ANALYSIS OF INDUSTRY ENVIRONMENT

INFRASTRUCTURE
FINANCE

Under the guidance of

Professor K G Sahadevan
Course name: International Business Environment

Submitted by:
Jatin Mongia (PGP31378)
Rohit Banka (PGP31405)
Section G
DECLARATION:
We, Jatin Mongia and Rohit Banka do hereby declare that the report is our joint effort and that no
part of the report is copied from published/unpublished sources without proper citation.

Table of Contents
Introduction........................................................................................................................................................3
Infrastructure: The Growth Driver..................................................................................................................3
Financing Infrastructure: Bridging the Gap....................................................................................................4
Changes in the industry post the 1990s..........................................................................................................4
Porters five forces analysis................................................................................................................................5
Intensity of rivalry among existing competitors:............................................................................................5
Threat of new entrants:...................................................................................................................................6
Bargaining power of buyers:..........................................................................................................................7
Bargaining power of suppliers:.......................................................................................................................8
Threat of Substitute products and Services:....................................................................................................8
Infrastructure, Finance, and Fiscal Prudence......................................................................................................9
Challenges of debt financing............................................................................................................................11
References........................................................................................................................................................13

List of Figures
Figure 1: Net worth - Infrastructure Finance Services Industry (% change).......................................................5
Figure 2: Net worth - Infrastructure Finance Services Industry (Absolute values).............................................5
Figure 3: Calculation of the HHI Index..............................................................................................................6
Figure 4: Bargaining power of suppliers............................................................................................................8
Figure 5: Infrastructure finance industry............................................................................................................9

Introduction
The International Monetary Fund, in its July 2015 update on World Economic Outlook, had
projected global growth at 3.3 percent in 2015, which was slightly lower than in 2014. The
Economic growth in 2016 is, however, expected to be higher at 3.6%. There was a downward
revision in projection, of 0.2%, relative to its World Economic Outlook in April 2015. An unexpected
fall in output in the United States and neighbouring Canada and Mexico was reflected in this
revision. The stronger consumption growth and improving employment conditions in the US is now
helping the economy rebound back. This update points to a slower growth in the developing and
emerging markets which is expected to slow down to 4.2 percent in 2015 from 4.6% in 2014. This
slow growth can be attributed to factors like deceleration in China's growth, lower commodity prices
in Latin America and the oil exporters and the weak demands of the EMDEs. The silver lining,
especially from India's perspective, is that there has been no revision in the outlook for our economy,
which is expected to grow at 7.5%. According to Christine Lagarde2, MD, IMF, while other
countries around the world are facing a slow growth period, Idia has been moving in the opposite
direction and is the fastest growing large economy in the world. According to Lagrade, 'By 2019,
Indian economy would have more than doubled than its size in 2009. And after adjusting for
differences in purchase prices between economies, Indias GDP is expected to exceed that of Japan
and Germany combined. Also, the Indian economy is projected to reach to a size of $20 trillion in
less than 20 years and it will be growing at around 9% from less than around 3% now.
However, we should be mindful of the roadblocks in our pursuit of higher growth. Some of these are
- weak investment demand, slow progress on structural reforms in respect of supply bottlenecks,
vulnerabilities arising out of erratic monsoon, stalled projects which need to be put back on track,
etc. Indian economy is much better placed on the external front as compared to 2013 when the
country witnessed high volatility on account of floodings from the global markets, especially, the
taper tantrums. An example could be the foreign exchange reserves cover for imports which have
gone up to 8.90 months as at end March 2015 from 7.80 months as at end March 2014. Similarly, the
ratio of short-term debt to the reserves has declined from 30.1% to 24.8%, and the share of reserves
to CAD has increased to 12 times from 3.3 times during the same period. This is also evident from
the relative calm in the Indian economy even during the recent Greece crisis and also when there was
an extensive speculation on impending rate hike by the Fed Reserve(which was ultimately done).
The measures taken by the RBI to resolve some of the structural issues, such as mounting CAD and
persistently high inflation, have helped to boost business confidence among both domestic and
international investors and had a salutary effect on the growth in general and market volatility in
particular.

