (para. 35). 41. Objective 5. ADB’s equity investment was intended to enhance the IDFC’s chances for success as the first financial institution in India to focus exclusively on infrastructure. ADB played a key role in the creation, establishment, and structuring of IDFC during the early stage of its development. As a founding investor, ADB was able to provide advice and guidance in preparing the IDFC’s business plan and to influence the structuring, capitalization, policies, and procedures the company adopted. 21 The IDFC went through an initial period of internal development. With ADB’s help, IDFC invested time and financial resources to develop best practices in credit appraisal. The IDFC developed credit tools enhanced by information technology over the years that have helped make it successful by making it efficient when evaluating infrastructure finance projects.
20
The shares are listed on the Bombay Stock Exchange and the National Stock Exchange. 21
Footnote 2.
11
42. The IDFC is now recognized as the leading source of knowledge and financing expertise in building India’s infrastructure. The IDFC was ranked the third largest project finance company in Asia and the Pacific in 2009 by Thompson Reuters and since 2006 has diversified its services into investment banking, private and project equity, asset management, and other services.22 The IDFC has received several awards in India by developing domain knowledge in project structuring, appraisal, and risk management.23 It has also developed expertise in financing a variety of products and introduced innovative financial products and structures that allow a broader cross-section of lenders and investors in infrastructure financing. 43. The success of the IDFC in developing infrastructure finance in India has in some ways, been replicated or being considered by ADB’s other developing member countries that are looking for institutional arrangement to stimulate reform in the infrastructure sector and to increase private sector participation in infrastructure finance and domestic debt market development. The success of the IFCs in India has made the country the preferred choice of investors with an appetite for private equity investment in emerging markets.24 With objectives similar to those it first pursued in its support of the IDFC, ADB helped established PT Indonesia Infrastructure Finance in January 2010 as one of its founding investors. 44. Objective 6. ADB’s loan to IDFC sought to catalyze commercial bank participation and facilitate the IDFC’s access to long-term funding. When ADB began divesting its shareholding, the IDFC still needed long-term funding and the $50 million loan facility agreement signed in March 2005 helped sustain the company’s requirements for funding infrastructure projects. ADB’s continued involvement in the IDFC inspired investor confidence both internationally and domestically (para. 38). In the years since ADB’s loan disbursement in 2007, the IDFC has secured long-term loans from various international lenders. 45. The loans extended by IFIs have in turn catalyzed the participation of commercial banks and facilitated the IDFC’s access to increased long-term funding. In addition, its IFC status provided the IDFC with an avenue to raise more capital through ECBs, which opened access to a new class of international debt finance agencies.25 During 2006–2011, the IDFC’s loan funds grew by a CAGR of 31.1% from Rs93.8 billion to Rs363.0 billion. Nonconvertible debentures and long-term loans from banks made up the bulk of IDFC’s loan funds. Term loans from banks grew by a CAGR of 18.9% during 2006−2011 (Table 5).
Table 5: Infrastructure Development Finance Company’s Sources of Funding (Rs billion)
Source: Infrastructure Development Finance Company’s annual reports, 2006–2011.
22
Footnote 11. 23
Back-to-office report of ADB representatives during the XARR mission, dated 19 September 2011, based on account of a senior IDFC official.
24 Preqin. 2011. Preqin Investor Outlook: Private Equity. H2 2011. The Opinions of 100 Leading LPs on the Market and Their Plans for the Next 12 Months. New York.
25 ECBs include bank loans, supplier and buyer credits, securitized instruments, and borrowings from private sector windows of multilateral financial institutions. The government allows India’s companies and public sector undertakings to use ECBs as an additional source of funds for their financing needs, although not for investment in stock markets or speculation in real estate.
12
46. Objective 7. ADB sought to enable the IDFC to provide continued support and dollar funding to subprojects and improve the cost and maturity profile of subprojects. ADB’s dollar loan to the IDFC has achieved this objective. The IDFC had the option to raise funds from the domestic corporate bond market before ADB’s loan. It could swap its rupee bond proceeds to dollars and still avail of dollar financing costs from the swap that were lower than the cost of direct commercial bank borrowing. However, the IDFC was willing to forego the cost efficiency of swapping rupee bond to dollars to avoid exhausting the funding available from the local bond market by using its bank limits for swap transactions. As an NBFI, the IDFC faced limits on the tenor and amount that it could raise through the domestic debt market. Most of the available forms of financing were limited to terms not exceeding 5 years and subject to compliance with the regulatory regime of the central bank. This made the need to broaden the base of funding sources of paramount importance. 47. The US dollar proceeds of ADB’s $50 million loan constituted the IDFC’s first offshore foreign currency funding. The loan enabled it to provide loans to eligible projects and particularly to those engaged in the operation of ports and airports. These operations provided a natural hedge on foreign exchange risk. Projects such as the Gujarat Pipavav Port, Dharma Port, and Delhi International Airport had the capacity to generate US dollar revenues that could match the US dollar subloan repayment requirements.
48. The IDFC has the option to lend in rupees provided that a US dollar–rupee swap is secured to mitigate the exposure to foreign currency risk. The IDFC’s dollar debts without forward contracts represented only a small portion of its foreign currency-denominated debt in FY2011, although the share has fluctuated significantly since 2006 (Table 6). When IDFC started lending, it obtained swaps on ADB’s dollar loans in accordance with the requirements of the RBI, fully hedging its foreign currency and interest exposure on ADB’s loan, which were then fully lent out in rupees. The longer tenor of ADB’s loan, which was previously not available in the market, matched the requirement of the subprojects for longer maturities, thus improving the cost and maturity profile of subprojects.
Table 6: Infrastructure Development Finance Company—Foreign Currency Debt
Debt 2006 2007 2008 2009 2010 2011 Total ($ million) 25.0 250.0 450.6 517.9 488.3 625.6 With forward contracts ($ million) 8.5 233.4 314.9 405.9 383.2 609.1 Without forward contracts ($ million) 16.5 16.6 135.7 112.0 105.1 16.5 Without forward contracts (%) 66.0 6.6 30.1 21.6 21.5 2.6 Source: Infrastructure Development Finance Company annual reports, 2006–2011.
49. Objective 8. ADB sought to enhance the IDFC’s environmental and social safeguards policies, procedures, and capabilities. ADB’s continued participation in IDFC helped IDFC improve its environmental management system. Within a year after its formation in 1997, the IDFC organized an environmental and social management group (ESMG) to (i) map out the environmental risks associated with infrastructure financing, and (ii) set up an environmental management system and procedure (EMSP). ADB and the other IFIs participated in the formulation of the IDFC’s EMSP, coordinating closely with the ESMG. In 2000, the IDFC approved its first EMSP and has used it since then. 50. ADB conducted an environmental due diligence on 6-10 September 2004 to complete the assessment of IDFC’s environmental management systems. The due diligence harmonized
13
the existing EMSP with the international standards of environmental management. Although the IDFC’s EMSP substantially complied with ADB’s Environmental Policy (2002) and Environmental Assessment Guidelines (2003), which are applicable to financial institutions and private sector operations, improvements were needed in several areas. 51. In response to ADB’s observations, the IDFC made its EMSP more robust and environmentally and socially responsive. The EMSP ensures that an infrastructure project will (i) adequately identify the environmental and social risks, (ii) incorporate the correct environmental management practices during the entire life of the project, and (iii) comply with India’s applicable environmental legislation.
