1.

INTRODUCTION TO INFRASTRUCTURE IN INDIA

1. INTRODUCTION TO INFRASTRUCTURE IN INDIA

1.1 Need for Infrastructure:
An average economic growth of 8.6 per cent over the past three years has India bursting at the seams, so to speak, with its infrastructure sector stretched way beyond capacity. Spiraling demand for air travel, reliable power supply, and efficient ports, roads, and railways has not been matched by a proportionate increase in supply. It is widely acknowledged, that severe supply-side bottlenecks can retard the economys potential rate of growth. There is a palpable urgency and competition among states to provide better infrastructure to users. As a first step, the infrastructure sector is being paid maximum policy attention to ensure that a supply shortage does not choke the growth rate.

The government has been dismantling longstanding barriers and actively encouraging private investment in big public-works projects. Private-sector companies have been invited to manage airports, which used to be exclusively government-run. The government is helping private sector developers by lowering their risk in road projects.

Telecom and aviation sectors have demonstrated that introduction of private capital introduces discipline of time management and leads to remarkable results even within the very short term. To harness private sector efficiencies in design and construction of infrastructure projects the Planning Commission envisages that at least 75 per cent of new investment into infrastructure will come from the private sectorsome in the form of fully private ventures, others as publicprivate partnerships (PPPs). This is feasible when investment in infrastructure grows to about 9 per cent of GDP compared to the current 5 per cent. The main thrust sectors are Power, Highways, Ports and Civil Aviation for the government and the lenders. A large portion of this investment may also come from foreign institutional investors.

According to the Parekh Committee Report it is estimated that over the next five years India will need US$ 475 billion of investment in infrastructure to this end (Table 2.1).

Table 1 Investment Required for Indian Infrastructure from 2007-2012 (in billions $) Power Highways Ports Civil Aviation Other Total 130 49 11 9 121 320

Note: Calculated at Rs 45.30 = US $ 1 Source: GOI (2007a).

1.2 RECENT POLICY INITIATIVES AND BENCHMARKING

To improve Indias poor roads, narrow bridges, and dilapidated airports, which choke the flow of goods and people, a large injection of capital into the system is required. The infrastructure sector is being paid maximum policy attention to ensure that supply shortages do not trigger runaway inflation. At present, it offers significant opportunities to private investors, both domestic and foreign. The government has been dismantling longstanding barriers and actively encouraging private investment in big public-works projects. Private-sector companies have been invited to manage airports, which used to be exclusively government-run. The government is helping private sector developers by lowering their risk in road projects. To harness private sector efficiencies in design and construction of infrastructure projects the Planning Commission envisages that at least 75 3

per cent of new investment into infrastructure will come from the private sectorsome in the form of fully private ventures, others as publicprivate partnerships (PPPs). The government is keen to raise funds from various sources using different financial instruments. The committee for the launch of dedicated infrastructure funds (DIFs) has proposed listing options for DIFs to provide liquidity to such funds. The committee has also recommended that the proposed DIFs should operate as a closedended scheme with a maturity period of seven years. Considering the long-term and closed-ended nature of DIFs, the committee suggested that retail investors be given tax incentives. DIFs should be given the option to invest the entire corpus in unlisted securities including equity and debt instruments (SEBI, 2007). On their part the Reserve Bank of India is following time tested step-bystep approach. It has released long awaited draft guidelines for banks and dealers to begin trading in credit default swaps that allow banks to hedge against the risk of default. The move will enable banks in India to step up lending to the corporate sector by allowing them to offload some of the risk to third-party investors

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2. PROJECT FINANCE

2. PROJECT FINANCE
2.1 Introduction:
Project financing is defined as the raising of funds on a limited-recourse or non recourse basis to finance an economically separable capital investment project in which the providers of the funds look primarily to the cash flow from the project as the source of funds to service their loans and provide the return of and a return on their equity invested in the project. Project financing is an innovative and timely financing technique that has been used on many highprofile corporate projects. Employing a carefully engineered financing mix, it has long been used to fund large-scale natural resource projects, from pipelines and refineries to electric-generating facilities and hydro- electric projects. Increasingly, project financing is emerging as the preferred alternative to conventional methods of financing infrastructure and other large-scale projects worldwide. Project Financing discipline includes understanding the rationale for project financing, how to prepare the financial plan, assess the risks, design the financing mix, and raise the funds. In addition, one must understand the cogent analyses of why some project financing plans have succeeded while others have failed. A knowledge-base is required regarding the design of contractual arrangements to support project financing; issues for the host government legislative provisions, public/private infrastructure partnerships, public/private financing structures; credit requirements of lenders, and how to determine the project's borrowing capacity; how to prepare cash flow projections and use them to measure expected rates of return; tax and accounting considerations; and analytical techniques to validate the project's feasibility Project finance is finance for a particular project, such as a mine, toll road, railway, pipeline, power station, ship, hospital or prison, which is repaid from the cash-flow of that project. Project finance is different from traditional forms of finance because the financier principally looks to the assets and revenue of the project in order to secure and service the loan. In contrast to an ordinary borrowing situation, in a project financing the financier usually has little or no recourse to the non-project assets of the borrower or the sponsors of the project. In this situation, the credit risk associated with the

borrower is not as important as in an ordinary loan transaction; what are most important is the identification, analysis, allocation and management of every risk associated with the project. In non-recourse or limited recourse project financing, the risks for a financier are great. Since the loan can only be repaid when the project is operational, if a major part of the project fails, the financiers are likely to lose a substantial amount of money. The assets that remain are usually highly specialized and possibly in a remote location. If saleable, they may have little value outside the project. Therefore, it is not surprising that financiers, and their advisers, go to substantial efforts to ensure that the risks associated with the project are reduced or eliminated as far as possible. It is also not surprising that because of the risks involved, the cost of such finance is generally higher and it is more time consuming for such finance to be provided.