Infrastructure: The Growth Driver

The importance of infrastructure for economic growth cannot be overstated. Infrastructure is the
lifeline of an economy and the fate of the economy is closely linked to the development of its
infrastructure. As mentioned in the twelfth Five Year Plan document, infrastructure provides the
primary support system for the other areas of the economy in increasing capabilities everywhere. A
well-developed physical connectivity in the form of road or rail network, for example, can help the
consumers and producers (by facilitating quicker movement of agriculture produce), promote
education, ensure the well-being of the citizens, ensure nations safety, and create greater
employment opportunities. Empirical work on the role of infrastructure done in the late 80s & early
90s had found the output elasticity to be around 0.38 to 0.56. Further studies have confirmed the
findings though with lower elasticity. For India, a 2009 study has found it to be up to 0.5. The studies

have also emphasised the role of public investment regarding crowding in private investments in
different sectors and enhancing the overall output.
The infrastructure gap that exists in India cannot be ignored. India is graded 87th out of 148
countries for its infrastructure in the World Economic Forums International Competitiveness Report
2014-15. Roughly 2/3rds of the freight and around eighty-five% of passengers in India are still
transported by the road network. To fulfill the growing requirements of the economy, the investments
that require to go into infrastructure are humungous. the overall investment in infrastructure, which
was 5.02 % and 7.21 percent of the GDP throughout the tenth and also the eleventh Five Year Plans
respectively, is projected to go up to eight.18 % in the twelfth plan (2012-17) at US$ 1 trillion. The
McKinsey report estimates that a rise in infrastructure investment such as one-hundredth of GDP
would translate into a further 3.4 million direct and indirect jobs in India. Therefore, the development
of infrastructure not only poses a major but not insurmountable, challenge however also provides an
excellent opportunity for accelerating the growth.

Financing Infrastructure: Bridging the Gap

Infrastructure development involves long maturation periods and faces several legal and procedural
problems besides designing and execution problems. The issues related to infrastructure development
vary from those concerning land acquisition for the infrastructure project to environmental
clearances. The further uncertainty as a result of these factors affects the chance appetite of investors
as well as lenders to increase funds for the development of infrastructure. The problems striking on
infrastructure development comprise both financial and non-financial factors and these ought to be
seen in totality. While financing remains a significant issue, the non-financial problems additionally
should receive appropriate attention.

Changes in the industry post the 1990s

The famously termed Hindu rate of growth, was present in India for many decades before the
1990s, where it experienced a small and stable growth rate of 3-4 percent per annum. But after the
1990s, there was the dismantling of the licencing regime in India and it was coupled with the
economic liberalisation. Post the 1990s, the country recorded a high growth rate of 7-9 percent
throughout the next decade.
The pressures on a deficient infrastructure industry increased manifolds with this acceleration in the
growth rate. This was mainly because the growth of the 1990s was largely dominated by the
manufacturing and services industries while the growth in the infrastructure industry was slow. Thus,
infrastructure became a major constraint in reviving and sustaining the growth rate and also in
attracting major investments or businesses in India.
In the past, infrastructure projects were usually supported from the limited resources of the general
public sector, which was defined by inadequate capability addition and poor quality of service.
Following the economic alleviation of the Nineties, non-public investment began to flow in
infrastructure with mobile telecom taking the lead. In power generation, non-public investment was
at first assisted by numerous varieties of government guarantees, which were shortly discarded as
they came to be viewed as an unsustainable kind of support for non- public sector projects.
Alternative sectors, like highways, railways, airports and ports witnessed piecemeal tries at reforms
that led to small outcomes.
Initial reforms predictably didn't mobilise non-public investment at the size envisaged. the whole
investment in infrastructure throughout the Tenth five Year plan (2002-07) was therefore restricted to

US$240 billion, of which only twenty two % came from non-public investment. Moreover, the
overall investment in infrastructure brought only about 5% of GDP, as compared to 9 to 11 %
witnessed within the East Asian economies. As a result, there was a growing realisation of the
pressing need to accelerate the flow of private capital in infrastructure.

Figure 1: Net worth - Infrastructure Finance Services Industry (% change)

Figure 2: Net worth - Infrastructure Finance Services Industry (Absolute values)

Porters five forces analysis

Intensity of rivalry among existing competitors:
The intensity of rivalry refers to the threat that the customers of the particular firm in the industry
would switch their business to competitors within the industry itself. For the Infrastructure Finance
industry, it is high at the moment given the current domestic market position of players and the
number of players in the industry so young.

