In the years since it was founded in 1997, the Infrastructure Development Finance Co. (IDFC) has become a major funder of India’s infrastructure upgrade. The company’s Project Equity group manages the US$927 million India Infrastructure Fund, a venture fund that invests equity in infrastructure projects. What costs does poor infrastructure impose on the Indian economy? What challenges do infrastructure builders face as they invest in everything from renewable energy projects to roads and ports? In an interview with India Knowledge@Wharton, Vikram Pant, IDFC Project Equity’s managing director, discusses these questions and more.
An edited transcript of the conversation follows:
India Knowledge@Wharton: To give our audience a sense of what IDFC Project Equity is, could you tell us about your organization and how it relates to IDFC as a whole?
Pant: IDFC Project Equity is one of IDFC’s initiatives in the asset management business. This was part of a larger venture called the India Infrastructure Financing Initiative, which recognized that the role of the private sector in India’s infrastructure development — along with the collaboration of the government of India — would be significant. To channel investment in the right way and with the right kind of support from the government, one would tie up with an institution like IDFC to take projects forward with foreign capital. Our fund has both domestic Indian investors and a pool of foreign investors. [It was] backed initially by IDFC and Citigroup, and then subsequently we raised money from different pools of international investors.
IDFC is a publicly listed company and part of India’s ‘Nifty 50’ now. It’s a leading infrastructure finance organization. It was established more than a decade ago but went public in 2005. It has been in the forefront of policy initiative improvements and advisory work to the government, as well as in the field of project finance. Initially, these were its two main arms — the project finance and the advisory groups — but now it also has significant investment banking and asset management businesses. IDFC Project Equity is part of the asset management business.
India Knowledge@Wharton: Usually, when people speak about Indian infrastructure — especially in contrast to, say, China — a lot of unfavorable comparisons are made. Since you’re an investor in this area, can you give us a sense of the opportunity cost for India of not having an infrastructure that is comparable to China’s?
Pant: I think that’s the heart of the matter. What is the opportunity cost of not having sufficient infrastructure? To put it in perspective, China has typically been spending about 9% to 10% of its GDP on infrastructure over the last 10 years or even longer. India, in contrast, has spent as little as 3% of GDP on infrastructure and now plans to creep up to 7% or 9%. These numbers are huge, because when you spend more on infrastructure, not only is there a short-term productivity gain, but also the longer-term impact on areas such as agriculture and trade is significant.
In India, the demand-supply gap in infrastructure is significant. If you break it down by sectors, the power sector, for example, has close to 140 GW (gigawatts) of installed capacity, but still this represents a deficit of 16% to 17% compared to peak demand for power. In the roads sector we have among the largest road networks in the world, about 3.5 million kilometers, but only 2% of these are national highways or are roads that can compare with China’s.
As for the costs imposed by inadequate infrastructure, there have been various studies. According to one study by a consulting group, the cost to the Indian economy of poor infrastructure could be US$200 billion over a period of time. That’s the scary part. The good news is that the government recognizes the need to improve infrastructure. Significant policy changes have been made and things have been moving in the right direction over the last 10 years. This is not a story which is starting now. People are beginning to recognize how things are changing.
Of course, when you compare India with China, the most glaring difference is that we function as a democracy, which comes with a lot of baggage in terms of legacy issues, political interests and vested interests. In China things can happen much faster. As the old saying goes: In India, there is law; in China, there is order.
There is definitely some merit to having regulations that balance the interests and efficiencies of the four constituents of infrastructure — the government, the regulators, the customers and the investors. It’s really a balancing act.
India Knowledge@Wharton: You said the policy environment has been changing for the past 10 years — could you talk about these changes and their impact on infrastructure? How did IDFC evaluate its investment opportunity in the context of these environmental changes?