2. Business Success 52. Financial and business performance. The IDFC’s robust financial and business performance is rated excellent. Table 8 shows the IDFC’s financial highlights for 2006–2011, beginning with the year in which it was registered as a publicly listed company.
Table 8: Infrastructure Development Finance Company’s Selected Financial Data (Rs million)
53. After its IPO in July 2005, IDFC’s assets quadrupled from Rs123.0 billion in FY2006 to Rs493.2 billion in FY2011. This is equivalent to a CAGR of 32.0%. In FY2008, the company scaled down its project finance activities and moderated its growth target in a prudent response during the economic slowdown. It achieved more modest asset growth of 6.1% and focused on maintaining asset quality rather than rapid expansion. With the gradual economic recovery, gross infrastructure loans subsequently increased markedly to Rs382.1 billion in FY2011 from Rs255.4 billion in FY2010. The sustainable demand for infrastructure financing allowed the IDFC to accelerate its lending. As of the end of FY2011, the ratio of infrastructure loans to loan funds jumped to 103.7% from 93.4% in FY2010. Infrastructure loans comprised about 74% of total assets and have been growing at a CAGR of 31% since FY2006. This is more robust than the 23% annual credit growth posted by India’s banks during the same period.26 54. The ratio of nonperforming assets (NPAs) to gross loans at the IDFC has remained flat and quite stable during FY2006–FY2011. The IDFC’s average gross NPA ratio of 0.3% during 26
ICRA Research. 2011. Indian Banking Sector: Challenges unlikely to derail the progress made. New Delhi.
14
the period was far lower than the 2.5% NPA ratio of India’s commercial banks (Table 9). Its net NPA ratio was 0.1%, which represent about 0.5% of total equity. Credit default risk has been historically low for infrastructure lending and infrastructure credit portfolios in the banking system, including the NBFIs, have been much more stable than those for industry. In addition, strong risk management and the IDFC’s adoption of best practices in credit appraisal, including the use of information technology tools, have helped it further minimize risk.
Table 9: Average Financial Ratios of India’s Financial Institutions, FY2006–FY2011
(%)
Item IDFC SCBs PSBs PBs Gross NPAs to gross loans 0.3 2.5 2.5 2.4 Net NPAs 0.1 1.1 1.1 1.0 Net NPAs to equity 0.5 9.1 12.5 6.0 ROAA 3.1 0.9-1.1 0.9 1.4 ROAE 15.6 ( ) 18.7 13.3 ROAE Current year (2011) 14.0 13.7 18.0 14.0
( ) = data not available, IDFC = Infrastructure Development Finance Company, NPA = nonperforming asset, PB = private bank, PSB = public sector bank, ROAA = return on average assets, ROAE = return on average equity, SCB = scheduled commercial bank. Sources: ICRA Research; Reserve Bank of India 2010-2011 Annual Report.
55. In India, the corporate bond market has remained underdeveloped and the stock of listed non-public sector debt at 2% of GDP is significantly lower than in other emerging market economies, such as the People’s Republic of China, Korea, and Malaysia.27 Furthermore, loans extended by local commercial banks are constrained by an asset–liability mismatch and commercial banks’ support for infrastructure financing is limited. In FY2011, term loans from banks represented about 25.5% of the IDFC’s funding and 69.5% came from issuing debentures. During FY2006–FY2011, the company’s loan funds grew to Rs363.0 billion from Rs93.8 billion, at a CAGR of 31.1% and about the same annual growth rate as the loan portfolio.
56. As an NBFI, IDFC has relied heavily on wholesale loans to fund its lending portfolio. Its designation as an IFC in July 2010 enabled it to diversify its funding sources through automatic access to ECBs, refinancing from the India Infrastructure Finance Company, issuance of retail bonds, and increased limits for bank borrowings (paras. 34 and 45). In 2010, the IDFC issued its first long-term retail bonds. Total funds raised from retail investors reached Rs14.5 billion or about 3.0% of IDFC’s balance sheet size in FY2011. Notwithstanding the expensive nature of retail distribution and its relatively lower contribution to the overall funding pool, the issuance has created a window of funding diversification in IDFC.
57. During FY2006–FY2011, total shareholder equity grew by 4.4 times to Rs112.5 billion as strong earnings enabled the accumulation of reserves and surplus by a CAGR of 44%. Growth in shareholder equity was supplemented by additional capital through QIPs and issuance of compulsory convertible preference shares, which together generated $1.3 billion. To support the rapidly growing balance sheet, the IDFC strengthened its capital through the Rs34.9 billion issuance of primary shares via QIP at a price of Rs168.25 per share in June 2010. The offered price was equivalent to a price–earnings ratio of 20.5 and a price-to-book ratio of 3.2. This raised the total capital adequacy ratio to 24.5% in FY2011 from 20.5% in FY2010 and Tier 1 capital to 22.0% from 17.4%. The ratios exceed the 12% of capital required by the central bank
27
RBI. 2011. Reserve Bank of India Annual Report: 2010-2011. Mumbai.
15
regulations and the overall banking sector’s capital adequacy ratio of 14% in FY2011. The strong capitalization and improved profitability of the IDFC will provide an adequate cushion for potential losses in the future.
58. The IDFC had an average gearing ratio of 4:1 for the period FY2006–FY2011. The ratio was consistent with the standard guidelines of the India Infrastructure Finance Company that prescribe a maximum debt–equity ratio of 4:1 for financing infrastructure projects (Table 10).28
Table 10: Infrastructure Development Finance Company—Selected Financial Ratios
Ratio FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 Return on average equity (%) 15.2 18.3 17.3 12.7 16.1 14.0 Return on average assets (%) 3.2 3.3 3.1 2.5 3.2 3.0 Cost to income (%) 57.3 60.8 64.4 71.5 64.8 63.9 Infrastructure loans to loan funds (%)
107.5 93.4 89.2 87.5 94.3 103.7
Gearing ratio (times) 3.8x 5.2x 4.2x 3.9x 4.0x 3.4x Total CAR (%) 25.6 20.3 23.1 23.8 20.5 24.5 Tier 1 ratio (%) 19.2 16.1 20.3 20.0 17.4 22.0 Dividend payout ratio (%) 28.8 22.4 21.0 20.7 18.4 25.3 CAR = capital adequacy ratio. Source: Infrastructure Development Finance Company’s annual reports, 2006–2011.
59. The IDFC’s operating performance has been robust during FY2006−FY2011. Operating income increased by 4.8 times to Rs49.3 billion after the company entered the capital markets in 2005. Lending activities accelerated in the second half of FY2010 and provided the momentum for increased revenues. Average cost-to-income ratio was 63.8% during FY2006−FY2011. The IDFC’s 6-year return on average assets of 3.1% for FY2006−FY2011 was better that the average profitability ratios of commercial banks in India. Furthermore, the company’s return on average equity of 14.0% in FY2011 was also within the 13.7%–14.0% range recorded in FY2011 by scheduled commercial banks and private banks, although lower than public sector banks, which have higher leveraging capacity than privately held financial institutions. The IDFC’s average dividend payout ratio during FY2006–FY2011 was 22.8% of net profit after excluding the share of minority interest.