2.2 Risk minimization process

Financiers are concerned with minimizing the dangers of any events, which could have a negative impact on the financial performance of the project, in particular, events, which could result in: (1) the project not being completed on time, on budget, or at all; (2) the project not operating at its full capacity; (3) the project failing to generate sufficient revenue to service the debt; or (4) the project prematurely coming to an end. The minimization of such risks involves a three-step process. The first step requires the identification and analysis of all the risks that may bear upon the project. The second step is the allocation of those risks among the parties. The last step involves the creation of mechanisms to manage the risks. If a risk to the financiers cannot be minimized, the financiers will need to build it into the interest rate margin for the loan.

Step 1 - Risk Identification and Analysis The project sponsors will usually prepare a feasibility study, e.g. as to the construction and operation of a mine or pipeline. The financiers will carefully review the study and may engage independent expert consultants to supplement it. The matters of particular focus will be whether the costs of the project have been properly assessed and whether the cash-flow streams from the project are properly calculated. Some risks are analyzed using financial models to determine the project's cash flow and hence the ability of the project to meet repayment schedules. Different scenarios will be examined by adjusting economic variables such as inflation, interest rates, exchange rates and prices for the inputs and output of the project. Step 2 - Risk Allocation Once the risks are identified and analyzed, they are allocated by the parties through negotiation of the contractual framework. Ideally a risk should be allocated to the party who is the most appropriate to bear it (i.e. who is in the best position to manage, control and insure against it) and who has the financial capacity to bear it. It has been observed that financiers attempt to allocate uncontrollable risks widely and to ensure that each party has an interest in fixing such risks. Generally, commercial risks are sought to be allocated to the private sector and political risks to the state sector. Step 3 - Risk Management Risks must be also managed in order to minimize the possibility of the risk event occurring and to minimize its consequences if it does occur. Financiers need to ensure that the greater the risks that they bear, the more informed they are and the greater their control over the project. Since they take security over the entire project and must be prepared to step in and take it over if the borrower defaults. This requires the financiers to be involved in and monitor the project closely. Imposing reporting obligations on the borrower and controls over project accounts facilitates such risk management. Such measures may lead to tension between the flexibility desired by borrower and risk management mechanisms required by the financier.

2.3 Types of risks

Every project is different and so are the risks associated with each such project. What is a major risk for one project may be quite minor for another. Following are the risks that are common to most projects and possible avenues for minimizing them. However, it is helpful to categorize the risks according to the phases of the project within which they may arise: (1) The design and construction phase; (2) The operation phase; (3) Either phase. It is useful to divide the project in this way when looking at risks because the nature and the allocation of risks usually change between the construction phase and the operation phase. 2.3.1. Construction phase risk - Completion risk Completion risk allocation is a vital part of the risk allocation of any project. This phase carries the

greatest risk for the financier. Construction carries the danger that the project will not be completed on time, on budget or at all because of technical, labor, and other construction difficulties. Such delays or cost increases may delay loan repayments and cause interest and debt to accumulate. They may also jeopardize contracts for the sale of the project's output and supply contacts for raw materials. Commonly employed mechanisms for minimizing completion risk before lending takes place include: (a) obtaining completion guarantees requiring the sponsors to pay all debts and liquidated damages if completion does not occur by the required date; (b) ensuring that sponsors have a significant financial interest in the success of the project so that they remain committed to it by insisting that sponsors inject equity into the project; (c) requiring the project to be developed under fixed-price, fixed-time turnkey contracts by reputable and financially sound contractors whose performance is secured by performance bonds or guaranteed by third parties; and (d) obtaining independent experts' reports on the design and construction of the project. Completion risk is managed during the loan period by methods such as making pre-completion phase draw downs of

further funds conditional on certificates being issued by independent experts to confirm that the construction is progressing as planned. 2.3.2. Operation phase risk Resource / Reserve Risk This is the risk that for a mining project, rail project, power station or toll road there are inadequate inputs that can be processed or serviced to produce an adequate return. For example, this is the risk that there are insufficient reserves for a mine, passengers for a railway, fuel for a power station or vehicles for a toll road. Such resource risks are usually minimized by experts' reports as to the existence of the inputs or estimates of public users of the project based on surveys and other empirical evidence; requiring long term supply contracts for inputs to be entered into as protection against shortages or price fluctuations; obtaining guarantees that there will be a minimum level of inputs; and "take or pay" off-take contacts which require the purchaser to make minimum payments even if the product cannot be delivered. Operating Risk These are general risks that may affect the cash flow of the project by increasing the operating costs or affecting the project's capacity to continue to generate the quantity and quality of the planned output over the life of the project. Operating risks include, for example, the level of experience and resources of the operator, inefficiencies in operations or shortages in the supply of skilled labor. The usual way for minimizing operating risks before lending takes place is to require the project to be operated by a reputable and financially sound operator whose performance is secured by performance bonds. Operating risks are managed during the loan period by requiring the provision of detailed reports on the operations of the project and by controlling cash-flows by requiring the proceeds of the sale of product to be paid into a tightly regulated proceeds account to ensure that funds are used for approved operating costs only.

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 Market / Off-take Risk The loan can only be repaid if the product that is generated can be turned into cash. Market risk is the risk that a buyer cannot be found for the product at a price sufficient to provide adequate cash flow to service the debt. The best mechanism for minimizing market risk before lending takes place is an acceptable forward sales contact entered into with a financially sound purchaser. Risks common to construction and operational phases Participant / Credit Risk These are the risks associated with the sponsors or the borrowers themselves. The question is whether they have sufficient resources to manage the construction and operation of the project and to efficiently resolve any problems, which may arise. To minimize these risks, the financiers need to satisfy themselves that the participants in the project have the necessary human resources, experience in past projects of this nature and are financially strong (e.g. so that they can inject funds into an ailing project to save it). Technical Risk This is the risk of technical difficulties in the construction and operation of the project's plant and equipment, including latent defects. Financiers usually minimize this risk by preferring tried and tested technologies to new unproven technologies. Technical risk is also minimized before lending takes place by obtaining experts reports as to the proposed technology. Technical risks are managed during the loan period by requiring a maintenance retention account to be maintained to receive a proportion of cash flows to cover future maintenance expenditure. Currency Risk Currency risks include the risks where depreciation in loan currencies may increase the costs of construction where significant construction items are sourced offshore; or depreciation in the revenue currencies may cause a cash-flow problem in the operating phase. Mechanisms for minimizing resource include matching the currencies of the sales contracts with the currencies of supply contracts as far as possible; denominating the loan in the most relevant 11

