The sunny side of Indian private equity story

Private Equity (PE) in India is still in its nascent stage, accounting for roughly 1% of the GDP. This is in contrast to almost 3% in the US. However, PE funding has come a long way in the recent past, accounting for 3-5% of the total capital raised by Indian companies.

Private equity is patient capital, another term for long-term capital,wherein the investor is ready to invest in a business with no expectation of immediate return or profit; the investor is ready to wait for better returns in the long-term. The general trend has been that even when corporate investors took a break from investing, PE funds showed no aversion in investing. PE investors are normally focused on capital-intensive sectors such as energy, retail, infrastructure and consumer goods, etc.

Among these, the infrastructure and energy space are the two sectors which are gaining prominence in the recent past because of the added thrust given to these sectors by the government.

Infrastructure is the most happening sector, which has been gaining attention ever since the government put its focus on developmental agenda. Over the next five years, the Indian infrastructure sector is in need of huge investment with the estimated requirement being $485 billion. Of this, the power sector is in need of an investment of $250 billion for the development of the sector, including components of generation, distribution, transmission and equipment.

The government has been giving prominence to infrastructure development as a way to augment economic growth in the country, with a lot of policy initiatives and efforts to attract investments and facilitate overall growth and development in the sector. Key infrastructure sectors such as roads, railways and ports, power, renewable energy, etc., have witnessed huge boost in the recent past. Especially the roads sector has outperformed the other major sectors during the past two years.

The investment in infrastructure is a national priority. The new regime has been proactive in initiating several measures in encouraging investments in development of sustainable infrastructure — states / PSUs have been encouraged to enter into PPA’s for renewable energy; aggressive plans on connectivity through road, rail power and telecom networks and evolution of the hybrid annuity structure for highways, are some of the key developments that are likely to spur investment in the sector.

With greater appreciation of the risks associated with large infrastructure projects, lending institutions are expected to channelise more investment in the sectors. While quality of diligence and project monitoring are rising, domestic banks have been again backing projects — renewables, highways and railway PPP projects showing the way forward.

New financial options and sources are now available to infrastructure projects, and the RBI has also taken various steps to facilitate more investment in the sector, through new investment structures as well as through changes in the existing project lending and ECB guidelines.

PE investments have played an important role in influencing India’s economic growth and development. With the country aspiring to tag itself as an emerging superpower and global economic powerhouse, the investment ecosystem is keeping pace by luring in capital inflows into the system.

PE firms first stepped into the Indian market in the early 1990s. It took almost a decade for the firms to realise the investment potential in India. With a population of 1.3 billion, an aspirational middle class and at least 6% rate of economic growth, the PE market in India began catching momentum.

PE investments in India experienced a robust increase over 2015, according to a report by Bain & Co India. Deal value, including real estate, infrastructure and VC deals, increased by 51% to $22.9 billion — surpassing 2007 peak levels of $17.1 billion. In terms of attracting PE investments, India remains the most attractive market in the Asia-Pacific region, followed closely by China. India boasts of  strong GDP growth, a vibrant entrepreneurship ecosystem and a positive outlook, making it one of the most attractive of the emerging economies for PE investments.

To attract investments, the report recommends, India needs to continue to improve the Ease of Doing Business in the country, a large part of which involves a regulatory environment that is more conducive to business growth. The report says that India’s government continues to focus on encouraging investments within the country through campaigns such as Make in India and Startup India and measures like tax regime rationalisation. Positively, the government is fast-tracking approvals for infrastructure projects and relaxing FEMA rules to provide easier access to capital for domestic investment funds.

India can and should take the foreign route to get more PE funding. With the PE sector showing an upward trajectory and the overall investment climate conducive for more investment to pour in, we can see renewed interest from foreign investors who want to invest in India’s infrastructure sector. There is potential for investment in Smart Cities, high-speed trains, and renewable energy.

On their part, Indian fund managers are now showing extreme pragmatism and due diligence after the investment ecstasy of 2007. The segment has learned key valuable lessons with the investors exercising prudence and circumspection before investing. A lot of factors need to be kept in mind in order to create a climate conducive for private equity investments, the primary one being creating a suitable investment climate. Other factors include rationalisation of the tax regime, removal of restrictions for participation of private and foreign capital, etc.

A promising global outlook backed by solid policy framework, promising growth rate, emergence of a slew of first-generation entrepreneurs and a consumption-driven ecosystem, have worked out to the advantage of the country’s investment climate, making it a destination for PE investment. 

Finally, it is important to understand that infrastructure projects, globally have had challenges and risks, which can never be mitigated through improved financial intermediation alone. India’s social, economic and political scenarios add another dimension to the issue. Systemic action has already commenced — including wide ranging changes to the legal system and the tax regime, and the currency cleansing — all of which bode well for the country and the sector. With the recent changes in the global political scenario, India is likely to emerge stronger, on the back of a connected economy of 1.3 billion people.

(The author is Founder and Managing Director, Singhi Advisors)