Concentration of the Industry: With ten existing players in an industry as young as 20

years, which went up to 15 in the year 2012-2013, the industry is moderately concentrated,
and boasts of big players like, IDFC, Power Finance Corporation, IFCI and Larsen and
Toubro ltd. The HHI index of the industry is 2544.544 as shown through the calculations
below, which is considered to be a representation of a highly concentrated industry.

Figure 3: Calculation of the HHI Index

Strong exit barriers: The exit barriers in the industry are high due to the high escalation of
commitments to the given projects, and hence the investors stay invested for long durations
of time and hence cannot back out easily.
Rewards of successful strategic rewards: The infrastructure gap that is existing in India is
enormous. Around 66 percent of the freight and 85 percent of passengers in India are still to
be transported by the road network. To match the growing requirements of the Indian
economy, the investments that are required are humungous. The total investment in
infrastructure, which stood at 5.02 percent and 7.21 percent of the GDP in the 10th and the
11th Five Year Plans respectively, is predicted to stand tall at 8.18 percent in the 12th Plan
(2012-17) touching US$ 1 trillion. Given these statistics, firms with first mover advantage,
could get them some significant share of the projects and hence could maximize their
shareholders value. [2]

Threat of new entrants:

Threat of new entrants, which refers to the possibility of erosion of profits of existing players by the
introduction of new players, is moderate in the industry given the contrasting nature of the below
mentioned factors.
Barriers to entry:

High initial investment: A lot of capital is required in such kind of an industry due to the
enormous capital requirements especially in the post-1990 era. Infrastructure in India is
regarded as inadequate and inefficient. Primary examples being, only 17 percent of the total
length comprising the National Highways network is of four-lane, 53 percent being two-lane
and the rest 17 percent being single highways. The power sector suffers from a deficit of 14
percent and energy shortage of 11 percent. Servicing and financing such industry would
require very high capital, even to procure the initial projects.
Regulations: To mobilise private investment at the pace and scale necessary, the Government
of India initiated measures to create an enabling framework to attract private capital to
infrastructure projects. A comprehensive architecture was, therefore, brought to effect to
promote Public Private Partnership (PPP) in sectors like power, highways, ports, airports and
railways. The objective of the government was to secure optimal sharing of risks and
rewards while ensuring bankability of the projects alongside the efficient delivery of services
at economic costs, which should be determined through a transparent and competitive process

of selection. The Economic Intelligence Unit (EIU), Economist (UK) commended this PPP
architecture and rated it among the best, by international standards. The standardization of
processes helped in a rapid roll out of PPP projects, which caused India being recognized as
the largest recipient of PPP investments during 2008-12. In short, the regulations in India are
liberal and aiding; and invite any such venture.
Loyalty: Given the dimensions and capital requirements of the infrastructure projects, it
might not be necessary that the mammoths in infrastructure be brand loyal and hence the
lenders in different projects can be different. But, the level of relationship with one financer
can prove to be decisive in procuring further projects; hence, the loyalty factor would be
moderate.
Switching costs: Switching costs, again, would be moderate given the fact that if a financier
is not capable of financing another project of the customer, the customer can quickly switch
with no cost at all, but given the dearth of financiers of such large scale projects, it can be
difficult to find an investor on similar terms and hence the switching cost would be moderate.

Expected Retaliation: Given the short history of infrastructure finance, the history of retaliation
cannot be traced as such. But, there can be retaliation from the cash-rich existing players to the new
entrants. Anyhow, given the presumption that the financier venturing into the industry would also
have deep pockets, the retaliation poses a moderate or little threat as such retaliation would not be
sustainable. [1]

Bargaining power of buyers:

The bargaining power of buyers refers to the threat, which might drive down prices, bargain for more
services and quality, and pit the competitors against each other. In the given industry, it is low, which
can be proved from the factors listed below:

Concentration of buyer industry: The concentration of the buyer industry is mild and is
very diverse. As aforementioned, the potential growth to $1 billion infrastructure in India, is a
clear indicator of the kind of opportunities which might crop up for the 5-6 major players
existing in the infrastructure Finance industry right now, is huge, and hence its effect on the
bargaining power of buyers is not significant.
Commoditized Product: The product that the buyers seek from the financier is the
investment, and hence can attempt to bargain on the commercial terms. But given existing the
narrow width of the Infrastructure Finance industry, buyers might not find many financiers if
they require humongous capital, and again the product has little effect on bargaining power of
the buyers.
Profit-minting infrastructure: Keeping aside the investments into public domain, private
infrastructure players are generally highly profitable buyers and hence comparatively lesser
price sensitive, proving that the bargaining power is low.
No chance of backward integration: There is no chance of backward integration, as this
industry exists on the fact that the buyers are in dire need of the investments for their projects.
Importance of the industrys product to buyers product: Investment, indeed is
quintessential to the buyers product i.e. infrastructure, as the capital requirements if not met
can be detrimental to the initiation and subsequently the completion of the project, and hence,
the buyers are comparatively lesser price sensitive.

Bargaining power of suppliers:

Lets first look at the suppliers to this industry; it would be some means through which the financiers
procure their cash. The following are some of the supplying means to the industry.

Suppliers
to Infra
Fin co.

Funds
from FDs

SBA loans

Capital
Market

Convertibl
e bonds

Refinance
from NHB

Figure 4: Bargaining power of suppliers

FDs, SBA, Capital Markets and bonds are the most reliable sources of supply to the financier. Such
options are generally interest income based and the redeployed principal in the Infrastructure Finance
industry for investing into their clients projects. For commercial banks, Fixed deposits can prove to
be the major source for funding their projects as one of the important feature of FDs are they cost
very low interest to banks.
Importance of the industry to suppliers product: Investment can be made in other industries too
by the suppliers, but if an opportunity is presented in term of an Infrastructural finance manner, it
wont hold much value given the potential and hence this factor contributes little to the bargaining
power.
With multiple financing options, and the given opportunities, suppliers have low bargaining power
over infrastructure financing institutions.

Threat of Substitute products and Services:

Strict substitutes to the industry dont exist right now. Though, the customers can approach
community-based organization and SHGs as they have much simpler and viable policies, but can lag
on the account of the capital being supplied to the industry. So we right now can safely presume that
the threat of substitute services is very low, as the upcoming projects in the tray of Infrastructure
Finance will be requiring humongous capital.
But, as we know, Porters forces are not static, down the line, the threat of substitutes is said to rise.
The AIIB (Asian Infrastructure Investment Bank), other international and national forays into the
industries can prove to be a tough nut to crack. They could provide Better Commercial Terms,
Readily Available services, which could be coupled with attractive pricing and low switching costs
to give competition to the Infrastructure Finance Industry. And hence itx is advisable that right now
is the time to enter the industry, the later it gets, the more difficult it would be, once such institutions
come into their full-swinging mode.

Infrastructure finance industry

New entrants
4

2
Buyers

Substitutes

Infrastructure finance
Attractive Industry

Suppliers

Inter-firm

Figure 5: Infrastructure finance industry

Infrastructure, Finance, and Fiscal Prudence

For an emerging economy, the lynchpin of growth is the investment. Fortunately India, having
historically been a nation that saved and invested little, has now transformed itself into a major saver
and investor. The aggregate savings rate (that is savings as a percentage of GDP) crossed the 30 per
cent mark in 2004 and had not looked back since. India's savings and investment rates currently look
very much like the statistics one encountered in East Asia in the 1970s and 1980s, during the heydays
of their rapid growth. In 2010-11, India saved 32.3 per cent and invested 35.1 percent of its GDP.
This massive capital formation becomes even more efficient if a substantial part of it is directed to
infrastructure. Between 2006 and 2011, net bank credit to infrastructure witnessed a handsome
annual growth of 48.4 percent, even though there has been some deceleration from April 2011
onwards. But even with this, the need to step up investment in this sector remains. Hence, a critical
question that India faces at this juncture is how to increase infrastructural investment. The Indian
Planning Commission has recognized that the infrastructural investment is more than just bricks &
mortar. It is more a matter of finance. The Indian Planning Commission has talked about a target of
one trillion dollars of infrastructural investment during the Twelfth Five-Year Plan, 2012-17, with
about half of this being raised from the private sector (see Chapter 11 for further discussion). This
task is not easy to establish. During the Eleventh Five-Year Plan, it is estimated that 36 percent of the
infrastructural expenditure came from the private sector.
The build-up of capital and infrastructure will depend to a large degree on what the government does
and also on what it does not do. Some initiatives have been taken vis-a-vis take out financing and in
the form of Infrastructure Debt Fund. There are areas where virtually all that government needs to do
to create an enabling atmosphere for private players. It does not have to spend money but facilitate
individual agents to do so. Human capital and research are an example. India, with its history of
higher education, has a natural advantage in this. It has the potential to be a major hub of global
education. Buying education is so expensive in several industrialized nations that it is possible for
India to provide quality education, charge to cover all costs, keep a margin, and still have students