foreign currency; and requiring suitable foreign currency hedging contracts to be entered into. Regulatory/ Approvals Risk These are risks that government licenses and approvals required to construct or operate the project will not be issued or that the project will be subject to excessive taxation, royalty payments, or rigid requirements as to local supply or distribution. Such risks may be reduced by obtaining legal opinions confirming compliance with applicable laws and ensuring that any necessary approvals are a condition precedent to the draw down of funds. Political Risk This is the danger of political or financial instability in the host country caused by events such as insurrections, strikes, and suspension of foreign exchange, creeping expropriation and outright nationalization. It also includes the risk that a government may be able to avoid its contractual obligations through sovereign immunity doctrines. Common mechanisms for minimizing political risk include requiring host country agreements and assurances that project will not be interfered with; obtaining legal opinions; requiring political risk insurance to be obtained from bodies which provide such insurance; involving financiers from a number of different countries, national export credit agencies and multilateral lending institutions such as a development bank; and establishing accounts in stable countries for the receipt of sale proceeds from purchasers. Force Majeure Risk This is the risk of events, which render the construction, or operation of the project impossible, either temporarily (e.g. minor floods) or permanently (e.g. complete destruction by fire). Mechanisms for minimizing such risks include conducting due diligence as to the possibility of the relevant risks; allocating such risks to other parties as far as possible (e.g. to the builder under the construction contract); and requiring adequate insurances which note the financiers' interests to be put in place.

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2.4 Key Project Parties

As a project moves from development stages to financial stages, and then to construction and finally to operations, several project parties get involved with the project. Some like the financial advisors exist once the financial is fully tied up and the project has drawn down loans from the lenders and equity from the investors while others like EPC contractors are extensively associated with the project during the construction phase and by contract defect liability period post commercial operations. A brief description of each of the project parties and their typical role in the project: Project Sponsors: The sponsor is the party, usually a consortium of interested groups typically including a construction group, an operator, a financing institution, and other various groups which, in response to the invitation by the Government Department, prepare the proposal to construct, operate, and finance, the particular project. The sponsor may take
the form of a company, a partnership, a limited partnership, a unit trust or an unincorporated joint venture. They are responsible for converting a concept into a project and having a role in setting

up a project vehicle identifying and recruiting right managerial talent to implement and run the project, providing a clear mandate to each management on their expectation and finally subscribing to a significant proposition of equity in the project vehicle. Project Vehicle: The SPV is responsible for delivering a bankable project during financial phase, implementing the project and thereafter operating it in a manner that is financially viable .It selects and appoints all project contractors, negotiates and executes the contracts, arranges the financing, supervises construction and commissioning and operates the project either directly or through an operations and maintenance contractor. Project Lenders: Project lender provides debt to finance the construction of the project. Typically a consortium of project lenders led by a lead bank ascertains a bankable project, cost and in consultation with the SPV and project develops the pattern of financing the same, disburses debt and performs a monitoring role during the construction phase and on commissioning monitors the performance and operation of project toll all the debt is repaid. Project lenders are secured by project assets and do not normally interfere in the day-to-day operations of the SPV. However, under conditions of default the project lenders rights increase substantially and in extreme cases of default and is provided for the project loan document project lenders can take over the management of the projects as well as sponsors equity. 13

EPC Contractor:-They design the project, procedure all engineering skills and equipment to construct the project, erect all project facilities, ensure that test and trial runs are completed and finally commissions the projects all on a turn-key basis. The EPC contractors key objectives are to deliver the project as per pre-defined specifications within a certain cost and time frame. It also provides performance guarantee to the SPV. It may choose to sub contract certain portions of assignment to other contractors but sub contracting does not relieve it from its sole responsibility of delivering a constructed project to the SPV.

Operation and Maintenance Contractor: The operator will be expected to sign a long-term contract with the sponsor for the operation and maintenance of the facility. They are responsible

for operating and maintaining the plant in line with industry best practices. Performance parameters that need to be achieved during operations are predefined in an O&M contract

and an O&M contractor provides managerial skills and operations experience to achieve and possibly surpass the agreement parameters. Again the operator may also inject equity into the
project.

Government Agency

A government department or statutory authority is a pivotal party. It will grant the sponsor the "concession that is the right to build, own and operate the facility, grant a long term lease of or sell the site to the sponsor, and often acquire most or all of the service provided by the facility. The government's co-operation is critical in large projects. It may be required to assist in obtaining the necessary approvals, authorizations and consents for the construction and operation of the project. It may also be required to provide comfort that the agency acquiring services from the facility will be in a position to honour its financial obligations. The government agency is normally the primary party. It will initiate the project, conduct the tendering process and evaluation of tenders, and will grant the sponsor the concession, and where necessary, the off take agreement.

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3. SOURCES AND METHODS OF PROJECT FINANCING

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3. SOURCES AND METHODS OF PROJECT FINANCING

Context:
Once suitable risk mitigation structures are in place, private sector projects become financeable in principle. At this stage project implementation depends on the ability to develop a financing package with a mix of finance suitable for the project. This mix varies from sector to sector. The mix between domestic and external financing requires careful consideration. Even if external financing is available, foreign exchange risk management considerations may argue in favour of keeping the amount of foreign financing within reasonable limits. There are limitations and constraints associated with each source of debt and equity financing, which should be kept in mind when devising financing packages for individual projects. Power projects with assured power purchase arrangements may be finance able with debt to equity ratios of 2.5:1 or even 3:1. The maturity requirements of debt will also vary across sectors. Power and roads, which have longer payoff periods, typically require long maturities, while telecommunications projects can manage with shorter maturities. The various sources of financing for private sector infrastructure projects in available in India are as follows: -