Pant: IDFC, in its first few years after being set up in 1997, was actively involved in a lot of the policy initiatives. The Electricity Act of 2003 was a watershed event; when one looks back even today, one recognizes the kind of changes it made in the regulatory environment. Changes made in the telecom regulatory scenario have been very successful. India today adds about 15 million mobile subscribers every month. After China, it’s the fastest growing mobile market in the world with close to half a billion subscribers. Single companies have 100 million-plus subscribers. A large part of the telecom success story in India has to do with effective regulation and the independence of regulation.
In sectors such as roads and highways, there are nodal agencies that manage that part of the infrastructure. There has been very strong and well-constructed regulation, but its implementation has seen a lot of setbacks. That issue is being addressed. We continue to have an optimistic view, but cautiously, in the area of urban infrastructure. [Power generation], transportation and the port sector remain key priority areas for us.
India Knowledge@Wharton: What investment priorities did IDFC and IDFC Project Equity set in the context of these policy changes?
Pant: IDFC has developed expertise across product groups. As I mentioned earlier, its primary product focus is on lending and project finance, but extending beyond that, it is very powerful in the field of investment banking and advisory services. It owns a unit called IDFC SSKI, which it acquired, which is a leader in the field of investment banking advisory work in India. On the asset management side, IDFC was one of the first groups which went into private equity infrastructure. IDFC Private Equity, which is a separate asset management group from Project Equity, is now in its third generation of funds and has a significant pool of capital which it manages. Seven years ago, private equity infrastructure was almost unheard of — it was not seen as a domain where you would go. But that’s the kind of product innovation and risk innovation that IDFC has backed.
Project Equity’s focus is on asset-level investments in four or five core sectors, including power generation, the transportation sector, which is ports and roads, and urban infrastructure. A large part of India’s infrastructure build up is happening at a green field and a brown field stage, which means they’re either new assets or existing road alignments, which are being expanded.
India Knowledge@Wharton: What impact did the global financial crisis have on IDFC’s strategy for infrastructure investment in India?
Pant: Fortunately, the global financial crisis had limited impact on the Indian credit markets. That had to do with the fact that the savings rate in India is nearly 35% to 40%. A large part of Indian savings are funneled into the banking market, through which they go back to the government. As you know, banks have high liquidity requirements, and that typically means they have to hold government securities. The impact of the financial crisis on infrastructure was not so much on the availability of credit. In fact, I don’t think credit availability for infrastructure is at all a challenge in India today. The challenges involve the kind of execution and implementation success people have had, and the kind of groups one can back.
India Knowledge@Wharton: Where do you see the principal opportunities today?
Pant: From a product or a sector perspective?
India Knowledge@Wharton: Both.
Pant: From the product perspective, opportunities exist across the line — whether it’s in project finance, in advisory services, or in asset management or even at the retail level. IDFC last year bought a mutual fund business; it acquired the mutual fund business of Stanchart [Standard Chartered Bank]. That business is going very well. Now the 40% savings rate that I mentioned can be intermediated by the mutual fund market, to divert funds directly into the infrastructure sector. That’s a powerful proposition.
On the sector side, by definition the entire energy sector — including electricity generation and transmission and even the oil and gas sector — has some exciting opportunities.
India Knowledge@Wharton: Could you offer any examples?
Pant: Take power generation, for example. India has large reserves of coal. But the challenge is to develop those reserves in a sustainable way, with minimal environment impact, and with the right rehabilitation and resettlement policies in place. This is something that everyone needs to be mindful of — and IDFC is.
Moreover, renewable energy represents an exciting opportunity. India has large, untapped renewable energy resources, but so far these have not been fully capitalized and been exploited. Now there is a lot more awareness, there is a lot more commitment. That is an opportunity which IDFC intends to be focused on and committed to as signatories to global principles and as part of our investment policies.
The other area that is very topical now is the transportation and the roads sector. The Indian roads sector has an aggressive build-out program that is supported and announced by the current government. Players like IDFC and many other financiers are going to be deeply involved in that. We could provide both advisory services and investment, maybe on the debt side or on the equity side. We are looking forward to that participation.
