Funding for the future

Sachin Vora, director-finance, Berggruen Hotels, shares his views on the challenges (particularly from the finance side) that the hospitality sector is facing today

Sachin Vora Director - finance, Berggruen Hotels

If we look at the hospitality industry through a wide-angle lens, the biggest challenge that it is facing is that of raising funds (mainly on the debt side). The hotel industry is a capital-intensive industry and it requires a huge amount of investment in terms of capital (both equity and debt). The cost of projects vary depending on the target segment (whether it is a luxury, upscale or a budssget hotel). Today, equity has to be brought to the fore as a promoter's contribution for the start up of any venture. There is no seed capital available to the hotel industry, unlike other start up ventures in the IT and BPO sector as well as some emerging industries on the manufacturing side.

Raising debt is a major challenge faced by the industry. Start-up ventures have their own issues of funding on the debt side, as banks and institutions are not willing to fund such projects, being of the opinion that these are risky ventures. Instead, they are more comfortable funding existing or running hotel chains. However, if the start-up venture has proper business plans and is able to convince the bank or the institution about its financial capabilities as well as its ability to roll out a chain of hotels, the banks will re-look at funding these new hotel chains. It also requires a promoter's strong background, the institution's willingness to commit funds, the team responsible for setting up the chain, the delivery model and redefining the offerings - be it in the luxury segment or in the budget hotel segment as well as a value-for-money product. Customers will become smarter when supply hits the market and will be more careful in choosing products which offer them real value for money.

Challenges galore

Today, there also exist other challenges involved in the raising of funds. The industry is looked at as a real estate industry and all the norms of funding a real estate sector are made applicable to the hotel industry. The banks and financial institutions, most of them already having had a high exposure to the real estate sector, are not keen on funding the hotel industry. The industry badly requires funds by way of debt to build new hotels; something that is becoming scarcer every day. The banks and financial institutions should be convinced to fund the hospitality sector beyond the debt equity ratio of 2:1.

The government and Reserve Bank of India (RBI) should alter their views on the hospitality sector by treating this industry on par with the other manufacturing industries and the infrastructure industry. Just to give an example of how the two arms of the government have diverse views on the same, the RBI and other agencies liken the hospitality industry to a real estate industry, whereas the ministry of labour wants to bring the hospitality industry under the Factories Act and accordingly wants to make applicable to this industry most of the laws that apply to factories.

The Reserve Bank of India has asked banks to provide higher provisioning and higher risk weight, which translates into higher capital adequacy for funding to real estate sector to guard against fuelling asset price bubbles, also known as 'speculative loans' for this sector since May 2006. With these norms made applicable to the hospitality industry, the cost of funding has substantially gone up, thereby making investment in some of the properties not a viable option. The interest rate in India has not kept pace with falling interest rates in the US and other countries. The cost of funding in India is also still high, falling in the range of 13 per cent to 15 per cent, as compared to the cost of funding at seven to nine per cent. This higher rate of interest on domestic funds is no doubt making a dent on the profitability of hotels.

Status quo

Today, this sector has not got 'infrastructural' status. Since July 2007, the RBI has stopped foreign currency loans under its External Commercial Borrowing (ECB) guidelines to the hospitality sector (as a part of the real estate sector). This has blocked availability of cheap funds to the industry from the overseas market. With lacklustre response from the banks and institutions to fund this industry domestically, this measure has acted double whammy to the industry, thereby further choking debt funds. The ministry of tourism has therefore urged the ministry of finance to permit the hotel industry to raise foreign currency loans under its ECB guidelines. All eyes in the industry are however fixed on the financial budget, as of now,.

Costing concerns

It has been a long standing demand of the ministry of tourism to extend tax holidays to this industry under section 80-IB of the Income Tax Act which was discontinued in 2001, henceforth only being available to Hilly Area/Rural Areas/Pilgrimage Areas. This industry in general has been neglected and has never got any fair treatment in the government policies, particularly in terms of capital subsidy, tax holidays/ tax deductions, cheaper interest rates or export benefits. The tax benefits are given to the manufacturing sector and later extended to the infrastructure sector, however, the hospitality sector is left out. The industry requires huge investments and for that financial resources should be ploughed back into building new hotels and expanding existing ones, as well as promoting new investments into this sector. One way of achieving is this by way of tax incentives which are crucial to attract investment in this sector. Most of the state governments are promoting investment in this sector by allowing concessions in stamp duty, electricity duty, capital subsidy, etc. However due to red tapism in the state government, the industry has to struggle to acquire these benefits. The state governments should therefore work towards reducing various layers and have a single window system to clear these benefits.

Incredibly Indian

The ministry of tourism has been promoting India with its 'Incredible India' and 'Atithi Devo Bhava' campaign in India and abroad. All this can translate into India becoming a favourite destination as far as tourism is concerned, subject, however, to infrastructure catering to the inflow of tourists being developed. Obviously the question remains as to why a tourist would come to India if the rooms are not available at prices as affordable as other south-east countries. Today, budget hotel chains in China give out rooms at Rs 900 per night - 50 per cent lower than similar products available in India. Thus, if China having three times more per capita income and a higher density population as compared to India, by similar logic, rooms in a budget hotel in India should be available at least at half price.

So why is our country not in a position to give rooms at these rates? The problem stems from the high cost of land which is mainly due to lower Floor Space Index (FSI)/ Floor Area Ratio (FAR) in most of the states. These need to be rationalised, if the government is to create affordable rooms in the country. Today, there are no restrictions on the FSI and height in most of the most of countries, including China. Due of this, land prices have been kept in check. However in India, by artificially restricting FSI, the government is reducing construction area and controlling supply of real estate, thereby creating artificial scarcity which just increases land prices. Today the cost of land has a significant bearing on any project cost and with high land prices, some of the projects may be not viable.

The norms for lending to this sector need to be rationalised with higher debt, at reasonable rate of interest and a long term pre-payment of loans. Today, institutions are not looking at funding beyond the period of seven to nine years. As the hospitality industry is highly capital extensive and has a long gestation period, repayment of loans beyond 11 to 15 years can make projects viable and open funding options for the industry. Banks and financial institutions today lend to the housing sector with repayment over a period of 20 years. Similarly, the norms for repayment are relaxed in case of infrastructure projects. Both these sectors are treated as priority sectors by the RBI, therefore the cost of funding and repayment gets favourable treatment. The hospitality sector is not very different from this sector and therefore the government needs to review funding to this sector by giving it special status.

The governments at the central and state level are promoting foreign direct investment to various sectors and going out of the way by offering a host of incentives and benefits to woo investors. As the flow of investments start accelerating, so do the visits of inbound investors and businessmen. The momentum in the economy has picked up with a better business environment and the opening up of sectors. However, the pace of this will also depend upon the availability of affordable rooms to these visitors, else this will be termed as poor infrastructural facilities. The time has come for the governments to rethink about this sector and provide a renewed boost to it.

(As told to Dinkar Farwaha)