3.1 Equity Financing:

Private sector infrastructure projects require substantial equity financing, with higher equity requirements required for projects with higher levels of perceived risk. Project sponsors are an important source of equity, but they contribute only part of the total equity in most cases. Although pre-construction, or developmental, costs represent only a small fraction of total cost in infrastructure projects, they can nevertheless run into several crores of rupees, all of which must be financed by equity provided by project sponsors. Once the developmental phase ends, equity must be committed as part of the financing package. Sponsors typically commit a substantial proportion of total equity themselves, and they also tie up additional equity from other investors at this stage. Foreign sponsors may often be keen to link up with domestic investors at this stage on the grounds that this will reduce political risk. Domestic investors tend to evaluate risk less conservatively than foreign investors, and their involvement often helps to improve the perceptions of foreign investors. Well-structured projects can expect to mobilize equity from international infrastructure funds specializing in investment in infrastructure projects. The Global Power Fund, which has a target 16

of $1 billion, is an example of an infrastructure fund aimed at financing power projects in emerging markets. The AIG Asian Infrastructure Fund, which will invest $1 billion in the AsiaPacific region, and the $750 million Asian Infrastructure Fund are examples of regional funds. The amounts available through these funds remain modest relative to the total requirement, but the pool of global capital they can tap is very large, and the flow of equity from this source could increase substantially if bankable projects become available and the track record of implementation improves. An important aspect of these funds is that they allow international investors to pool risks by investing in a mix of projects. They also enable institutional investors, who are relatively risk averse, to invest in infrastructure projects after the construction stage, when project risks are much lower. This provides valuable opportunities for "take-out" financing, enabling projects to be financed through the earlier and riskier stage by much larger involvement of equity from the sponsors or by high-cost debt, with a subsequent restructuring through attraction of equity from infrastructure funds through sale of sponsors' equity or refinancing of debt with equity. A limited amount of equity support for private sector infrastructure is also available from multilateral organizations, such as the International Finance Corporation and the private sector window of the Asian Development Bank. Although these funds can provide only a small amount of capital, their participation in a project provides comfort to other investors. The scope for raising equity from domestic capital markets is probably limited. Public utilities and domestic institutional investors may be willing to contribute part of the equity for project expansion, but significant domestic equity support may not be forthcoming for new infrastructure projects until there is a track record of performance. However, once project implementation proceeds and revenues begin to be generated through partial commissioning, it may be possible to tap a wider range of equity investors

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3.2. Debt Financing:

Several sources of external and internal debt financing are available to well-structured private sector projects: Export Credit Agencies: Export credit agencies, which provide direct finance and guarantee commercial bank credit, have been the dominant source of international capital to finance infrastructure projects. In recent years export credit agencies have tended to guarantee bank loans. Traditionally, they fund public sector projects backed by the host government, with some willingness in recent years to lend against guarantees of commercial banks. Unless the agencies can reorient themselves to provide financing without sovereign guarantees, their role in financing private sector infrastructure projects is likely to be limited. International Commercial Banks: International commercial banks are the largest source of private finance for infrastructure development in developing countries. Banks tend to be "hands-on" financiers, lending on the basis of a detailed analysis of project risk. There are important limits to bank financing, however. The number of international banks actively involved in India is small, and they are subject to exposure limits for projects and countries. This often leads to syndication, which involves cumbersome procedures. Another important limitation of commercial bank lending is the mismatch between the fifteen-to twenty-year loans needed by infrastructure projects and the seven- to ten-year maturities sought by international banks. Maturities of commercial bank loans can be lengthened from the beginning through multilateral guarantee support for later period repayments. Reliance on bank financing for infrastructure projects must therefore be part of a mix involving other long-term lending, or it must be accompanied by suitable refinancing arrangements. International Bond Markets: Bond financing is in many ways the ideal source of finance for infrastructure. Costs are higher than for syndicated loans, but maturities of ten to thirty years are typical, and even longer

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maturities are available for creditworthy issuers. Bond financing has been the fastest growing source of finance in recent years. Its role remains modest. One reason for the modest scale of bond financing of infrastructure is that access to international bond markets is not easy. Rule 144a and Regulation S of the U.S. Securities and Exchange Commission allow non-U.S. companies to raise capital in the United States from qualified institutional buyers without complying with the full listing procedures or conforming to generally accepted accounting practices. However, only corporate bodies with relatively high credit ratings can effectively tap this window. Newly established infrastructure companies may find it difficult to access bond markets. Despite these limitations bond markets are likely to become increasingly important over time as more and more private sector infrastructure projects are successfully implemented in the country, companies engaged in such projects gain financial recognition, and our country develops a track record of successful implementation. New infrastructure companies are able to access bond markets in the post-construction stage, when risk perceptions have diminished and projects begin to generate steady revenue streams. Bond financing could be used in this way to refinance shorter-term loans taken initially to finance the construction stage. Multilateral Institutions: Multilateral institutions, such as the World Bank [1] and the Asian Development Bank [2], which have traditionally funded public sector infrastructure projects, are now willing to support private sector projects. The role of these agencies is necessarily limited, however. There are many competing claims on their scarce resources, and diversion of resources to fund private sector projects may represent no net gain for the Indian economy. It can be argued, however, that these agencies can play an important catalytic role in the early stages of attracting the private sector into infrastructure. The transparency of their project evaluation procedures and their ability to benchmark an individual private sector project in a particular country against international experience of similar projects could help avoid controversies that may otherwise arise about private sector projects. Their active involvement as lenders in a project can also help reduce risk perception on the part of other investors. However, the procedures of these institutions are often too cumbersome to be acceptable to private sector investors. An innovative role played by multilateral institutions is the use of their guaranteeing capacity to extend the maturities of

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commercial loans to private sector infrastructure projects. The World Bank's partial credit guarantee is an example of such assistance. Bilateral Aid Agencies: Bilateral aid agencies have traditionally funded public sector infrastructure projects, but their role in funding private sector projects is likely to be very limited. Their resources are severely limited, and their priorities are shifting to social sector projects, making them reluctant to finance projects that are commercially financeable. However, like multilateral agencies, bilateral agencies could play an important catalytic role in the early stages of promoting private sector investment in infrastructure, especially by co-financing private sector projects with multilateral agencies. Domestic Debt Financing: Unlike the supply of external debt, which is plentiful, the supply of domestic debt is severely limited in India. Moreover, all of the domestic debt was from local commercial banks, which do not provide long-term finance. This is clearly not a viable financing pattern. If private sector investment in infrastructure is to increase substantially, more domestic debt must be secured, and the composition of this debt must shift to longer maturities. This can happen only if the domestic debt markets in India develop.

