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PP RUEHAST RUEHCI RUEHLH RUEHNEH RUEHPW
DE RUEHBI #0569/01 3400753
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P 050753Z DEC 08
FM AMCONSUL MUMBAI
TO RUEHC/SECSTATE WASHDC PRIORITY 6793
INFO RUEHNE/AMEMBASSY NEW DELHI PRIORITY 8034
RUEHBI/AMCONSUL MUMBAI PRIORITY 1958
RUEHNEH/AMCONSUL HYDERABAD PRIORITY 0004
RUEHCI/AMCONSUL KOLKATA PRIORITY 1764
RUEHCG/AMCONSUL CHENNAI PRIORITY 1969
RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEAIIA/CIA WASHDC
RHEHAAA/NSC WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RULSDMK/DEPT OF TRANSPORTATION WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RHMFIUU/DEPT OF ENERGY WASHINGTON DC

UNCLAS SECTION 01 OF 04 MUMBAI 000569 
 
SENSITIVE 
SIPDIS 
 
DEPT PASS TO EXPORT-IMPORT BANK FOR JESSICA FARMER 
DEPT PLEASE PASS TO USTR AADLER/CLILIENFELD 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD ENRG IN
SUBJECT: INDIAN INFRASTRUCTURE FINANCE GRAPPLES WITH NEW REALITIES 
DUE TO FINANCIAL CRISIS 
 
REF: A. A. NEW DELHI 2995 
     ¶B. B: 2007 MUMBAI 649 
 
MUMBAI 00000569  001.2 OF 004 
 
 
¶1.  (U) Summary.  The global credit crisis has hit 
infrastructure finance in India, making it difficult for 
financiers and development companies to raise funds to start or 
continue projects.  While slow execution, regulatory 
uncertainty, high commodity prices, and investment barriers have 
slowed the expected inflow, difficulties in ensuring a steady 
flow of investment has exacerbated these problems.  At two 
conferences in Mumbai, infrastructure fund managers asserted 
that India would miss its infrastructure development targets 
this year, and for the next five years.  Private equity players, 
particularly those with no need to raise additional capital, 
appear poised to be beneficiaries of the current problems in the 
capital markets and expect large, well-known developers to turn 
to them for financing.  Over the last few years, due to 
countrywide scarcity of power, the power sector attracted the 
interest of financiers and developers.  However, the capital 
crunch and the lack of debt financing is starting to affect 
investment opportunities in this area as well.  In addition, 
financiers confirmed that increasing construction capacity was 
solving at least one bottleneck in the infrastructure 
development sector.  End Summary. 
 
McKinsey Managing Partner Paints a Gloomy Picture 
--------------------------------------------- -- 
 
¶2.  (U)  At the Mckinsey infrastructure conference held on 16h 
October, Anil Zainulbhai, the managing partner of McKinsey 
India, noted that over a year ago, U.S. Treasury Secretary 
Paulson and Indian Finance Minister Chidambaram opened an 
infrastructure conference in Mumbai at which participants agreed 
that implementation, and not capital, was the main inhibitor to 
India's infrastructure development (reftel B).  In this 
conference, Indian leaders estimated that the country would need 
to spend close to USD 500 billion on infrastructure in the next 
five years, with approximately USD 150 billion coming from the 
private sector.  With the current global financial crisis, the 
situation has changed dramatically, with multiple projects 
chasing scarce liquidity.  According to Zainulbhai, governments 
are struggling to fund their huge infrastructure investments, 
estimated at USD1.6 trillion a year.  This includes investments 
of about USD860 billion in high income countries, and USD670 
billion in low income countries; in comparison, he said, India's 
target of about USD100 billion a year looks small.  Zainulbhai 
said that given India's slow execution, the country would have 
missed its target for infrastructure spending of USD 500 billion 
even without the global financial crisis. 
 