3. Economic Sustainability 60. Economic return on invested capital. During its development stage, the IDFC disbursed about Rs37.2 billion in loans, with net profit of Rs3.0 billion at the end of FY2005. During FY2006–FY2011, after its IPO, annual disbursements grew by a CAGR of 39% to Rs267.0 billion at the end of FY2011, while net profit grew each year by a CAGR of 26% to Rs13.0 billion at the end of FY2011(Figure 2). Taxes paid totaled Rs17.2 billion during the same period.
28
Government of India, Planning Commission. 2009. Financing Infrastructure Projects through the India Infrastructure Finance Company Limited. May. New Delhi.
16
61. ADB’s loan to IDFC is rated excellent. The high economic return was attributed to increased tax payments due to significant growth in IDFC profitability. More compelling than the company’s fiscal contribution to the government is the IDFC’s deep involvement in the transformation of infrastructure finance in India. Since its inception in 1997, it has participated in many large infrastructure projects through project financing and advisory services to
(i) 50% of government and privately financed large hydropower generation projects in India,
(ii) 50% of India’s container cargo capacity addition in ports, (iii) 20% of national highways constructed under PPP projects, (iv) 33% of international airports throughout India, (v) 50% of total telecommunication towers constructed in India, and (vi) 66% of Indian wireless subscriber base.29
4. Environment, Social, Health, and Safety Performance
62. ADB’s development impact on the environment, social, health, and safety investment is rated satisfactory. 63. Environment. ADB’s loan to the IDFC was classified as a financial intermediary project under ADB's Environment Policy (2002). A financial intermediary project involves a credit line or an equity investment to a financial intermediary and an environmental management system is required unless all subprojects will result in an insignificant environmental impact. For a financial intermediary specializing in infrastructure finance, lending involves subprojects with comprehensive development plans that can have pervasive and irreversible impacts on the environment. Such negative impacts, if not mitigated, will reduce the viability of infrastructure projects. To ensure the sustainability of financed projects, ADB’s loan aimed to enhance the
29
Footnote 23.
Figure 2: Infrastructure Development Finance Company’s Gross Loan Approvals and Disbursements, 2001–2011
IPO = initial public offering Source: Infrastructure Development Finance Company’s Fourteenth Annual Report 2010-11:
Partnering for Growth.
50
100
150
200
250
300
350
400
450
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Rs
bill
ion
sGross loan approvals,
Rs427 billion
Gross loan disbursements,
Rs267 billion
Pre-IPO
Post-IPO
17
IDFC’s environmental and social safeguards policies, procedures, and capabilities. One key objective of the loan was to develop an effective EMSP to mitigate any negative environmental impacts and ensure the project’s sustainability. 64. The International Finance Corporation considers the IDFC’s EMSP to be the best in India’s financial institution sector. 30 The EMSP requires subprojects to comply with both minimum government regulations and the IDFC’s own environmental parameters to lessen or mitigate negative project impacts. An environment management and social development group provides support in assessing the environmental and social issues and risks associated with infrastructure projects.31 Training and seminars are provided to senior officers and managers of the IDFC to keep them abreast of new environment and social management standards in areas such as financing for a sustainable low-carbon economy, climate change, hazardous waste management, and global best practices on land acquisition, resettlement, and rehabilitation.
65. The IDFC is committed to financing environmentally and socially sustainable infrastructure projects and no infrastructure project with high environmental and social risk has yet passed its EMSP. The company also has other achievements in environmental management:
(i) In 2010, it became India’s first signatory to the Principles for Responsible Investment, a global investors’ network initiated by the United Nations in 2006 that aims to help investors consider environmental, social, and governance issues in decision making.
(ii) The IDFC is a member of the United Nations Global Compact and a signatory to the Carbon Disclosure Project. It launched an internal project in FY2011 to minimize the company’s environmental impact and carbon footprint and has submitted an application to secure the US Green Business Council’s LEED Gold Certification (Leadership in Energy and Environmental Design) for its new office in Chennai.
66. Social safeguards. ADB’s loan to IDFC was classified as a Category C for impact on indigenous peoples.32 The project was classified as Category B/C for involuntary resettlement since it would entail little significant involuntary resettlement impact or none at all. The IDFC’s activities have not to date involved involuntary resettlement or any significant impact on indigenous peoples.33 The IDFC's strong policy advocacy on matters related to the infrastructure sector has resulted in meaningful government reforms on the environment. This includes the streamlining of procedures for securing environmental clearances and processing land acquisition, which resulted to environmental risk categorization of projects and faster acquisition of land for road projects. C. ADB Investment Profitability
67. ADB’s profitability on the equity investment is rated excellent. ADB’s investment in the IDFC consists of the equity investment and the loan. ADB initially held a 6.1% equity stake in the IDFC amounting to Rs610 million. In July 2005, the IDFC launched its IPO in keeping with
30
Back-to-office report of ADB fact finding mission, dated 7 October 2004, based on account of an International Finance Corporation’s official.
31 Footnote 13.
32 A Category C project does not require an indigenous peoples development plan or an indigenous peoples development framework.
33 Footnote 13.
18
the original objectives of IFI participation in the company. ADB divested all its shareholding in IDFC through the public markets.
68. IDFC’s loan profitability is rated satisfactory. The IDFC has been current on its principal and interest repayments to ADB. Given the strategic importance of ADB’s early-stage equity contribution to IDFC, this evaluation rates the profitability of ADB’s overall engagement excellent. D. ADB Work Quality 69. ADB's work quality is rated excellent based on its (i) screening, appraisal, and structuring of the project; (ii) monitoring and supervision; and (iii) role and contribution.
1. Screening, Appraisal, and Structuring of the Project
70. ADB's screening, appraisal, and structuring process is rated excellent. 71. Prior to ADB’s equity investment in the IDFC, a team composed of representatives from the Private Sector Operations Department and Office of the General Counsel conducted due diligence missions in response to the government’s request that ADB participate in the IDFC’s equity capital. The mission team worked with a cross-functional task force set up by the government to ascertain the extent of support required for the IDFC, including the formulation of an operating strategy and preparation of business plan. The operating strategy and business plan were further discussed during a meeting with IDFC officials in Manila in June 1997. ADB’s resources for financing private sector infrastructure projects were limited. Hence, an investment in the IDFC presented an opportunity for ADB to leverage these resources in India, where investment demand was huge and public funds short. 34 Given the breadth of government support and the considerable interest of foreign investors, an equity investment by ADB as founding investor provided a demonstration effect to complement that of other foreign institutions. 72. India’s economy had seen a remarkable improvement since the government initiated economic reform measures in 1991. However, investments in infrastructure development had remained inadequate and needed a boost to sustain India’s economic growth. Infrastructure capital provided mainly by the government was inadequate while maturity mismatches constrained the availability of private capital for infrastructure projects. In addition, India’s long-term corporate debt market was in the development stage and an active secondary market did not exist. The government was aware that it was crucial that these problems be addressed by eliminating administrative obstacles and introducing major policy reforms. The creation of the IDFC as a specialized financial intermediary was seen as a way to boost reforms in the infrastructure sector.