India Knowledge@Wharton: Speaking about the roads sector, you referred earlier to challenges in implementation. What are some of the main hurdles you have found in building out India’s infrastructure?
Pant: The entire land acquisition process in India needs to be reformed. There is a Land Acquisition Reform Bill, which is pending in Parliament, and that is going through its motions there. But that has been the single biggest obstacle — if you track, across projects, the process of land acquisition. The process is currently based on a law which is very troublesome. It has multiple layers. It has long processes. Information flows are often not adequately and intelligently passed on. There is a great amount of distrust, and that leads — in a classic democratic set up — to non-mobility. Land acquisition has been a problematic issue.
The other challenges have more to do with implementation and project execution. For example, in the power sector, the build-out India is looking at involves adding between 50,000 to 80,000 megawatts of power in the next five years. The amount of equipment that is required, having it supplied both domestically and internationally is a challenge.
India Knowledge@Wharton: How serious a problem is political corruption and how have you dealt with it?
Pant: This goes back to what I said about the four constituents of infrastructure and balancing their interests. The first constituent is the customer, who is only looking for value for money. The second group consists of investors who are looking for returns. The third is the regulator, which wants independence to come across as being fair and impartial. And the last, but not the least, is the government, which wants to stay in power.
An institution like ours is signed up for anti-corruption practices. Integrity is absolutely non-negotiable in a firm like ours. But that said, corruption is something which plagues the country. One has to be very cautious of it and has to constantly keep the bar high in making sure you do your due diligence and your integrity checks. You make sure you are partnering with promoters and partners who believe in the rule of law, who have followed a system, and who uphold the best industrial practices. Where there is blatant corruption and where there is political interference, we don’t support those projects.
You will find a trend where certain states have had very exceptional and very remarkable development of their infrastructure because certain policies and practices were put into place with efficacy. And in areas where the risk is perceived to be too high, either because of corrupt practices or political interference, typically private capital will not go there.
India Knowledge@Wharton: What areas would you consider too risky for private capital?
Pant: I wouldn’t want to identify any particular area or state. I think all of them are aware of the situation. But certainly there are pockets where you have law and order problems. There are states where you have to be very cautious. But on the other hand, states like Gujarat or Andhra Pradesh have had significant success in developing their infrastructure development because of governments that recognize their priorities.
India Knowledge@Wharton: Apart from the risks you just named, what other risks do you have to contend with in doing what you do?
Pant: One defining difference between infrastructure and other kinds of investments is that in the former, there is an element of nation building. A lot of decisions taken in 2010 or 2011 will have an impact for many generations ahead on the environment. This means one has to be very careful. In a classic kind of investment-banking, finance world, you tend to see a lot of short term-ism. But when you invest in infrastructure, you must be cognizant of not just short-term profits for shareholders, but also the long-term consequences of what we’re doing. That is a constant challenge you put to yourself as a firm.
India Knowledge@Wharton: Where would IDFC want to be in the next four or five years?
Pant: IDFC aspires to be a world-class organization, a knowledge-driven organization, which in its domain is respected for best practices, principles, values, and for constantly pushing the envelope in terms of innovation. The opportunities in India undoubtedly are huge but you have to navigate them carefully.
India Knowledge@Wharton: I know you had a previous career in investment banking. What was for you, personally, the biggest single challenge in working with infrastructure finance, and how did you overcome it?
Pant: I don’t think there was a challenge, to be honest. When I thought about coming back to India after being overseas for almost 11 years, I had had a lot of private equity and leveraged buy-out experience. It was exciting to be coming back into an area where you had to roll up your sleeves and go beyond doing financial engineering. I had to think about issues which would have implications for generations ahead — policy issues, and social issues. This work has a nation-building element, and in that sense there’s a bigger purpose to what we are doing beyond bringing a paycheck home or putting food on the table.