¶3.  (SBU) Also at the conference, Singapore-based infrastructure 
financier Jaap Kalkman of Arcapita agreed, stating that the 
recent boom in infrastructure spending was built on the belief 
that low interest rates would remain.  This assumption was 
reinforced by increased investment interest from the developed 
world, as investors looked to infrastructure as a new, low-risk 
asset class.  Three "uninvited guests" spoiled the party, he 
said:  high oil prices, the economic downturn, and the credit 
crisis.  He predicted that three forces will cause India to fall 
short of its projected infrastructure investment target.  First, 
high interest rates and the economic slowdown will depress the 
number of deals in the pipeline.  Second, problems with land 
acquisition will impact the pace of implementation of projects. 
Third, the government's slow and lengthy project approval 
process will ensure that India's targets will not be met.  He 
agreed with McKinsey& Co.'s prediction that the shortfall for 
the current five year plan will be USD160-170 billion. 
 
Infrastructure Developers See Some Upside Emerging from the Gloom 
--------------------------------------------- --------- 
 
¶4.  (U)  According to Zainulbhai, infrastructure financiers face 
a number of challenges.  While the Public Private Partnership 
(PPP) model is in favor now globally, financiers have not seen a 
strong record of success in low income countries like China and 
India, as well as the developed world.  In developing countries, 
the PPP model has many risks, such as design and development 
risks, contractual risks, a lack of skilled labor, and 
 
MUMBAI 00000569  002.2 OF 004 
 
 
regulatory uncertainty.  He noted financiers are increasingly 
aware that leverage has proven to be a double-edged sword; in 
upmarkets, leverage makes valuations go up even more but in 
downmarkets leverage works against the investor.  As a result of 
the crisis, players with high leverage and short-term financing 
have been hit the most.  Finding debt financing is harder and 
more expensive and new deals have slowed significantly. 
However, he foresaw increased opportunity for developers with 
proven excellence in operational execution.  The full impact of 
the crisis on infrastructure is possible lower  leverage, 
increased debt costs, and reduced availability of public funds, 
though the extent is unclear in India, he said. 
 
¶5. (SBU) Nevertheless, infrastructure experts see some silver 
lining in these clouds.  Zainulbhai acknowledged that moderating 
commodity prices, as well as slower demand growth for 
transportation and energy, will reduce input costs for the 
infrastructure development as well as lower the immediate need 
for the projects. .  In another conference organized by 
Macquaire Capital, Issac George, the Chief Financial Officer of 
GVK Industries, a major Indian infrastructure firm, said that 
the limited supply of equity will ensure that the better 
projects are financed.  Parvez Umrigar, the Managing Director of 
Gammon Infrastructure Investment, another large Indian 
construction company, believes that the financial crisis will 
eliminate non-serious players and limit bidding to qualified and 
seasoned companies.  Praveen Sood, the Chief Financial Officer 
of Hindustan Construction Company, believes that infrastructure 
financiers and developers should look at the financial crisis as 
an opportunity to grab more projects.  He noted that Warren 
Buffet has said that when the world is greedy, you should be 
fearful and when the world is fearful, you should be greedy. 
 
More Could Be Done to Make Financing Easier 
--------------------------------------------- - 
 
¶6.  (SBU)  According to Kalkman, the Indian government has 
provided a better regulatory framework for FDI in 
infrastructure, particularly for the power sector, than Brazil 
and China, but bottlenecks in financial regulation remain.  He 
stated that the Reserve Bank of India's limit for external 
commercial borrowing (ECB) of USD 500 million per infrastructure 
project with a maximum interest rate of LIBOR plus 500 basis 
points (bps) was unrealistic in the current environment. 
Currently, infrastructure projects cannot readily raise high 
yield foreign funds (mezzanine funds) for infrastructure 
projects, he continued.   Kalkman predicted that multilateral 
agencies could come back into favor, but a time-consuming 
application process could prevent how many projects could tap 
this route. 
 
