Infrastructure & Project Finance

Transcription

1 Credit Neutral but Downside Risks Exist Special Report Infrastructure Motive For Foreign Currency Borrowing: The near-zero LIBOR rate, the base rate for almost all external commercial borrowing (ECB)-funded India Ratings & Research s (Ind-Ra) projects, is the key driving factor for infrastructure projects to lean towards foreign borrowings. This is testified by the fact that the peak LIBOR rate observed since 21 is.81% while the peak base rate for an INR loan for the same period is 1.%. Among Ind-Ra rated projects, the all-in-cost of an ECB is in the range of 4.75%-9.55% while the range for an INR loan is 1.75%- 13.5%, the higher end of 9.55% for the former being due to the presence of a currency hedge contract which is a rarity for infrastructure projects in the agency s portfolio. Beneficial to Fund Capex Imports: Though revenue for infrastructure projects is invariably denominated in INR, some projects incur varying portions of their capex in foreign currency - the highway sector for maintenance and operations of toll systems and the power sector for buying the boiler turbine generator equipment. In such instances, the ECB acts as a natural hedging tool for payments to be made to vendors in foreign currency over a fairly long construction period. However, debt servicing remains exposed unless hedged, which is seldom the case. Savings Limited to Initial Years Only: Ind-Ra, based on its portfolio of rated projects, estimates that a project saves around 6%-15% of the total debt service obligations during the initial three to five years of debt amortisation on account of ECB funding. The potential savings are beneficial owing to the fact that the ECB funding aids cash flows during the project s initial ramp up stages - the main pain point for most infrastructure projects. Total Outflow Higher: If one considers the entire tenure of the loan (notwithstanding the potential savings in the initial years), the total outflow of an ECB funded facility is likely to be higher than that of a facility funded solely in the domestic currency. This is primarily due to two reasons: the heavily back-ended structure of the loan and the fact that its conversion to a rupee term loan is scheduled to occur at possibly much higher exchange rates prevailing five-six years subsequent to the commencement of loan amortisation which, in the case of a weakening rupee, would compound the problem further. Over 5% of Ind-Ra rated projects have a standard structure wherein the ECB facility, availed to take out part of the INR term debt used for financing project construction, is in place only for the initial five years (on door-to-door loan tenure of around 15 years). In such cases, where only about 5% of the ECB loan amortises; the balance loan amount is automatically swapped with a domestic loan and follows the amortisation schedule in line with the remainder INR term loan, leaving the project exposed to currency fluctuation risk at the conversion date. Analysts Chintan Lakhani Sriram Parthasarathy Risk on Unhedged Exposure Remains: Though there are a few material benefits expected to accrue from the ECB, the unhedged exposure of the loans to currency fluctuations and variable interest rate poses a threat to the potential savings envisaged over the term of the ECB loan. Almost all the projects are exposed to exchange rate fluctuations regardless of whether they are exposed to variable interest rate risk or not. While the projects may be availing loans at interest rates lower than those charged in the domestic market, their debt service commitments in rupee terms may rise sharply if the rupee depreciates more than initial expectations. This could neutralise the benefit of an interest rate differential June 213

2 Ind-Ra s estimates reveal that even a minimal 5% yoy fall in the Indian rupee (the rupee has depreciated by over 21% since June 21) would wipe out and/or minimise the benefits envisaged in the initial years of the project (Please refer Appendix 1 for comparison of debt service costs and coverage ratios under different scenarios (i) with ECB debt (ii) without ECB debt). The current depreciating trend of INR against USD is likely to erode the potential savings expected while availing the ECB facility. This is reflected by the currency rate which has, on an average, depreciated, depending on each project, by around % from the time the project had availed the ECB facility. Portfolio Composition: Around 12% of the total Ind-Ra rated projects have opted for an ECB facility. The agency observes that the number of projects availing an ECB facility has increased steadily over the years. Though the market offers a host of ECB funding options, the agency observes that a significantly large number of projects opt for funding through commercial bank loans. In Ind-Ra s portfolio, all the projects have ECB liabilities in the form of bank loans (mostly denominated in USD). Is ECB Indeed a Better Mode to Ease the Debt Burden? ECB s main purpose is to take advantage of the relatively lower interest rates in the projects initial years of project stabilisation. Given Ind-Ra s experience, in relation to the performance observed, the project should face minimal problems in accomplishing this objective. That said, benefits in the initial years are likely to come at the expense of higher cash outflows, thanks to the unhedged exposure and heavily back-ended amortisation in the later years of the project life cycle. In Ind-Ra s view, the inclusion of an ECB facility in the funding structure or substitution of the existing domestic debt with an ECB facility will not, automatically, improve the overall credit profile of the project. Although the foreign currency debt exposes the project to currency risks by being un-hedged, only around 5% of the total debt is to be repaid in USD, with the balance to be converted automatically into an INR facility in around FY19 and repaid along with the remainder of the INR term loan. Also, although cash flows will be vulnerable to currency depreciation as the conversion will take place at exchanges rates prevailing in FY19, Ind-Ra s analysis shows that most transactions can withstand a reasonable depreciation of INR against USD. So, downward pressure on ratings is not immediately likely. June 213 2

3 Appendix 1 Figure 1 Project A 8, 7, 6, 5, 4, 3, 2, 1, FY16 FY17 FY18 FY19 FY2 FY21 FY22 FY23 FY24 FY25 FY26 FY27 FY28 FY29 FY Figure 2 Project B 2,5 2, 1,5 1, 5 FY14 FY15 FY16 FY17 FY18 FY19 FY2 FY21 FY22 FY23 FY24 FY25 FY Figure 3 Project C 4,5 4, 3,5 3, 2,5 2, 1,5 1, 5 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY2 FY21 FY22 FY23 FY24 FY June 213 3

4 Figure 4 Project D 2,5 2, 1,5 1, 5 FY14 FY15 FY16 FY17 FY18 FY19 FY2 FY21 FY22 FY Figure 5 Project E 9, 8, 7, 6, 5, 4, 3, 2, 1, FY14 FY15 FY16 FY17 FY18 FY19 FY2 FY21 FY22 FY23 FY Figure 6 Project F 14, 12, 1, 8, 6, 4, 2, FY14 FY15 FY16 FY17 FY18 FY19 FY2 FY21 FY22 FY June 213 4

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