Role of InvITs: Transforming Urban Infrastructure Through PPP Model

INTRODUCTION:

India's total infrastructure spending has grown exponentially over the years, with budget allocations rising to ₹10 lakh crore in 2023-24. By 2036, 600 million Indians will reside in an urban setup, posing significant challenges for healthcare, power supply, and efficient transportation. India’s water demand is expected to double by 2030. Therefore, it required an investment of $840 billion in infrastructure development. However, from 2011 to 2018, only half the required amount was invested. Infrastructure will be the backbone of country’s growth and the unaddressed demand will cripple the urban spaces.

This transition will push the limits of the adaptability of the city's infrastructure. Infrastructure development is administered at the three levels of governance: Urban Local Bodies (“ULB”), State, and Centre. Central and state governments finance 72% of urban infrastructure, with the private sector contributing only a meagre 5% compared to global standard practices. The traditional forms of infrastructure financing are inadequate. Municipal finances are constrained as their source of revenue through service charges and property taxes is still low compared to other countries; therefore, they depend on government grants.

The massive investment is not the only issue; the main problem is the appropriate financing mechanism. The Public Private Partnership (“PPP”) has been used in India for infrastructure development; however, it has been grappling with challenges aggravated by weak policy, global headwinds, financing issues, contractual issues, and time cost overruns. This expedites the need for alternative models like Infrastructure Investment Trusts (“InvITs”) in urban infrastructure financing.

 InvITs are collective investment vehicles funded by citizens and support fractional ownership (i.e., owning a small piece of a big project, like being one of 1,000 people who each own a slice of a toll road). InvITs provide a mechanism to unlock capital from existing infrastructure and reduce the upfront infrastructure financing burden on developers.

This blog analyses the importance of InvITs, risk allocation issues, and policy recommendations to enhance their effectiveness. If the InvITs are structurally reinforced with effective legal instruments, time-bound transference, and a robust dispute resolution mechanism, they can unlock India’s urban infrastructure potential.

Understanding PPPs in Urban Infrastructure

PPPs in India are financed through a mix of public and private investments, and with the support of Development Financial Institutions (“DFIs”). The private partner is selected through open-competitive bidding and is responsible for designing, building, and operating, in some cases, albeit transferring ownership in other cases, to the government, with or without the future scope of leasing. Recovery is through tariffs on the utilization of the project.

Financing mechanisms under PPPs include Infrastructure Debt Funds, Real Estate Investment Trusts (“REITs”), and InvITs. Bonds issued through ULBs and the Viability Gap Funding (“VGF”) Schemes provide grants to PPP-based projects. At times, infrastructure projects in India remain economically viable but not financially viable, so VGF provides financial support to make them commercially viable, making the projects more attractive to private investors. The Indian Infrastructure Project Development Fund (“IIPDF”) was formulated to fund up to 75% of the cost incurred towards PPP Project development.

Successful Implementation of the PPP Model in India

a)     The 29.2 km Mumbai Coastal Road Project is funded partly by charging builders a premium for fungible Floor Space Index (FSI), an innovative policy that monetized additional construction rights to raise over 40,000 crores since 2011 for investing in the project itself, effectively leveraging private sector contributions without burdening government budgets.

b)     Pune Metro Line-III, Maharashtra, developed on a Design-Build-Finance-Operate-Transfer (DBFOT), received financing through VGF, ensuring the project’s commercial viability.

The PPP model in India showcased its capacity to cater to large-scale road infrastructure. Despite the success of PPP in some sectors like airports and highways, rising cost overruns and a lack of policy cohesion hindered its potential.

The early projects, like Rau-Pithampura Road in Madhya Pradesh and Noida Toll, showcased promise, but long-term sustainability has been limited. Some of the major causes of failures are:

Contract failures- Contracts were drafted poorly with ambiguity in risk sharing, and inadequate contract management led to conflict between parties, causing inefficiency and ultimately harming the project’s implementation.

Low revenue predictability- Flawed business models often include large upfront investments with long waiting periods between money spent and revenue made (gestation periods), making revenue streams uncertain and difficult.