¶7.  (SBU) McKinsey's Anu Madgavkar, partner in its banking and 
infrastructure practice, agreed with these problems and stated 
that India's savings and capital markets have not allocated 
sufficient funds to infrastructure development.  She said that 
over the next five years banks and non-banking financial 
institutions (NBFIs) will have USD465 billion of additional 
capital to invest.  Looking at historical trends, she projected 
that only 8 percent of that capital would be available for 
infrastructure investment.  To fix these financing bottlenecks, 
she proposed a series of recommendations.  First, the ECB 
approval process should be simplified and the interest rate cap 
be eliminated to facilitate mezzanine financing.   Second, she 
recommended that government provident funds, which currently 
cannot invest in infrastructure projects, should be asked to 
invest a minimum allocation in infrastructure, and banks should 
be allowed to raise infrastructure bonds that qualify for 
Statutory Liquidity Reserve Ratio (SLR) status.  (Note:  Indian 
banks must invest a minimum amount of their capital into 
government securities, known as the SLR, currently at 24 
percent.  If infrastructure bonds gained SLR status, they would 
not be counted in the overall loan book of the bank, making the 
bonds more attractive.  End Note. )   Third, the government 
should accord priority sector status for infrastructure which 
would ensure that a minimum amount of capital was supplied to 
the sector even in times of capital scarcity , and reform the 
corporate bond market.   She also recommended that the 
 
MUMBAI 00000569  003.2 OF 004 
 
 
government should allow new sources of foreign capital in 
addition to private equity, like sovereign wealth funds and 
global pension funds as well as create new tax incentives for 
direct infrastructure funding.  She also proposed that new 
mechanisms be created to channel new funds, like putting a 
portion of foreign exchange reserves into infrastructure or 
replicate the National Highways Authority India model of a 
special purpose fund funded by a cess to invest in different 
infrastructure sectors.  If these measures are undertaken, then 
more of India's domestic savings can be channeled into 
infrastructure development. 
 
Still No Municipal Bond Market 
---------------------------------------- 
 
¶8.  (SBU) Sanjay Palve, Country Head of Infrastructure Banking 
at Yes Bank, pointed out an often overlooked problem: there is 
no proper structure for municipal governments to raise finance. 
As a result, well-known metros like Mumbai found it much easier 
to obtain financing than smaller ones like Bhivandi, a 
municipality in Maharashtra.  Amit Tandon, Managing Director of 
Fitch Ratings, noted that it was because of this gap that his 
company had become the first to start rating Indian 
municipalities, which had been greeted by much enthusiasm. 
Shailesh Phatak, Managing Director of ICICI Ventures, remarked 
that urban infrastructure has been completely overlooked in the 
current Five Year Plan, and he hoped that this would change in 
the next.  (Note:  The government has started a multi-year urban 
renewal "mission" to co-fund infrastructure projects, like 
sanitation and waste management, with municipalities.  End note.) 
 
Private Equity Players Poised to Reap Benefit from Problems in 
Public Markets 
--------------------------------------------- --- 
 
¶9.  (SBU) Responding to media reports that private equity 
players will be the beneficiaries of the current financial 
turbulence, Gopal Jain, Managing Partner of Gaja Capital 
Partners, stated that private equity professionals have two 
jobs: the first is raising capital for investment and the second 
is investing.  He stated that those funds needing to raise 
capital may run into problems, but capitalized funds will have 
rich pickings after the crisis blows over.  M.K. Sinha, CEO of 
IDFC Project Equity, told Congenoffs that IDFC  had  raised a 
USD 900 million infrastructure fund, in two tranches, by early 
August.    (Note:  Initially proposed during the November 2006 
U.S.-India CEO Forum meeting in New York, this fund has been 
raised in partnership with Citibank and several other 
international partners.  It was originally slated to raise up to 
USD 5 billion, but now has more modest funding goals.  End 
Note.)  According to Sinha, the timing was fortunate, as 
American investment has now frozen up, and most of the USD325 
million that he raised in his second fund came from Middle 
Eastern investors.  He added that the bear market had made 
American investors risk averse, and wary of infrastructure 
investment in particular, to which they had little previous 
exposure.  On the investing side, Sinha stated that because 
equity and debt markets have begun to dry up, he was beginning 
to see an improvement in the quality of projects coming to him, 
as better players need financing not available in the markets. 
He predicted that companies that would normally go to the public 
markets for capital, like GVK and GMR, will soon seek private 
equity funding.  When pressed on the topic of carbon credits in 
infrastructure projects, he commented that last year he would 
have taken into account carbon credits before they had been 
accredited; now, however, he is waiting until the U. N. 
Framework Convention on Climate Change  approves them.  (Note: 
Echoing these comment, another infrastructure-related company, 
Ispat Energy and Steel, confirmed that it is now seeking private 
equity investors for project funding instead of the capital 
markets.) 
 