[1] Investment in India is US$ 14 billion 2009-2012 [2] $500 million over 4 years (FY2007-FY2011)

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Table 2 Financing sources for private sector infrastructure: Domestic Sources Equity Domestic developers (independently or in collaboration with international developers) Public utilities (taking minority holdings) Other institutional investors (likely to be very limited) International developers (independently or in collaboration with domestic developers) Equipment suppliers (in collaboration with domestic or international developers) Dedicated infrastructure funds Other international equity investors Multilateral agencies (International Finance Corporation, External Sources

Asian Development Bank)

Debt Domestic commercial banks (3-5 years) Domestic term lending institutions (7-10 years) Domestic bond markets (7-10 years) Specialized institutions infrastructure International commercial banks (7-10 years) Export credit agencies International bond markets(10-30 yrs) Bilateral aid agencies financing Multilateral agencies (15-20 years)

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4. INFRASTRUCTURE FINANCING IN INDIA

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4. INFRASTRUCTURE FINANCING IN INDIA

4.1. Definition of Infrastructure Lending
Any credit facility in whatever form extended by lenders (i.e. banks, FIs or NBFCs) to an Infrastructure facility as specified below falls within the definition of infrastructure lending. In other words, a credit facility provided to a borrower company engaged in: developing or operating and maintaining, or developing, operating and maintaining

any infrastructure facility that is a project in any of the following sectors: i) a road, including toll road, a bridge or a rail system; ii) a highway project including other activities being an integral part of the highway project; iii) a port, airport, inland waterway or inland port; iv) a water supply project, irrigation project, water treatment system, sanitation and sewerage system or solid waste management system; v) Telecommunication services whether basic or cellular, including radio paging, domestic satellite service (i.e., a satellite owned and operated by an Indian company for

providing telecommunication service), network of trunking, broadband network and internet services; vi) an industrial park or special economic zone; vii) generation or generation and distribution of power viii) transmission or distribution of power by laying a network transmission or distribution lines.

4.2 Guidelines Stated by Reserve Bank Of India

Banks/FIs are free to finance technically feasible, financially viable and bankable projects undertaken by both public sector and private sector undertakings subject to the following conditions: (i) The amount sanctioned should be within the overall ceiling of the prudential exposure norms prescribed by RBI for infrastructure financing. (ii) Banks/ FIs should have the requisite expertise for appraising technical feasibility, financial viability and bankability of projects, with particular reference to the risk analysis and sensitivity analysis. 23

(iii) In respect of projects undertaken by public sector units, term loans may be sanctioned only for corporate entities i.e. public sector undertakings registered under Companies Act or a Corporation established under the relevant statute. Further, such term loans should not be in lieu of or to substitute budgetary resources envisaged for the project. (iv)The term loan could supplement the budgetary resources if such supplementing was contemplated in the project design. While such public sector units may include Special Purpose Vehicles (SPVs) registered under the Companies Act set up for financing infrastructure projects, it should be ensured by banks and financial institutions that these loans/investments are not used for financing the budget of the State Governments. (v) Whether such financing is done by way of extending loans or investing in bonds, banks and financial institutions should undertake due diligence on the viability and bankability of such projects to ensure that revenue stream from the project is sufficient to take care of the debt servicing obligations and that the repayment/servicing of debt is not out of budgetary resources. (vi) Further, in the case of financing SPVs, banks and financial institutions should ensure that the funding proposals are for specific monitorable projects. (vii)Banks may also lend to SPVs in the private sector, registered under Companies Act for directly undertaking infrastructure projects which are financially viable and not for acting as mere financial intermediaries. Banks may ensure that the bankruptcy or financial difficulties of the parent/ sponsor should not affect the financial health of the SPV.

4.3. Types of Financing by Banks

In order to meet financial requirements of infrastructure projects, Indian banks are allowed to extend credit facility by way of working capital finance, term loan, project loan, subscription to bonds and debentures/ preference shares/ equity shares acquired as a part of the project finance package, which is treated as deemed advance and any other form of funded or non-funded facility.

Take-out Financing Take-out financing structure is essentially a mechanism designed to enable banks to avoid assetliability maturity mismatches that may arise out of extending long tenor loans to infrastructure projects. Under the arrangements, banks financing the infrastructure projects will have an arrangement with IDFC/IIFCL or any other financial institution for transferring to the latter the outstanding in their books on a pre-determined basis.

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Inter-Institutional Guarantees Indian banks are permitted to issue guarantees favoring other lending institutions in respect of infrastructure projects, provided the bank issuing the guarantee takes a funded share in the project at least to the extent of 5 per cent of the project cost and undertakes normal credit appraisal, monitoring and follow up of the project.

Financing Promoter's equity Indian banks are allowed to finance the acquisition of promoter's shares in an existing company, which is engaged in implementing or operating an infrastructure project in India. This facility is subject to the following conditions: (i) The bank finance would be only for acquisition of shares of existing companies providing infrastructure facilities. Further, acquisition of such shares should be in respect of companies where the existing foreign promoters (and/ or domestic joint promoters) voluntarily propose to disinvest their majority shares in compliance with SEBI guidelines, where applicable. (ii) The companies to which loans are extended should, inter alia, have a satisfactory net worth. (iii)The company and promoters/ directors of such companies should not be a defaulter to banks/ FIs. (iv) In order to ensure that the borrower has a substantial stake in the infrastructure company, bank finance should be restricted to 50% of the finance required for acquiring the promoter's stake in the company being acquired. (v) Finance extended should be against the security of the assets of the borrowing company or the assets of the company acquired and not against the shares of that company or the company being acquired. The shares of borrower company /company being acquired may be accepted as additional security and not as primary security. The security charged to the banks should be marketable. (vi) The tenor of the bank loans may not be longer than seven years. However, the Boards of banks can make an exception, where necessary, for financial viability of the project.