73. According to the initial capital structure plan, the government, the RBI, and the Industrial Development Bank of India would have 40% ownership of the IDFC. Although the government would be the largest shareholder, the RBI and the Ministry of Finance assured investors that management control would be entrusted to the company’s board, where private sector representatives would constitute a majority. Moreover, foreign investors would be given the opportunity to exit through the planned IPO. The public listing of the IDFC complemented ADB’s efforts in India to increase private sector participation in infrastructure investment.
34
Footnote 2.
19
74. ADB’s direct participation in IDFC demonstrated complementarity between ADB’s public and private sector operations in relation to ADB’s Private Sector Infrastructure Facility’s foreign currency loans for on-lending to subprojects, which was approved by ADB in November 1996.35 By requiring subprojects to issue rupee debentures against subloans, the IDFC enhanced the marketability of these securities by mobilizing local long-term currency funds to invest on these instruments.
75. Following its initial success, the IDFC needed to broaden the base of funding sources to support its rapidly growing balance sheet. A fact-finding and due diligence mission was conducted in 2004 by the Private Sector Operations Department, the Environment and Social Safeguards Division, and the Office of the General Counsel. ADB subsequently approved the $50 million dollar-denominated loan that could be on-lent to subprojects that had a natural hedge on foreign currency exchange risks. The IDFC could also effectively leverage this loan to raise investments and attract loans from domestic commercial banks and other financial institutions.
2. Monitoring and Supervision 76. ADB's monitoring and supervision is rated satisfactory. 77. The project administration unit (PAU) of ADB’s Capital Markets and Financial Sectors Division periodically monitors the IDFC’s business and financial performance. The IDFC submits quarterly unaudited financial statements and annual audited financial statements. Until 2010, the PAU prepared a quarterly private sector investment management report that summarized business performance during the period and evaluated financial results using prudential limits, current market price of IDFC shares, and relevant ratios as gauges. In 2010, this report was replaced by the private sector semiannual report, a more comprehensive monitoring tool that includes monitoring of sovereign performance, industry outlook, and the development effectiveness of the account. The IDFC has not breached any of the reporting covenants. 78. The PAU also conducts annual reviews of IDFC performance and the macroeconomic environment for a report submitted to the Office of Risk Management. As part of the annual report, the continued viability of ADB’s loan in the IDFC is evaluated.
3. ADB's Role and Contribution 79. ADB's role and contribution is rated excellent. 80. ADB’s equity investment in the IDFC was instrumental in the successful IPO, which effectively reduced government shareholding from 40% to 18% and paved the way for wider private sector participation in infrastructure finance (paras. 8 and 39).
81. ADB’s loan gave the IDFC the opportunity to leverage this loan by raising additional long-term funds from diverse sources. Before the loan was disbursed, potential infrastructure projects capable of generating dollar revenues had been identified. By leveraging ADB’s loan, the IDFC was able to finance almost every identified potential subproject.36 Furthermore, ADB’s 10-year term loan to the IDFC has demonstrated the viability of extending beyond the average 5-year loan term in India and contributed to the development of long-term debt market.
35
Footnote 2. 36
Footnote 23.
20
82. The appointment of the new chief executive officer (CEO) in January 2005 can be ascribed to the condition precedent included in ADB’s $50 million loan facility to IDFC. The appointment of the new chief executive officer provided greater focus by the IDFC management on the IPO plan and improved the company’s administrative coordination and management reporting.
E. ADB’s Additionality 83. ADB's additionality is rated satisfactory. 84. As a founding investor, ADB was given one of the two board seats on the IDFC board allocated for foreign institutional investors. ADB’s participation in strategic management decisions by the board helped the IDFC enhance its internal governance, improve its credit risk management, and ensure that an effective ESMP was put in place. 85. ADB also played a role in ensuring that the IDFC remained on course toward its original objective of becoming a premier finance company for catalyzing private capital investment in infrastructure. Through ADB’s nominee director on the board, ADB and all the other foreign investors remained firm on the original objectives of the investment and pursued an exit through IPO. ADB’s equity investment was instrumental in the successful public listing of the IDFC’s shares and ADB’s continued commitment to the IDFC, as evidenced by its loan, has had a positive influence on IDFC’s debt funding activities and its credibility in the market. ADB’s continued presence on IDFC’s lending list has helped catalyze additional investments by other strategic, institutional, and individual investors.
F. Overall Evaluation 86. Overall, ADB’s participation in IDFC is rated highly successful (Table 14).
Table 14: Evaluation of ADB's Equity Investment and Loan to IDFC
Item Unsatisfactory Partly
Satisfactory Satisfactory Excellent
A. Development Impact
1. Private sector development √
2. Business success √ 3. Contribution to economic development √ 4. Environment, social, health, and safety √ B. ADB's Investment Profitability √ C. ADB's Work Quality
1. Screening, appraisal, and structuring √ 2. Monitoring and supervision √ 3. ADB's role and contribution √ D. ADB's Additionality √
Overall Rating Highly Successful
Source: ADB.
III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS
A. Issues and Lessons 87. ADB approved the $50 million dollar loan to support infrastructure projects in India that possess a natural hedge against foreign currency risk. Airports in Mumbai and Hyderabad, as
21
well as ports in Ennore and Gujarat Pipav, were targeted investments due to their dollar-earning capacity. During the extended annual review mission, the IDFC confirmed that all its subloans are denominated in rupees. To mitigate the impact of foreign currency risk, the IDFC hedges its foreign currency borrowings by obtaining a forward contract on the loan’s principal or obtaining either an interest rate swap or full currency swap of the loan amount. ADB should consider providing a loan in local currency for similar projects in the future so that borrowers can avoid incurring additional costs in hedging transactions. B. Recommended Follow-Up Actions 88. The following follow-up actions are recommended:
(i) The IDFC’s exposure in the power and road sectors makes up about 70% of its loan assets. Significant growth will come from these sectors in the future. Energy generation in India comes from fossil fuels and harnessing clean energy. The IDFC has taken an active role in clean energy projects as the government focuses on investing in solar projects. However, India had a peak power deficit of 10.2% at the end of 2010 and the extent of clean energy infrastructure expansion currently being planned cannot meet the growing demand for power in India. ADB should increase its financial investment for clean energy projects in India considering this very substantial unfilled demand.
(ii) Notwithstanding the critical role played by the IDFC in providing infrastructure finance in India, a huge infrastructure investment gap remains that the combined financial resources of the government, India’s banking sector, and the NBFIs cannot fill. The linkages between capital markets and infrastructure need to be strengthened further by efficiently channeling resources from external financial markets and retail markets to sustain infrastructure development. The banking sector is constrained by exposure caps and the terms by which credit can be extended to infrastructure projects. As of 31 March 2011, only about 14% of the sector’s credit portfolio was in the infrastructure sector.37 ADB should consider increasing its role in providing financial intermediation to the banking sector to encourage wider private sector participation in infrastructure finance.