¶10.  (SBU) Despite the "drying up" of foreign capital, Pathak 
expressed confidence that it would return to India.  He saw his 
local private equity fund as perfectly placed to be a partner 
for foreign investors who wanted to invest in Indian projects. 
For example, he stated that he is currently in discussion with 
 
MUMBAI 00000569  004.2 OF 004 
 
 
the private equity arm of an American investment bank for  a 
partnership agreement in which the bank would  invest alongside 
his fund or invest directly into his fund. 
 
Power: Receiving Great Attention Amid Great Challenges and the 
Capital Crunch 
--------------------------------------------- --------- 
 
 
¶11.  (SBU) Power, one of the sectors needing the most 
investment, is also the sector receiving the most amount of 
attention.  M.K. Sinha remarked that power sector investment is 
attractive in any scenario because of India's persistent power 
deficit, coupled with an improved regulatory environment.   R.K. 
Dash of the State Bank of India (SBI) stated that though his 
firm was supporting a large number of power projects, he saw 
several bottlenecks.  For many projects, coal linkage may be 
problematic and the distribution sector needs reform.  He also 
noted that the power equipment manufacturing capacity is limited 
in India.  The domestic power equipment manufacturer, Bharat 
Heavy Electrical Limited, is booked for the foreseeable future, 
he continued.  Some developers are turning to Chinese equipment 
makers, but the quality of their products is questionable.  He 
clarified that even though some companies have had success with 
Chinese equipment, there are concerns in the private sector and 
the Indian government that this equipment is not durable.  In 
addition to these sector-specific concerns, Anu Madgavkar 
cautioned that in November 2008, the power sector started to be 
affected by the capital crunch, Indian banks began to hit their 
lending limits for this sector.  This is especially true for the 
Ultra Mega Power Projects.  She noted that private equity 
players were still looking to invest in power, but the 
complementary debt funding that is needed has dried up. 
However, she said that given the persistent power deficit in the 
country, this should be one of first sectors to bounce back when 
debt-financing was once again available. 
 
One Bottleneck Improving: Increasing Construction Capacity 
--------------------------------------------- ---------- 
 
¶12.  (SBU) One year ago, Sanjay Reddy, Vice-Chairman of the GVK 
Group, cited the dearth of sizeable construction companies as a 
key bottleneck in the development of infrastructure in India 
(reftel B).  However, some infrastructure financiers say this 
has changed.  Sreekumar Chatra of Macquerie Capital noted that 
in recent years, a number of mid-sized construction companies 
like Gammon, Simplex, Punj Lloyd, and IDRCL are emerging as 
leaders in the construction sector.  He also noted that in some 
specialized cases, companies that normally were not construction 
experts had learned specialized construction skills.  Bhavin 
Shah, Vice-President of the Mundra Port and SEZ for the Adani 
Group, agreed, noting the Adani Group had constructed much of 
its port and SEZ facilities itself. 
 
¶13.  (SBU) Comment:  Last year, international investors promised 
that a "wall of money" was waiting to invest in Indian 
infrastructure.  This promise was held out as an incentive to 
push Indian policymakers and developers into speeding up reforms 
that would allow Indian infrastructure development to keep pace 
with the demands of a growing economy.  Due to problems with the 
international financial markets, infrastructure financiers say 
this "wall" no longer exists.  This year, high commodity prices 
drove up input costs dramatically, followed by a global credit 
crunch and falling capital markets.   Though commodity prices 
have fallen, infrastructure and development companies are still 
having difficulties raising funds to begin or continue their 
projects.  Particularly notable is that  power projects which 
first appeared to be surviving the capital crunch are currently 
having trouble achieving financial closure due to the problems 
attracting debt financing. The RBI's moves to encourage more 
ECBs in infrastructure appear to have not worked so far; 
according to central bank data, corporates raised USD 1.12 
billion through ECBs in October, less than half of USD 2.8 
billion raised in the previous month.   In the meantime, 
infrastructure developers maintain that Indian infrastructure 
spending is stagnating.   End Comment. 
FOLMSBEE