Appraisal Infrastructure projects are often financed through Special Purpose Vehicles. Financing of these projects would, therefore, call for special appraisal skills on the part of lending agencies. Identification of various project risks, evaluation of risk mitigation through appraisal of project 25

contracts and evaluation of creditworthiness of the contracting entities and their abilities to fulfill contractual obligations will be an integral part of the appraisal exercise. Often, the size of the funding requirement would necessitate joint financing by banks/FIs or financing by more than one bank under consortium or syndication arrangements. In such cases, participating banks/ FIs may, for the purpose of their own assessment, refer to the appraisal report prepared by the lead bank/FI or have the project appraised jointly.

4.4 Prudential Requirements

Credit Exposure Limits Credit exposure to borrowers belonging to a group may exceed the exposure norm of 40 per cent of the bank's capital funds by an additional 10 per cent (i.e. up to 50 per cent), provided the additional credit exposure is on account of extension of credit to infrastructure projects. Credit exposure to single borrower may exceed the exposure norm of 15 per cent of the bank's capital funds by an additional 5 per cent (i.e. up to 20 per cent).

Asset - Liability Management The long - term financing of infrastructure projects may lead to asset liability mismatches, particularly when such financing is not in conformity with the maturity profile of a banks liabilities. Banks would, therefore, need to exercise due vigil on their asset-liability position to ensure that they do not run into liquidity mismatches on account of lending to such projects.

Administrative Arrangements Timely and adequate availability of credit is the pre-requisite for successful implementation of infrastructure projects. Banks/ FIs should, therefore, clearly delineate the procedure for approval of loan proposals and institute a suitable monitoring mechanism for reviewing applications pending beyond the specified period. Multiplicity of appraisals by every institution involved in financing, leading to delays, has to be avoided and banks should be prepared to broadly accept technical parameters laid down by leading public financial institutions. Also, setting up a mechanism for an ongoing monitoring of the project implementation will ensure that the credit disbursed is utilised for the purpose for which it was sanctioned.

26

Tax Incentives for Infrastructure Financing Faced with weak debt markets, India has used tax incentives to stimulate a larger flow of domestic savings to infrastructure development. The most popular incentive is a tax holiday for the profits of private sector infrastructure projects. This instrument is not aimed specifically at domestic debt financing. However, it improves project profitability and thus enables the project to compete more effectively with other

claimants for scarce domestic debt. The additional cash flow also enables the project to sustain larger debt service payments, thus enabling it to manage with shorter maturities, an important advantage where long-term debt is scarce. Incentives are also directed at individual holders of equity or debt. Long-term savings by individuals in the form of premiums for life insurance policies or contributions to the Provident Fund benefit from a tax credit. This incentive has been extended to investments in the shares or bonds of infrastructure projects. Also, capital gains on sale of shares have been exempted from taxation if the proceeds are invested in equity or debt instruments issued by infrastructure projects. These incentives do not distinguish between equity and debt but help to attract debt financing into infrastructure.

Tax incentives are also aimed at financial intermediaries. Financial institutions in India are encouraged to provide long-term finance for infrastructure by allowing 40 percent of the profit attributable to such loans to be deducted from income in computing taxable income. The concern that tax incentives may lead to excessively high rates of return is fully met by ensuring a process of competition in fixing tariffs or license fees. Within this framework tax incentives essentially allow private investors to provide services at lower cost to the consumer than would otherwise be possible. Since public sector suppliers benefit from various hidden subsidies (such as low-cost loans from the budget or provision of government equity on which a commercial rate of return is rarely earned or even planned for), the tax incentive serves only to level the playing field.

Innovative Instruments with which to promote Debt Financing. Innovative financing instruments, such as the use of mezzanine debt, are used to attract domestic financing to infrastructure projects. Mezzanine debt refers to hybrid instruments that are somewhere between debt and equity (subordinated to secured debt but senior to equity in the hierarchy of creditors). A variety of such instruments, including simple subordinated debt, convertible debt, debt 27

with stock warrants, and debt with an additional interest payment above the coupon rate contingent upon financial performance, exists. These instruments appeal to investors looking for higher returns than secured debt provides or for a share in the "up-side" risk of the project. Introduction of mezzanine debt in project financing for a given level of equity has helped to improve the quality of senior debt and therefore its marketability. The ability to adopt a mixed strategy of relying on a combination of higher-cost mezzanine debt and lower-cost senior debt widens the pool of investors that can be tapped and can lower the overall financing cost of the project

4.5 Features of Limited/Non-Recourse Financing Structure of Infrastructure Projects

(a) Sponsor Support Obligation In a limited/non-recourse financing structure, the sponsor group commits to provide standby support for cost overruns in the projects, provided the quantum of such support has crystallized prior to financial closure. In the event of any cost overrun in the project, it is met from such standby support. In case the overrun exceeds the amount of such support, while there will be no obligation on any party in view of the exposures already taken, all the players can negotiate the quantum and terms of additional funding requirement. After satisfactory completion of the project, no recourse would be available to the project sponsors for any shortfall in the revenue projections unless specifically agreed to between the parties.

(b) Security Structure SPVs have a security structure, which is generally more stringent than that for normal projects. The security package generally includes a registered mortgage/hypothecation of all assets, besides pledge of sponsor holdings in the SPV and an assignment in favor of institutions of all the project contracts and documents as also charge on the future receivables. (c) Trust and Retention Arrangement (TRA) The cash flows of the SPV are captured by way of a TRA arrangement such an arrangement provides for the appropriation of all cash inflows of the company by an independent agent (acting on behalf of the security trustee). This is then allocated in a pre-determined manner to various requirements including debt servicing and it is only after all requirements are met that the

28

residual cash flow is available to the project company. Thus, the lender would have the security of cash flows in addition to the assets of the company.