37
Footnote 26.
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PROJECT-RELATED DATA A. Overview
1. The Infrastructure Development Finance Company (IDFC) was organized in 1997 primarily to provide long-term financing for sustainable infrastructure projects in India. At the time, India’s economy was rapidly expanding after government liberalized trade and industry and opened up several business sectors to encourage larger foreign and private investments. Infrastructure development remained inadequate to sustain the country’s economic growth. The India Infrastructure Report noted in 1996 that India needed to increase infrastructure spending to about $30 billion per year starting 2001 to achieve a 7% ratio to gross domestic product (GDP). This compared with the current $16 billion per year in infrastructure development, which was equivalent to 5.5% of GDP. The demand–supply gap in infrastructure was huge. There was also a need to develop the long-term corporate debt market to effectively channel private capital into infrastructure investment and initiate policy reforms for each infrastructure subsector to eliminate infrastructure bottlenecks. International financial institutions supported the establishment of the IDFC through an aggregate 40% equity investment, including a 6.1% share held by the Asian Development Bank (ADB). ADB actively participated in the development of a business plan and formulation of strategies as part of a task force for the IDFC. A board seat was occupied by ADB’s nominee, which ensured that the IDFC would remain aligned with ADB’s policies.
2. In its development phase, the IDFC focused on its core businesses of project finance and government advisory. The company developed a deep understanding of the business and formulated innovative products and financing structures. It was involved in a lot of the policy initiatives undertaken in every infrastructure subsector. The IDFC developed credibility in infrastructure finance and became the leading infrastructure finance company in India. ADB’s development objective of supporting the government in establishing a premier infrastructure finance company to catalyze private capital in commercially viable infrastructure investments was achieved. In July 2005, the IDFC entered the public market through an initial public offering (IPO) of 403.6 million shares. The issue was oversubscribed 36.7 times, with over 630,000 applications. The shares were listed on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) on 12 August 2005. ADB divested the balance of its shares in 2006.
3. In March 2005, ADB approved a $50 million loan to the IDFC to support the company’s growing infrastructure project portfolio and to improve the cost and maturity profile of subprojects. The loan had a tenor of 10 years, including grace period of 3 years. The loan leveraged additional support for the IDFC because ADB’s continued participation in the company enabled it to attract more investments and loans from domestic commercial banks and other financial institutions.
4. Following years of rapid growth, the IDFC diversified in 2006 into asset management, loan syndication, corporate advisory, investment banking, and institutional brokerage. The IDFC maintained a strong capital position through a qualified institutional placement (QIP) to support its rapidly growing balance sheet. In keeping with its plan to increase private sector participation in infrastructure finance, the government gradually reduced its ownership in the IDFC from 40% at the outset to about 18% in 2011. The IDFC received the infrastructure finance company (IFC) status from the Reserve Bank of India (RBI) in July 2010, which has allowed it to source funding from the issuance of long-term, incentivized retail bonds. The IDFC was the first company in India to obtain IFC status.
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B. Business Platforms
5. The IDFC has strategic business units (SBUs) in four broad categories: (i) corporate and investment banking, (ii) alternative asset management, (iii) public market asset management, and (iv) the IDFC Foundation.
1. Corporate and Investment Banking
6. As a non-bank financial intermediary (NBFI), the IDFC provides financing services through lending, direct equity investment, and debt financing for infrastructure projects. Corporate and investment banking includes the following SBUs:
(i) Project finance. This is the IDFC’s core business and the main source of interest income. The IDFC lends to customers through financial instruments such as senior debt financing, subordinated debt, loans against shares, mezzanine finance, and equity. Senior debt financing in the form of loans, debentures, and securitized debt is the largest component of the loan assets. Project loans comprised about 58% of the IDFC’s loan portfolio in FY2011.
(ii) Fixed income and treasury. This SBU performs treasury business, which manages the IDFC’s liquidity and investment in debt instruments and debt capital markets business.
(iii) Investment banking and institutional brokerage. Investment banking is handled by IDFC Capital Limited while brokerage is the function of IDFC Securities. The services include private placements of equity and debt, public offerings, and project advisory to mergers and acquisitions.
2. Alternative Asset Management
7. IDFC asset management focuses on mobilizing third party equity-based funds through these two SBUs:
(i) IDFC Private Equity Company Limited. The company is a wholly-owned subsidiary of IDFC. It was set-up in 2002 to mobilize private equity into infrastructure funds and provide equity-based capital to companies in the early stages of their development. To date, three funds with an aggregate value of $1.3 billion are under its care: (a) India Development Fund has assets worth $60 million and the original
corpus of funds was repaid to investors. (b) IDFC Private Equity Fund II has assets of $371 million and has been fully
invested. (c) IDFC Private Equity Fund III has assets of $644 million. About 56% of the
fund was committed in 2011. (ii) IDFC Project Equity Company Limited. The company is 100% owned by the
IDFC and is the leading infrastructure equity investment manager in India. IDFC Project Equity invests in operating assets during the post-construction and stabilization stage of infrastructure projects. It currently manages the India Infrastructure Fund, a domestic venture capital fund amounting to $927 million.
3. Public market asset management
8. Public market asset management is the function of IDFC Asset Management Company. This IDFC subsidiary’s main business is managing mutual fund products for institutional and retail investors.
24 Appendix 1
4. IDFC Foundation
9. The IDFC Foundation is a non-profit organization that is a leader in policy advocacy, capacity building initiatives, government transactions advisory services, and corporate social responsibility in the infrastructure sector. Its main purpose is to provide leadership in streamlining and rationalizing policies and regulatory frameworks to facilitate the channeling of private sector capital to infrastructure projects. The foundation also provides capacity building programs for public–private partnerships with respect to urban services, rural infrastructure, education, and health care. C. Organizational Structure
1. Ownership Structure
10. Table A1.1 shows the ownership structure of IDFC.
Table A1.1: Ownership Structure of Infrastructure Development Finance Company, as of June 2011
Ownership Class No. of Shares
(million) Shares
(%)
FIIs 672.3 46.0 Office of the President of India 261.4 17.9 Insurance companies 159.8 10.9 Resident individuals 131.6 9.0 Corporate bodies 89.5 6.1 Mutual funds 65.4 4.5 Indian FIs 27.8 1.9 Banks 25.4 1.7 FDI 11.8 0.8 Clearing members 6.1 0.4 HUFs 5.6 0.4 Non-resident Indians 5.3 0.4 Trusts 0.7 0.0 Foreign nationals 0.0 0.0 OCBs 0.0 0.0 Total 1,462.8 100.0
FDI = foreign direct investment, FI = financial institution, FII = foreign institutional Investor, HUF = Hindu undivided family, No. = number, OCB = overseas corporate body. Source: Infrastructure Development Finance Company.
