Financing Indian infrastructure: The $1 trillion question

In his speech at Wembley Stadium during his visit to the UK, Prime Minister Narendra Modi made a reference to rupee bonds, jokingly comparing their delights to those of watching James Bond films and drinking Brooke Bond tea. Many in the audience were puzzled as to why it was included in a showcase speech. The reason is the financing of India's infrastructure. The Indian economy, growing at 7.5 per cent, is the fastest growing major economy in the world. In order to boost development and make a significant reduction in poverty (it is estimated that 700 million Indians live in poverty), India needs to grow at around 9 to 10 per cent for many years. High sustainable growth can only be achieved if there is significant investment in infrastructure.One only has to look at China to appreciate the potential. According to the World Bank, in 1990 GDP per head in India (at $380) was a little higher than China ($315). By 2014, the same figure for China is $7,600. In contrast, India's figure was $1,600.In other words in 1990, the average Indian was slightly richer than the average Chinese person. Nearly 25 years later, the latter is nearly five times richer than the former. Over this period, China has pulled many hundreds of millions of people out of poverty while India's progress, though better than previous decades, has been much more pedestrian. The reasons for this divergence are too complex to be completely analysed here. China's spectacular growth has been enabled by huge investments in infrastructure. Due to a poor policy mix, India's growth has been less spectacular. India needs to upgrade its infrastructure across all sectors - roads, ports, airports, railways, power, water, urban infrastructure, housing and so on. The Indian government estimates that as much as $1 trillion is required just in the next few years. The question is how will all this be funded The government has large current spending needs, a large stock of debt outstanding and large deficits. Indian banks cannot take on the funding needs as they have mainly short term deposits and infrastructure requirements are, by definition, long term.Bond markets are a better source of funding. The local bond markets are currently too small to provide all the funds required. Foreign capital will be needed both in the form of equity and long- term debt. Indian issuers have in the past issued US dollar-denominated bonds and $17 billion worth of these are currently outstanding. In these instruments, the exchange rate risk is borne by the Indian issuers.The Indian government wants to create an international Rupee Bond market where long -dated bonds can be issued. As these bonds are rupee-linked, the foreign exchange risk is taken by foreign investors.The proposed international rupee bonds have become known as “Masala Bonds”. We expect the first Masala Bonds to be issued in the next few weeks. The likely issuers include Housing Development Finance Corporation (HDFC), Indian Railway Finance Corporation (IRFC), National Thermal Power Corporation (NTPC) and Power Finance Corporation Limited (PFC). All these have a local AAA Rating (the highest possible) for their rupee bonds These bonds could prove to be interesting investments for foreign investors as the yields for similar bonds in India are 8.2 per cent (p.a.).The final detailed terms of Masala Bonds are not yet known but the minimum investment is likely to be Rs 10 million or about £100,000 or $150,000. Investors who want a diversified portfolio would have to invest about £600,000. For smaller investors, a newly-launched Exchange Traded Fund (ETF) which is listed on the London Stock Exchange (LSE) many be more appropriate. This is called the LAM SUN GLOBAL ZYFIN SE BOND UCITS ETF.Sanjiv Shah is the Chief Investment Officer at Sun Global Investments in London. He has worked for Bank of England, FSA, Paribas Capital Markets Group and Lazard Brothers & Co. He also co-founded India Value Investments Limited (INVIL) in 1996, which is an India-centric long-only equity fund.