(d) Guarantees The payment risk in some of the infrastructure projects is further mitigated by way of a guarantee from the State or Central Government. ______________________________________________________________________________

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5. CIVIL AVIATION SECTOR

30

5. ANALYSIS OF CIVIL AVIAITON SECTRO IN INDIA

5.1Current Scenario
India is one of the few civil aviation markets in the world that witnessed near double-digit growth continuously for the past two decades and this growth story continues. While the aviation industry in many parts of the world faces a recessionary trend, Indian market has maintained its growth momentum both in terms of passenger and cargo traffic. The domestic air passenger traffic in India has witnessed a growth of over 19% between January and August 2010, compared to the same period last year. India's domestic passenger traffic is expected to grow at a rate of 9-10 per cent to reach a level of 150-180 million by the year 2020. It makes India amongst the fastest growing aviation markets in the world with private airlines accounting for major share. With the rapid growth achieved in the recent years, India has become the ninth largest civil aviation market and is expected to be fifth largest civil aviation market in the world in the next few years. It is projected that the center of gravity in the aviation industry will be shifting to the Asia-Pacific region in the coming years. Further, India has an enormous potential for becoming a hub for 'air cargo logistics' and 'Maintenance, Repair & Overhaul' (MRO) work triggered primarily by massive development across the country, fast-growing passenger traffic, aircraft demand, availability of talented engineering workforce, manpower cost competitiveness, fast developing engineering services/R&D expertise and strategic position in the South East Asia. In future also this trend in the civil aviation sector is expected to grow at the same pace despite

current slowdown due to global recession. But airport infrastructure has not kept pace with the growth of the civil aviation traffic. This has resulted in congestion and inefficient services in major airports, limited landing slots, inadequate parking bays and congestion during peak hours for airlines. Development of quality infrastructure will have an impact on international competitiveness and economic growth. This requires faster development of civil aviation infrastructure on public private partnership mode. In tune with the requirement many initiatives have already been started in the 10th five-year plan and they are expected to continue in the 11th plan also.

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Table: 3 Growth of Air Passenger Traffic

40 30 20 10 0
Cror
5.92 7.33 9.64 11.68 10.88 11.97 15.7 24.02

31.66

2004- 2005- 2006- 2007- 2008- 2010- 2014- 2019- 202205 06 07 08 09 11 15 20 23

(Source: Review of Traffic at Indian Airports 2007-08 by AAI & Jan-Mar 2009 Quarterly Review of Traffic, AAI)

Table: 4 Growth of Air Cargo Traffic

Lakh Tonnes
60 50.52 50 38.5

40

30 19.75 20 12.78 10 13.97 15.5 17.14 16.97

25.9

0 200405 200506 200607 200708 200809 201011 201415 201920 202223

(Source: Review of Traffic at Indian Airports 2007-08 by AAI & Jan-Mar 2009 Quarterly Review of Traffic, AAI)

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5.2 POLICY INITIATIVES

The following policy and regulatory frameworks are being initiated / already initiated in the airport sector to ensure time-bound creation of world-class airports in India. 100% FDI is permissible for existing airports; approval required for FDI beyond 74%. 100% FDI under automatic route is permissible for Greenfield airports. 49% FDI is permissible in domestic airlines under the automatic route, but not by foreign airline companies. 100% equity ownership by Non Resident Indians (NRIs) is permitted. 100% tax exemption for airport projects for a period of 10 years. Open Sky Policy of the Government and rapid air traffic growth have resulted in the entry of several new private airlines and increased frequency/flights for international airlines. A Model Concession Agreement has been developed for standardizing and simplifying the PPP transactions for airports, on the analogy of the highways sector. Upgrading of the ATC services at the airports. Issues relating to customs, immigration and security are also being resolved in a manner that enhances the efficiency of airport usage. A comprehensive Civil Aviation Policy is in the process of finalization covering different areas of the aviation sector. India has entered into bilateral Air Services Agreement (ASA) with 104 countries.

5.3 Trends in Civil Aviation Project Financing

The four critical elements that determine the financial viability of an airport project are concession period; traffic volumes; user fees and other revenues; and capital costs.

Method of Project Sanction: The projects have been initiated by the Central Government to promote Public Private Partnerships (PPP) on Design, Build, Finance, Operate and Transfer (DBFOT) basis.

Concession Period: Airports being capital-intensive projects, the concession period granted has been normally in the range of 50 to 60 years. This timeframe enables a robust project structure and any further extension 33

in the concession period improves the financial viability only marginally as the present value of projected revenues after 50 years would be very low from the Project Companys perspective. For a Greenfield airport, conservative traffic projections should be assumed, as it would take time for traffic to build up. As a result, user fees alone may not provide financial viability, especially since they would have to be kept at affordable levels. Additional revenues can, however, be generated from non-aeronautical sources and real estate development to enable some cross-subsidization of user fees.

Capital Costs: If the potential for non-aeronautical and real estate revenues is inadequate, Project Company is allowed to seek appropriate capital grant/subsidy from the Government in order to reduce its capital investment for arriving at an acceptable rate of return. Reduction in capital costs and phasing out some capital expenditure can improve project viability significantly. Though PPPs undertaken so far in the sector have been financially viable and self-sustaining, the governments thrust to build Greenfield airports in remote areas may require cost-efficient designs as well as some capital subsidy.

Technical parameters: There has been a reduced focus on construction specifications and more on technical parameters that are based mainly on output specifications. These parameters are assumed to have a direct bearing on the level of service for users. The core requirements of design, construction, operation and maintenance of the airport terminal are specified by the government and/or the project sanctioning authority, and enough room is left for the Project Company to innovate and add value. This provides the requisite flexibility to the Project Company in evolving and adopting cost-effective designs without compromising on the quality of service for users. Cost efficiencies because of the shift to output-based specifications provide the private sector with a greater opportunity to innovate and optimize designs in a way normally denied under conventional input-based procurement specifications.

Performance standards The Project Company is required to procure the civil works and equipment, along with various passenger related services including cargo handling. The efficiency of the operations is monitored through the quality of service provided to the users. The key performance indicators relate to the operation of the aeronautical assets, terminal building and cargo terminal. Specific penalties are 34

stipulated for failure to achieve the requisite levels of performance, especially in relation to user services.

Risk allocation Project risks along with commercial and technical risks relating to construction, operation and maintenance are expected to be assumed by the Project Company. Commercial risks such as the rate of growth of traffic have also been allocated to the Project Company. The Government assumes all direct and indirect political risks and risk of change in economic growth pattern.

Risk Mitigation Facilities: Provisions have been allowed for extension of the concession period in the event of a lower than expected growth in traffic. Conversely, the concession period would to be reduced if the traffic growth exceeds the expected level.