2. Organization.
11. The board of directors is the policy making body of the IDFC and is responsible for the overall business plan, annual and capital budget approval, internal management framework, audit, strategic development in human resources, and review of compliance with all laws applicable to IDFC. The board of directors is composed of 12 directors, which includes the chairperson of the board as a non-promoter, five independent directors, two nominees from financial institutions, two government directors, and two full-time directors. The composition of the IDFC's board is in accordance with its listing agreement that prescribes that 50% of its
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members must be non-executive directors. As of 31 March 2011, the board of directors has six non-executive directors, including the chairman. The listing agreement also provides that if the chairman of the board is non-executive and not a promoter, one-third of the board should be independent directors.
12. The board of directors has six outstanding committees: (i) the audit committee, (ii) the compensation committee, (iii) the nomination committee, (iv) the investors grievance committee, (v) the executive committee, and (vi) risk committee. They assist the board in policy formulation, tactical operations, and strategic direction. There are also subcommittees that are constituted by the board to manage specific functions.
3. Human Resources Management.
13. The IDFC launched what it called its One Firm strategy in 2010 to build a common culture and instill shared values within the organization. The company’s key goals and performance are measured through employees’ responses to selected questions. The IDFC scored an average of 4.57 on a 5-point scale from a sample scope of over 90% of the population. The score put IDFC in the global upper quartile of all company’s measured by YSC Company (i) on employee engagement, (ii) on being an organization with sustainable business performance and social impacts, and (iii) living up to its professed company values.1
14. The IDFC conducted a training program in FY2011, in partnership with First Ascent Group of the United Kingdom, for about 75 senior managers to help them sharpen their knowledge, enhance their ability to influence others, and improve their leadership skills. This is an ongoing project. The IDFC has collaborated with leading firms that specialize in designing training programs to fill the key learning and development needs of the business. The performance management system has also been enhanced through technology and performance targets are assessed by measurable metrics at every level.
15. At the end of FY2011, IDFC had 586 employees, up from 189 at the start of 2006. This growth followed the rapid expansion in business after the IPO in 2005.
D. Risk Management 16. Risk management is the overall function of the board of directors. Three separate board subcommittees handles risk management: (i) the portfolio review committee for credit risk, (ii) the asset liability committee for market risk, and (iii) the operational risk committee for operational risk. The IDFC began implementing a comprehensive enterprise risk management system during FY2010. Although its risk management practices with respect to market risk and credit risk have been strong historically, it sought to expand its risk management framework for all three risks across all companies within the IDFC group.
1. Credit Risk Management
17. At the heart of the IDFC’s credit risk management is a project appraisal process that uses a wide range of quantitative and qualitative credit parameters. Review of credit risk is an integral part of the project’s multistage evaluation process from the preliminary screening, due diligence review, and final review until the final stage of approval. The IDFC uses credit appraisal tools enhanced by information technology to assess a project proposal. The IDFC
periodically conducts a comprehensive portfolio review of all project assets and equity investments as part of the company’s credit risk management.
2. Market Risk Management 18. Market risk management mainly focuses on loan portfolio assessment, asset–liability management and loan pricing. The risk group uses an automated asset–liability management system to capture relevant financial data in a timely manner and process these data to generate risk maps at all levels of the business. Historical risk information is stored to enable the IDFC to perform trend analysis of risk.
19. The volatility of interest rates in the market and the introduction of new products in the treasury portfolio increase the IDFC’s exposure to interest rate risk. However, a large portion of the IDFC’s long-term debts are in debentures with fixed interest rates while borrowings from IFIs have lower risk exposure than loans from domestic commercial banks. The company matches the longer maturities of its loan assets with long-term debt instruments. Periodic monitoring of liquidity and interest rate risk significantly mitigates the company’s exposure to market risk. Furthermore, IDFC’s foreign currency-denominated loans are fully hedged, making foreign exchange risk is negligible.
3. Operational Risk Management
20. Operational risk management has traditionally been implemented in the IDFC using a top-down approach. The board defines the operational risks and the specific mitigation process for each risk. However, enterprise risk management has followed a different approach by involving all the units across the IDFC Group so that awareness of operational risks of the business is built from the ground up. The process has enabled IDFC to identify top operational risks in terms of probability of occurrence, potential impacts, and the proposed measures of mitigation.
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PRIVATE SECTOR DEVELOPMENT INDICATORS AND RATINGS: INFRASTRUCTURE
Indicators
Ratings a
Justifications/Annotations Impact to Date b
Potential Impact b
Potential Risk c
Combined Rate a
1. Beyond company impacts
1.1. Private sector expansion. Contributes as a pioneering or high-profile project to facilitating or preparing for more private sector participation in the sector and economy at large
4 4 4 4 IDFC was established in collaboration with the Government of India and international financial institutions. IDFC has become the largest privately held infrastructure finance company (IFC) in India after entering the public markets in 2005. Private sector share in infrastructure financing steadily increased from 20% in 2006 to 34% by end of FY2010. The share is expected to reach 36% by the end of Eleventh Five Year Plan (2007−2012). The ratio of infrastructure to GDP grew from just 3% in FY2006 to 5.6% in FY2011.
1.2. Competition. Contributes new competition pressure on public and/or other sector players to increase efficiency and improve access and service in the industry
2 3 4 3 After IDFC issued the first of its four series, 10-year infrastructure bonds with an interest rate of 7.5%−8.0% per year in October 2010, L&T Infrastructure Finance came up with its own retail bonds in November 2010, priced at 8.2%−8.3% per year. IDFC’s retail bond issuance clearly has contributed new competition pressure between players in the industry.
1.3. Innovation. Demonstrates efficient new products and services, including areas such as marketing, distribution,
4 4 4 4 In 2004, IDFC launched its first private equity fund, the India Development Fund, to mobilize private capital for
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tariffs, production, and technology; and ways to cover or contain cost, manage demand, etc.
infrastructure investment. As an asset management company, IDFC was able to utilize limited capital efficiently, thus ensuring significant return on equity.
1.4. Linkages. Relative to investments, contributes notable upstream or downstream linkage effects to business clients, consumers, suppliers, key industries, etc. in support of growth.
3 4 3
3 The precise direct linkage effects of IDFC’s infrastructure projects could not be separately verified, considering the broad infrastructure database. Despite this, its activities contributed to the following linkage effects and growth: (i) Telecom. The number of wireless
subscribers continued to grow at an average rate of 19 million subscribers a month during 2011. India’s telephone density increased to 71% in March 2011 from 53% in March 2010 due to lower call rates, increasing network reach, and innovative tariff plans.d
(ii) Energy. Increased hydropower generation partly alleviated peak shortages to about 10.2% in 2011 from 12.7% in 2010. Efforts to increase investments in renewable energy sources have also started by the government.
(iii) Civil aviation. The inauguration of Terminal 3 Delhi International airport increased the passenger capacity by 34 million passengers per year.
(iv) Ports. Port capacity grew to over 1 billion tons in 2011 through due to the growth of private port operations. The
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Potential Impact b
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Combined Rate a
corporatization of some public ports through PPP initiatives has paved the way for increased efficiency in port operations.
(v) Roads. About 29% of the National Highways Development Program’s awarded road projects (48,642 kilometers) were completed at the end of FY2011. The setting up of special land acquisition units at state level helped speed up the process of acquiring land for road projects.