come. The surplus generated can be used to increase our gross enrollment ratio. Providing higher
education to the world will also enhance the nation's global stature. Since this is a financially viable
operation, all government needs to do is to give educational institutes autonomy, including regarding
fees and salaries, and then allow private investment into the arena. It will also have to work on some
nuts and bolts measures such as having provision for foreign students to get four-year visas at one
go. There will, of course, have to be a regulatory framework within which this works, so that
students are not misinformed or cheated and do not face mid-course increases in fees. It's like a
resource that is lying unused on the ground. With the right enabling rules, we can create huge returns
and boost our higher education and research sector.
Returning to the subject of infrastructure, one problem is that these are usually such large projects
and also have such long gestation before they become financially viable that most entrepreneurs
would have to find agents willing to invest money, such as angel investors and venture capitalists
before they can start up. Should government get involved in boosting and channelizing private-sector
money for this or should it follow a hands-off policy? Should the government give guarantees or
comfort letters to investors trying to decide whether to put their money in infrastructure? It is known
that such assurances greatly facilitate investment by reassuring the investor, but they also place
responsibility on the government, because if there is a default, the government has an obligation to
step in. It is one of the areas which have been heavily debated internationally. With India about to
embark on big infrastructural projects, the debate has come to our doorstep. To look away from it
will mean a decision by default.
Some of the reckless governments, while trying to take large investment projects, gave a guarantee to
the investors that if the project goes bankrupt, the government will pay off to them. From our past
experiences we know that when a government, having an ability to print money, gives a guarantee,
there will be investors galore to put their money in projects. However, this might not be a particularly
useful strategy for the government as giving such a guarantee will not add anything to the
government's financial numbers immediately, but it amounts to undertaking future financial
expenditure. And since there is always the probability that such a guaranteed project will fail in the
coming future, so each such guarantee amounts to some particular additional expected expenditure
by the government in the future. And hence, such assurances, given recklessly, may lead to
unsustainable fiscal deficits shortly with all their attendant problems, like inflation, collapse in
investment, and, ultimately, economic recession. For this reason, under the Fiscal Responsibility and
Budget Management Act 2003, India rightly places restrictions on such guarantees.
Also, governments are repeatedly warned by international bearers of financial standards not to give
guarantees to investors, especially for private-sector initiatives. While the warning is a valid one and
governments should keep it in mind, there are instances where a few strategic and well-designed
guarantees and comfort letters from the government might be desirable in the total interest of the
country. It can happen in a buoyant nation on the verge of take-off and considering an expansion in
some infrastructural projects. Hence, it is an argument that has direct relevance to India. The gist of
the argument is surprisingly simple and is outlined in below.
Doing Better by Coordination - Among infrastructural projects, there is typically a lot of positive
externality. The new road which will be operated by a toll system will be more successful when the
residential township towards the end of the road is completed, and the developer NIL the suburban
town is more likely to be successful if the road gets built. The government, by giving some carefully
orchestrated guarantees to investors, can ensure that all these projects are started up, thereby raising
the probability of success for each of these projects. Of course, if they all fail, that will be a more

