Sovereign Cover For Risk

A debt instrument offering 24 per cent returns. That too, post-tax. The reference is to the Konkan Railway bond. You should grab it. If you miss, wait for the next one. Sure, it makes perfect investment sense as you cant aspire for anything near that figure from any other investment avenues. But have you paid enough attention to the long term nature of the investment and the risk involved?

Risk? You are convinced I must be kidding. After all, these new infrastructure bonds are free of all risks. If you believe so, fine. But the truth, according to investment experts, is that infrastructure projects carry a high element of risk.

 

They point out: In the Konkan bond the risk is diluted considerably thanks to the backing of the Ministry of Railways. Informs Subodh K Shah, executive director, Crisil, The rating awarded to Konkan was not for a stand-alone project. The rating was based on the external support for it. The railways have a separate budget and the cash flows are strong.

Sceptics wont stop there. They argue, but in the future, if the Rakesh Mohan Committee report is any indication, you will have the private sector, too, in line. In that situation, are you sure your faith in infrastructure bonds is not entirely misplaced? If you look at the projects alone, yes, the risk is very high. Unlike a manufacturing project, the risk cannot be quantified here, says AK Basu, chief of IDBI mutual fund. He is pointing to the long gestation period and unforeseen problems that plague such projects.

The build-up: Before getting to the meat of the matter, some history lessons are in order. As you know, it is feared that inadequate infrastructure facilities may cripple the on-going reform process. To tide over the problem, the government had allowed private participation in the infrastructure sector. Despite all tax holidays and concessions, financing these projects remained a daunting task. for the same reasons: they are highly capital intensive, have a long gestation period, are slow in revenue generation and carry high risk.

The total fund requirement for infrastructure development is estimated at about Rs 4,000-4,500 billion over the next five years. The action will be mainly confined to sectors like power, telecommunications, roads, ports, urban development and industrial parks. As of now, the solution seems to be raising money through sovereign bonds. Around five major issues Sardar Sarovar Project, Konkan Railway Corporation, Maharashtra Krishna Valley Development Corporation, Krishna Bhagya Jala Nigam and the Indian Railway Finance Corporation have tapped the market. And the National Highway Authority is next in the line.

These bonds have the backing of governments, both central as in the case of the Konkan and state as in the MKVDC issue. The rating of these projects is based entirely on this factor. Konkan Railway managed AAA (SO), the highest, whereas MKVDC could secure only AA-(SO). The reason being the first had the guarantee of the Railway ministry while the latter was backed by the Maharashtra government.

Incentives: This is where you enter. The first carrot was the addition of Rs 10,000 under section 88, exclusively for investments in infrastructure projects. Followed by extension of long term capital gains benefits, too. In the future, however, innovative instruments will be out to draw you. The next budget is expected to have more incentives for investment in the infrastructure sector. Says Basu, No doubt these sops will lure people to these instruments in a lacklustre market.

That they would. For instance, the Konkan bond was offering 10.5 per cent tax-free returns. In addition, there was also an upfront discount of 5 per cent on the face value. Add to this the 20 per cent rebate under section 88 and the benefit of Rs 12,000 deduction under 80L, and you have the average post-tax return of 20 per cent from the bond. The figure is a phenomenal 30 per cent in MKVDC.

Problem areas: Infrastructure projects, say market players, carry enormous risk. Says D R Dogra, general manager, Care, That is essentially because of the uncertainty involved in these projects. And that makes it difficult to arrive at projections. We need a new set of tools to assess the viability of the project, adds Basu. He is hinting at the irritants which could be as diverse as social, political or natural. It is very difficult to quantify these issues.

Agreed, we as a nation have an unsatiated appetite for controversies. But apart from that what is it that makes these projects scary? As said before, these ventures are highly capital intensive and have a long gestation period. Second, the cost of the fund. Abroad they raise long-term, low cost funds for infrastructure projects. This is not happening in India, opines Basu.

Point is, on a rough estimate, these projects take around 20 years or more to return the capital. Add to this the high coupon rates plus upfront discounts and you know why they could backfire. Third, there are no figures available to assess them. Informs a general manager of IL&FS who does not want to be quoted, It is in the very nature of these projects that they carry high risk at their development stage. That is the way they are.

Agreed the projects demand a Herculean effort and the risk is immeasurable. But what about the sovereign bonds? Most opine that where these are present, (that is, in all of the existing issues) the risk is only notional. For, as the name suggests, they are backed by various governments who are unlikely to back out of their commitment. (Even then, one would be well-advised to gauge the credibility of the guarantor before putting in ones investible funds in these projects. An overload of unviable projects could take the wind out of many a bankrupt state.)

Still some glitches remain. For one, the grey areas in the legal frame work. Besides, can they meet service charges and redemption needs entirely from the revenue? It is very unlikely that they will generate enough money initially, says Dogra. This could put undue pressure on the project as the income generated will not be enough to meet the liabilities, such as servicing debt, redemption, etc, agrees Basu.

Counters the IL&FS official, Due to the very nature of these projects the capital is structured taking into account the inflows and outflows. As for the private offerings in the future, the official says, By that time we will have some benchmark figure to compare. But it will be a long time before the private players tap the retail investor, opine most. The future issues, says Shah, if structured like the existing ones, are not at all risky.

To sum up then, before investing examine the project viability, cost structure, track record of promoters and guarantors, available figures for comparison, insurance, etc. This apart, meditate on the political, social and environmental snags the project may run into. But for the present, your only worry is the absence of a secondary market.