1.5. Catalytic element. Contributes by including pioneering and/or catalytic finance, mobilizing or inducing more local or foreign market financing and/or foreign direct investment in the sector
4 4 4 4 As an IFC, IDFC was able to channel India’s high retail deposits to infrastructure products. The company raised Rs14.5 billion through the issuance of long-term bonds from over 730,000 domestic retail investors. Through IDFC’s policy advocacy, financial regulations were relaxed to encourage foreign investments in the infrastructure sector. In 2003, the share of infrastructure investment in total foreign direct investment was merely 4%. It had grown to about 16.7% at the end of FY2011.
1.6. Affected laws, frameworks, and regulation. Contributes to improved laws, and sector regulation for PPP, concessions, joint ventures, and build-operate-transfer projects; and to liberalizing markets as applicable for
3 4 4 4 Since IDFC’s inception, the company has participated in almost all of government’s initiatives in formulating policies relating to infrastructure. IDFC had in many ways, contributed in the passing and amendment of laws that impact
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improved sector efficiency infrastructure, including the following: (i) The Electricity Act of 2003, which
transformed the energy sector by addressing major issues involving generation, distribution, transmission and trading of power.
(ii) Creation of IFCs as a subset of NBFIs, which widened their capacity to raise financing for infrastructure projects.
(iii) IDFC’s joint venture with the governments of Karnataka, Uttarakhand, and Delhi, which has increased private sector engagement in areas that substantially benefit from the flow of private capital and management expertise through government advisory services.
2. Direct Company Impacts with Wider Potential
2.1. Skills contribution. Contributes to new strategic, managerial, and operating skills with actual or potential wider replication in the sector and industry
3 4 4 4 IDFC distinguishes itself as a pioneer among IFCs by having domain knowledge in project structuring, appraisal, and risk management. IDFC has developed expertise in financing a variety of projects and introduced innovative financial products and structures, which allow a broader cross-section of lenders and investors in infrastructure financing.
2.2. Demonstration of new standards. Demonstrates new ways to operate the business and compete, and investee
3
4 4 4 IDFC has developed what the finance industry recognizes as the best techniques of credit appraisal, using
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Indicators
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Justifications/Annotations Impact to Date b
Potential Impact b
Potential Risk c
Combined Rate a
performance against relevant best industry benchmarks and standards.
information technology and a wide range of parameters.
2.3. Improved governance. As evident in set standards in corporate governance, stakeholder relations, ESHS fields, and/or good energy conservation standards
3
4 4 4 In 2011, IDFC became one of the top 50 Indian companies under S&P’s Environmental, Social, and Corporate Governance India Index. The index measures environmental, social, and corporate governance practices that strike a balance of interests of various stakeholders. IDFC is India’s first signatory to the Principles for Responsible Investment, a global investors’ network initiated by the United Nations in 2006. The network aims to help investors integrate consideration of environmental, social, and governance issues into decision making. According to the International Finance Corporation, the IDFC has the best Environmental Management System and Procedure (EMSP) of all India’s financial institutions.
3. Overall Rating. Unsatisfactory, partly satisfactory, satisfactory, and excellent
3.2 3.8 3.9 3.6 3.6 is excellent.
ADB = Asian Development Bank, BOT = build, operate, and transfer; FY = fiscal year; EMSP = environmental management system and procedure; ESHS = environmental, social, health, and safety, IDFC = Infrastructure Development Finance Company, IFC = infrastructure finance company; NBFIs = non-bank financial intermediaries; PPP = public–private partnership; PSD = private sector development; S&P = Standard & Poor’s. a
The combined rating weighs impacts and risk to sustainable realization. b Rating scale: excellent (4), satisfactory (3), partly satisfactory (2), unsatisfactory (1). The rating is not an arithmetic mean of the individual indicator ratings, and these
have no fixed weights. It considers already manifest actual impact (positive or negative) and the potential for impact as well as risk to its realization. c Rating scale for risk: low (4), modest (3), medium (2), high (1).
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d Telephone density is the number of telephone lines in use for every 100 individuals living within an area.
Sources: ADB. 2008. Extended Annual Review Reports for Nonsovereign Operations. Project Administration Instructions. PAI 6.07B. Manila; IDFC. 2011. Fourteenth Annual
Report 2010-11: Partnering for Growth. Mumbai; Back-to-office report of ADB nominee’s mission, dated 15 March 2004, based on account of an IDFC board meeting; Back-to-office report of ADB fact finding mission, dated 7 October 2004, based on account of an IDFC official; Back-to-office report of ADB representatives during the XARR mission, dated 19 September 2011, based on account of a senior IDFC official.
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Figure A3.1: Loan Portfolio Distribution of India’s Financial Sector
Sources: Reserve Bank of India; ICRA Research
NBFI - Infrastructure
, 6%
NBFI - Retail, 5%
HFCs, 4% Public sector banks, 65%
Private banks, 16%
Foreign banks, 4%
SCBs, 85%
Figure A3.2: Growth in Banking Assets
Sources: Reserve Bank of India; ICRA Research
0%
5%
10%
15%
20%
25%
30%
35%
40%
-
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
Mar 03 Mar 04 Mar 05 Mar 06 Mar 07 Mar 08 Mar 09 Mar 10 Mar 11
Rs
Bill
ion
s
Total assets Total credit Growth in assets % Growth in deposits % Growth in credit %
INDUSTRY AND OPERATIONS REVIEW 1. India’s financial sector is composed of banks, non-bank financial intermediaries (NBFIs), and housing finance companies (HFCs). From FY2008–FY2011, the sector’s total assets grew by a compounded annual growth rate (CAGR) of 19%, with the loan portfolio increasing to Rs49 trillion ($1.1 trillion) as of fiscal year-end 2011.1 About 85% of loan portfolio belongs to scheduled commercial banks (SCBs) while NBFIs control about 11% of the loan assets (Figure A3.1). The banking system remains the domain of the public sector banks, which control over 76% of loan assets. Large infrastructure NBFIs including Power Finance Corporation, Rural Electrification Corporation, and the Infrastructure Development Finance Company (IDFC), among others have a higher market share of loan assets (55%) than the retail NBFIs. 2. Consistent with the objective of the government’s Planning Commission to provide some impetus to boost infrastructure investment, the Reserve Bank of India (RBI), which is the central bank, introduced a new subset of NBFIs in February 2010 called infrastructure finance companies (IFCs). RBI amended its existing regulation governing NBFIs to give IFCs wider borrowing limits, including automatic access to external commercial borrowings. It also allowed IFCs to raise additional infrastructure capital from the issuance of long-term retail bonds. To encourage foreign investment in India, the government reduced the withholding tax rate from 20% to 5% on income derived by foreign institutional investors from infrastructure debt funds and increased the investment limit from $5 billion to $25 billion in corporate bonds of infrastructure companies with maturity of over 5 years. A. Banking Assets 3. Total assets in the banking sector (excluding NBFIs and HFCs) grew steadily by an average rate of 19% per year during FY2003–FY2011 (Figure A3.2). Growth in the banking sector was the result of India’s robust economic growth, which boosted activities in the financial markets. Despite the global financial crisis that started in 2008, India’s banking system has largely remained sound due to its limited exposure to subprime assets and the countercyclical prudential norms