significant failure. But that precisely is the dilemma. To assume that there is no dilemma and to be
wedded to one of these options by habit is clearly no solution. To illustrate this with a simple
arithmetic example, suppose there are three projects, about a road, a township, and a power project.
Each entails an initial cost of 100. If the project succeeds, it yields 150; if it fails, the entire initial
cost goes unrecovered. If all three projects are undertaken, each project is more likely to succeed,
because of the kind of positive externality mentioned; let us suppose that the probability of success
of each project, when the other two are implemented, is 0.95. If, on the other hand, the other two are
not performed, then assume the project that is implemented has a probability of success equal to 0.5.
If the government gives a guarantee to the investor for a project, then for an investor it is worthwhile
investing in the project, since she incurs no risk of default. In the event of a default, the government
pays off the investor the 100 that she had invested. Suppose now government gives a guarantee to
only one project. Assuming that the other projects are not undertaken under the circumstances, there
is an expected loss of 50 units of money to the government, since the probability of failure is half and
if a failure is witnessed, the government has to pay the investor 100. Hence, the expected fiscal
deficit rises by 50. Now suppose Government gives guarantees to all three projects, then all three
projects get implemented; and the Government's expected financial cost of this is only 15 (= 3 0.05
100), since there are three projects, each project has 0.05 probability of failure and, in the event of
a project's failure, government has to pay 100 units of money. If these projects create socially
valuable wealth, which is worth more than 15 units of money, it is arguable that guarantees to all
three are desirable; even though it may not be worthwhile giving a guarantee to any single project.
This simple arithmetic is not a reason to rush and give out guarantees or even comfort letters
(comfort letters often, in effect, turn out to be like safeguards in the eyes of the law) but it alerts us to
the fact that for a nation on the verge of take-off, and with complementarities between projects, the
calculus of guarantees and fiscal deficits is not straightforward. We should evaluate the benefits and
financial costs of government trying to give a big coordinated push to a cluster of infrastructural
projects, and recognize that the costs and benefits would not be the same if we worked this out for
each project separately and then just added them up.

Challenges of debt financing

One of the main challenges in bringing up private investment was the mobilisation of debt financing for
meeting the high targets set by the Government. As the PPP projects are usually financed on a 3:7 ratio of
equity and debt, mobilisation of the required debt resources seemed a challenging task. Moreover,
infrastructure projects often bear a long period of maturation, which needs to be supported by debt of a longer
tenure. Unavailability of long-term debt from local financial institutions, therefore, posed an additional
challenge for sustainable financing of the PPP projects.
Unlike the developed countries, where long-term debt can be mobilised from the capital markets, the bond
market in India did not present such an option as it was characterised by a lack of liquidity and depth. Listed
corporate debt formed only two percent of GDP, which was significantly lower as compared to other emerging
economies, such as Malaysia, Korea and China. Further, quasi-government entities like banks, public sector
oil companies and government-sponsored financial institutions have remained the principal issuers in the
corporate debt market, leaving virtually no appetite for new infrastructure projects that are perceived as riskprone. As a result, there was little possibility of relying on the bond market for financing infrastructure
projects.
Insurance and pension funds, which are also a source of long-tenure debt in the developed economies, offered
a limited window in India, primarily due to various regulatory requirements associated with risk mitigation.
As a result, these funds were not available for the Special Purpose Vehicles typically used for implementing

infrastructure projects. Moreover, insurance and pension funds in India were heavily invested in government
securities which were difficult to displace.
Foreign debt, a comparatively cheaper option as compared to domestic borrowings, provided a limited elbow
room for infrastructure companies, given the limits imposed by the Central Bank on external commercial
borrowings to (or intending to) preventing excessive capital inflows in order to maintain macro-economic
stability.
In the above scenario, commercial banks and non-banking financial institutions became the principal source of
debt funds for infrastructure projects. However, the banks faced their constraints arising from the nature of
their asset base, which primarily consists of short to medium term deposits. This implied a potential assetliability mismatch in lending for the long term. Moreover, banks also lacked the experience and capacity to
undertake limited recourse financing of infrastructure projects that typically do not provide much collateral
security. Since the security for such debt primarily comprises the expected revenue streams of the respective
projects, commercial banks were unlikely to show much appetite for such lending.
Given the various constraints, there was an urgent need to evolve and introduce an intervention that would
enable mobilisation of long-term debt for PPP projects in different infrastructure sectors. Government
intervention had also become necessary since the available sources of finance offered a limited scope for
expansion. Without such an initiative, there was every possibility of a significant shortfall in the projected
investment for infrastructure.

References

http://blogs.worldbank.org/ppps/innovative-financing-case-india-infrastructure-financecompany
https://rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=968
http://industryoutlook.cmie.com/kommon/bin/sr.php?
kall=wshowtab&icode=0102030700000000&tabno=0001