In a move that is likely to strengthen opportunities for infrastructure projects with regard to raising funds and provide another long-term investment avenue for the general public, rating agency Crisil on Thursday announced that it has developed a credit rating system for infrastructure projects in consultation with the Ministry of Finance and other stakeholders. As bank borrowing has been turning tough for infrastructure companies because of their existing high debts and bank credit to the sector contracting — hitting a low of -6.7 per cent in November— experts say that investors need to be careful while investing directly in infrastructure projects and while the credit rating may offer some help on pricing of the paper, there is a need for greater due diligence on the project and the companies operating them, before buying the papers.
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“The due diligence is much more required and the investors will not only have to decide on the investment based on the credibility of the finance organisation coming out with the paper but will have to go through the details of the project. It needs to be seen as to how much transparency is maintained,” said Surya Bhatia, CFP and founder Asset Managers Wealth Managers.
There are some who say that ideally these projects have to run as independent profit centres and there has to be a separate escrow account.
In its statement, Crisil said, “The new credit rating system is based on the ‘expected loss’ (EL) methodology. Which means, the rating will be an expert judgment on EL over the life of the debt instrument by taking into account the two pillars of credit risk — the probability of default (PD), and the prospects of recovery”.
What this essentially means is that this rating does not only take into account the risk of timely repayment, but also prospects of recovery post default.
“As of now, in the initial phase, we expect completed and operational projects to go in for such ratings. Such projects are likely to have steady cash flows. While the cash flows of a project may at times limit its ability to repay on time, but the chances of recovery post default is viable in such cases and that will be reflected in this rating system,” said Somasekhar Vemuri, senior director, Crisil Ratings.
He further added that the new rating scale will provide a valuable input — in addition to the existing rating scale based on the PD approach — to investors for effective pricing of debt instruments, and consequently, investment decisions. In contrast, the old rating system only provided commentary on the ability of the borrower to repay on time.
The rating agency said that the ratings will be assigned on a scale from CRISIL INFRA EL1 to CRISIL INFRA EL7, with EL1 having the lowest expected loss and EL7 the highest. It will initially be used to assess completed and operational infrastructure projects.
Crisil points that while India’s infrastructure sector needs Rs 43 lakh crore of investments over five years ending March 31, 2020, the domestic corporate bond market will have to pitch in with at least Rs 11 lakh crore out of this because of capital constraints at public sector banks. It said that there is a need for new innovative structures such as infrastructure debt funds, and credit enhancement mechanisms such as partial guarantees, that would enable long-term investors such as insurers and pension funds to pitch in and bridge the funding gap.
Should you invest?
While finance companies are expected to come out with such papers to be invested by investors of all categories, experts say that retail investors should wait for this avenue to play out before they enter them directly. “It is ideally suited for institutional investors as they can understand the nature of project and the complications associated with the same. Later, as they become more prevalent, retail investors can look to have direct exposure to them,” said an investment advisor who did not wish to be named.
Finance minister Arun Jaitley, in his Budget speech proposed to develop a new credit rating system for projects, which would rate infrastructure projects rather than companies executing these projects. This approach is expected to result in lower credit costs for good projects, even though these may be executed by companies having weak balance sheet. “A new credit rating system for infrastructure projects which gives emphasis to various in-built credit enhancement structures will be developed, instead of relying upon a standard perception of risk which often result in mispriced loans,” Jaitley had said in the Budget 2016-17.
Long-term investors and the corporate bond market have shied off infrastructure projects in India because of higher perceived risk and lower credit ratings and this has happened despite the fact that once such projects stabilise, their credit profiles improve significantly. On Thursday, The Indian Express reported that bank credit to the infrastructure sector, which had been steadily sliding over the first eight months of the current financial year, has recorded its sharpest contraction of 6.7 per cent in November. The data released by RBI Tuesday shows that credit outstanding to the infrastructure sector has slipped from Rs 9,64,800 crore in March 2016 to Rs 9,00,700 crore in November 2016.