InvITs: Structure and Promise

InvITs are innovative investment vehicles that function similarly to mutual funds. They pool money from individuals for investment in revenue-generating infrastructure projects through a stable instrument. Investors buy units of it and receive regular income from the cash flow.

key stakeholders:

a)     Government- monetizes the assets,

b)     Public- the consumers of the assets,

c)     Private sector- Sponsors, developers, managers

In 2014, the Securities and Exchange Board of India (“SEBI”) introduced norms to regulate the functioning and methods of InvITs coupled with Real Estate Investment Trusts (“REITs”). InvITs comprise Sponsors, trustees, and trustee-appointed managers (Investment and Project). InvITs are established as trusts under the Indian Trust Act, 1882.

One of them is the National Highways Infra Trust (“NHIT”), the InvIT set up by the National Highway Authority of India (“NHAI”), which has raised 18,380 crores, showcasing its effectiveness. However, in India, the implementation of InvITs faces several challenges and risks.

Challenges InvITs Face in India

1.     Regulatory Challenges: 

The lack of a streamlined policy introduces uncertainties, and consequently, sponsors lose interest. The lack of a clear exit strategy for investors adds to the sponsor's woes, as in IL&FS Transportation Network Ltd. The company failed to transfer assets to InvITs due to a delay in approval from the Jharkhand Government, leading to investors abandoning the plan, ultimately degrading investors' confidence.

2.     Project Delays Mispricing: 

Delays in project identification, land acquisition, and regulatory approval have led to increased construction costs. The process involving InvIT from asset selection to exit is hindered by bureaucratic hurdles, like in the IL&FS Case of Jharkhand.

3.     Weak Risk Management: 

PPP contracts underpinning InvITs frequently lack clauses for policy changes, leaving InvITs vulnerable to unmitigated damages. The absence of specific recognition of the roles of the loss bearer raises the risk. It’s absence in the Pimpalgaon-Nashik-Gonde Tollway Limited (“PNGTL”) project led to revenue loss, and consequently, disputes arose.

4.     Under-construction Project Risk: 

Sponsors of the InvITs are restricted to investing only 10% of assets in infrastructure projects that are redeveloping or repurposing previously used, often abandoned, or underutilized land parcels that may have existing infrastructure but are currently vacant or contaminated (brownfield project), which limits their ability to reap long-term growth benefits.

5.     Investment Barriers:

The InvIT has attracted domestic investors; however, it lags in getting investment from foreign institutional investors due to high withholding tax rates of 5-20% (Income tax deducted before a foreign investor gets paid), lengthy tax compliance rules, making investment less attractive for foreign players.

Policy pathways to strengthen InvITs' implementation in urban infrastructure projects:

Recommendations           Action Step          Evidence/Benchmark     Risk/Mitigation

Broaden investor base	Raise limits in phases from 3 to 25%	Australia’s model	Monitor volatility
Reduce withholding tax for foreign investors	Lower the tax to 0–10%	UAE, Singapore	Fiscal assessment
Centralize approvals	SEBI-led authority, dashboard	IL&FS case	Transparency measures

1.         Broadening the investor base:

a)   Increasing the permissible investment of pension and insurance funds from 3 to 25%. Backed by pension funds, Australia’s InvIT model successfully funded over $100B in investment, generating double-digit returns over 10 years.

b)   Increasing the limit of mutual fund investment in InvITs from 10% to 30% can broaden the investor base.

c)   Reducing the withholding tax to 0-10%, similar to other countries like the UAE (0%) and Singapore (0-10%), can increase foreign investments.

2.     Institutional Reforms: 

a)   Establishing a centralized authority under the aegis of SEBI to fast-track approvals for InvITs and rectify the issue of project delays.

b)   Leverage the National Infrastructure Pipeline’s (“NIP”) digital infrastructure to create an online dashboard for real-time project progress tracking to help cut short delays.

3.     Dispute Resolution Reform: 

a)     The contractual agreement should include terms allocating risks, defining the roles of stakeholders, and it’s enforcement should be given priority.

b)     Streamlining the dispute resolution mechanism and recovery process, and bringing disputes under the Insolvency and Bankruptcy Code (“IBC”) can resolve disputes currently governed under the framework of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”) and the Recovery of Debts and Bankruptcy Act, 1993 (the “RDB Act”) thereby enabling faster recovery.

c)     Recognizing InvITs as financial creditors in case of default can help recover the money on a priority basis under the IBC.