1 ICRA Research. 2011. Indian Banking Sector. Challenges unlikely to derail the progress made. New Delhi.
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prescribed by RBI.2 Loan growth per year has been above 20% except during FY2010, when the banking sector moderated its growth targets in response to a series of central bank increases in key policy rates to contain inflation. In FY2011, credit growth rebounded with a 21.4% year-on-year increase to Rs39 trillion that was mainly attributed to strong credit growth in infrastructure loans and loans to NBFIs. About 14% of the banking sector loan portfolio represents loans to infrastructure sector. During FY2003–FY2011, credit growth increased by a CAGR of 24%, much higher than the 19% CAGR in the growth of deposits. Notwithstanding the rapid growth in credit lending, the loans–deposits ratio has remained below the 75% level. This is consistent with the India’s statutory liquidity ratio, which requires banks to hold 25% of deposits in government securities. 3 This prudential approach, albeit conservative, has encouraged banks to raise deposits to finance incremental loan growth and minimize use of more expensive wholesale funds. B. Profitability 4. Profitability in the banking sector has been stable, with an average return on assets during FY2011 of 1.1%. This was supported by the steady growth in banking assets and the active role of RBI in maintaining health in the system through regulation. By comparison, the profitability ratios of NBFIs were significantly higher, with systemically important non-deposit-taking NBFIs such as IFCs posting an average return on assets of 2.2% during FY2011. 5. In May 2011, the central bank increased the savings bank deposit rate by 50 basis points to 4.0%, bringing the spread of the savings bank deposit rate closer to that of the term deposits rate. This may reduce the net interest margins of scheduled commercial banks (SCBs) and public sector banks, which averaged around 3% at the end of FY 2011. Savings deposits make up about 23% of total bank deposits. In addition, RBI asked banks in FY2011 to increase provisioning and maintain a provision cover ratio of 70% of gross nonperforming assets (NPAs), as a macro-prudential measure to increase cushions during a period when banks are generating higher earnings. C. Asset Quality 6. The NPA level in the banking sector has remained low despite resurgent credit growth. The asset quality ratios of the SCBs and private banks improved in 2011 due to higher loan loss provisioning (Table A3.1). However, the sector’s exposure to state power utilities is large and amounted to Rs2.7 trillion as of March 2011. This is about 7% of total banking credit and 56% of the banks’ total net worth. Moreover, about 30%−40% of the exposure represents loans used to fund cash losses of state utilities.4 Given the poor financial health of the state power utilities, this exposure is a concern for the banking sector. 6. In 2009, the RBI allowed a restructuring of corporate advances, which provided for a suspension of principal payment for eligible borrowers for 6–12 months. As of March 2011, restructured loans made up about 4.0%−4.5% of the banking sector’s advances. Historically, about 8%−20% of these advances become nonperforming loans.5
4 ICRA Research. 2011. Indian Banking Sector. Challenges unlikely to derail the progress made. June. New Delhi.
5 In November 2011, Moody’s downgraded the outlook for banks to ―negative‖ from ―stable‖ citing slowing domestic
and overseas growth hitting asset quality, capitalization, and profitability of the banking sector.
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7. IFCs have a lower credit default risk than commercial banks. The ratio of gross NPAs and net NPAs to total loans portfolio in the IDFC was 0.2% and 0.1%, respectively, as of the end of FY2011. The lower risk is due to the huge demand for infrastructure in India. For example, although the power sector generates close to 140 gigawatts of installed capacity, the recurring power deficit during peak periods is 10%. At about 3.5 million kilometers in length, India’s road network is the largest in the world but only 2% of these roads are national highways or of a standard that compares well with those in the People Republic of China.6
Table A3.1: Nonperforming Assets of India’s Banking Sector (%)
Subsector 2006 2007 2008 2009 2010 2011 SCBs Gross NPAs 3.3 2.5 2.3 2.3 2.4 2.3 Net NPAs 1.2 1.0 1.0 1.1 1.1 0.9 Net NPAs to net worth 10.1 9.2 7.8 8.6 9.1 10.0 PSBs Gross NPAs 3.6 2.7 2.2 2.0 2.2 2.3 Net NPAs 1.3 1.1 1.0 0.9 1.1 1.1 Net NPAs to net worth 13.1 12.1 11.2 11.4 13.5 13.4 Private banks Gross NPAs 2.1 2.1 2.4 2.9 2.7 2.3 Net NPAs 0.9 0.9 1.1 1.3 1.0 0.6 Net NPAs to net worth 6.3 7.8 6.1 7.5 5.3 3.2
NPA = nonperforming asset, PSB = public sector bank, SCB = scheduled commercial bank. Sources: Annual reports of banks, ICRA Research, Reserve Bank of India.
D. Capital Position 8. The capital position of the banking sector remained strong and above the minimum regulatory requirement of 6% for Tier 1 capital and 9% for total capital adequacy ratio (CAR). During FY2011, the overall CAR for the SCBs weakened slightly to about 14% as increased on-lending drove higher balances of risk-weighted assets. Private sector banks, on the other hand, have maintained a higher average CAR of 16%. Nonetheless, government support to public banks through additional capital infusions will likely continue. In February 2011, the RBI raised the minimum CAR for deposit-taking NBFIs from 12% to 15%, effective 31 March 2012. The central bank expects that this tightening of prudential norms will provide a cushion to these NBFIs in times of stress.7
E. Infrastructure Financing
9. The Planning Commission’s Twelfth Five Year Plan for 2012–2017 projected an investment requirement for the infrastructure sector of about Rs41 trillion to sustain an economic expansion of 9% per year during the period. It conceded that the public sector alone cannot meet this requirement due to fiscal constraints. Much of this funding would have to come from more active participation by the private sector. The private sector share has been gradually but steadily increasing. From 20% in FY2006, it reached 34.3% in FY2010 and is expected to be 36.2% in FY2012.8 In addition, following the government decision to raise the maximum
6 Knowledge at Wharton online business journal. Interview with Vikram Pant, IDFC Project Equity’s managing
director. http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4440 7 Business Standard. 2011. RBI raises capital adequacy ratio for deposit-taking NBFCs. 18 February.
allowable limit of foreign investments and to reduce some taxes to encourage more foreign investments in infrastructure, the share of infrastructure sector investment in overall foreign direct investment has increased from 4% in 2003 to 16.7% in 2011. 10. NBFIs engaged in infrastructure financing have a 6% market share of the total loan assets of the financial sector. The bulk of these assets are controlled by large IFCs, which are mostly government-owned corporations. The rest are held by a few privately held companies, the largest of which is the IDFC.
11. Debt financing has been the main source of funding for infrastructure projects. This has included corporate bonds, debentures, and wholesale funds from international investors and domestic commercial banks. Securitization of financial instruments for infrastructure financing in India has significantly increased debt financing because it is an efficient risk transfer mechanism for investors. The RBI has been improving the securitization process and this is expected to contribute to the further development of the corporate bond market in India.