Reserved Services Certain services at any airport are to be provided by government agencies. Specific details of the obligations of the Project Company in respect of these reserved services, with a view to ensure that the respective agencies are able to provide such services without any hindrance, have been stipulated by the government.

______________________________________________________________________________

35

6. ROAD & HIGHWAYS SECTOR

36

6. ANALYSIS OF ROAD & HIGHWAY SECTOR IN INDIA

6.1 Current Scenario:

India has one of the largest road networks in the world (over 3 million km at present). For the purpose of management and administration, roads in India are divided into the following five categories: National Highways (NH) State Highways Major District Roads Other District Roads (ODR) Village Roads (VR)

The National Highways are intended to facilitate medium and long distance inter-city passenger and freight traffic across the country. The State Highways are supposed to carry the traffic along major centers within the State. Other District Roads and Village Roads provide villages accessibility to meet their social needs as also the means to transport agriculture produce from village to nearby markets. The roads and highways in India account for about 80 per cent of the total passenger traffic and about 60 per cent of the total freight traffic in the country. Of the 49,585 km of National Highways in India about 33 per cent are single lanes and only about 2 per cent of the total road networks are four laned. The poor quality of Indian roads is highlighted by congestion; old fatigued bridges and culverts, railway crossings, low safety, no bypasses and slow traffic movement. Considering the importance of the road sector in the country, the government has embarked on the ambitious National Highway Development Project covering 13,000 km with a cost of Rs.54, 000 crore and the projects have already started rolling. The Indian construction industry that had been experiencing a slowdown witnessed a growth of 9 per cent and 8.5 per cent for the periods FY2009 and FY2010 respectively. This was possible due to the increased spending in infrastructure and the actual taking off of some of the road sector projects.

37

6.2 POLICY INITIATIVES

Strategy for Funding Highway Development In the absence of user charges, the road sector in India has relied entirely on budgetary resources, which stagnated at about 3 percent of the total plan expenditure. Given the emphasis on expansion of basic social services coupled with the pressure on fiscal deficit, dependence on budgetary resources in favor of highways is difficult. The government has decided to invite private investment in highways. The government has also announced the policy of four-laning the existing two-lane national highways on BOT basis. Shadow Tolls Shadow toll projects are predicted on recovery of user charges for the use of the highway by each vehicle, in accordance with a pre-determined tolling structure. They are referred to as shadow, as opposed to real tolls because the payment for usage is made by the government, and not by the user. Annuity Scheme The annuity scheme is a modified version of shadow tolls, has also been applied in certain projects. Under this arrangement, payments to the BOT Project Company are determined in absolute terms, irrespective of the number vehicles using the highway. Shadow toll and annuity payments essentially entail budgetary funding on a deferred basis. In the Indian context, the constraint of budgetary allocations, present as well as future, makes both options unviable as these can at best sustain only a fraction of the highway development program. New Toll Policy The draft rules of a new toll policy have been firmed up and now need to be vetted by the law ministry. Each year the rates are slated to increase by three per cent. Government vehicles will no longer be exempt from paying tolls. Moreover, commercial vehicles will have to pay more depending on the number of axles they sport. So, vehicles with 36 axles would have to pay lower toll rates than those with 7 or more axles. At present, only the length of the road is taken into account while calculating the toll

38

 Central Road Fund (CRF) In a historic decision, the Government of India introduced a Cess on both Petrol and Diesel. This amount at that time (at 1999 prices) came to a total of approximately Rs. 2,000 crores per annum. Further, Parliament decreed that the fund so collected were to be put aside in a Central Road Fund (CRF) for exclusive utilization for the development of a modern road network. Today the Cess contributes between Rs 5 to 6 Thousand crores per annum towards NHDP.

6.3 Trends in Highway Project Financing

The four critical elements that determine the financial viability of a highway project are traffic volumes, user fee, concession period and capital costs.

Method of Project Sanction: The projects have been initiated by the Central Government to promote Public Private Partnerships (PPP) on Design, Build, Finance, Operate and Transfer (DBFOT) basis.

Concession Period: The guiding principle for determining project-specific concession period is the carrying capacity of the respective highway at the end of the proposed period. The concession period is determined on a project specific basis depending on the volume of present and projected traffic. The time required for construction (about two years) is generally included in the concession period so as to incentivise early completion, implying greater toll revenues. Generally the period given to such projects is an average of 15 years.

Grants to Fill Viability Gap The Government of India along with the respective state governments have provided a capital grant of up to a maximum of 20 per cent of the project cost. This has helped in bridging the viability gap of the PPP projects. Where such assistance is found inadequate for making a project commercially viable, an additional grant of not exceeding 20 per cent of the project costs is also granted. This is provided for O&M support during the period following the commissioning of the Project Highway.

39

Technical Parameters: There has been a reduced focus on construction specifications and more on technical parameters that are based mainly on output specifications. These parameters are assumed to have a direct bearing on the level of service for users. The core requirements of design, construction, operation and maintenance of the airport terminal are specified by the government and/or the project sanctioning authority, and enough room is left for the Project Company to innovate and add value. This provides the requisite flexibility to the Project Company in evolving and adopting cost-effective designs without compromising on the quality of service for users. Cost efficiencies because of the shift to output-based specifications provide the private sector with a greater opportunity to innovate and optimize designs in a way normally denied under conventional input-based procurement specifications.

Operation and Maintenance Operation and maintenance of the Project Highway is proposed to be governed by strict standards with a view to ensuring a high level of service for the users, and any violations thereof would attract stiff penalties. In sum, operational performance would be the most important test of service delivery.

Risk Allocation Project risks along with commercial and technical risks relating to construction, operation and maintenance are expected to be assumed by the Project Company. Commercial risks such as the rate of growth of traffic have also been allocated to the Project Company. The Government assumes all direct and indirect political risks and risk of change in economic growth pattern.

Risk Mitigation Facilities: Provisions have been allowed for extension of the concession period in the event of a lower than expected growth in traffic. Conversely, the concession period would to be reduced if the traffic growth exceeds the expected level.

40

Reserved Services Certain services at any airport are to be provided by government agencies. Specific details of the obligations of the Project Company in respect of these reserved services, with a view to ensure that the respective agencies are able to provide such services without any hindrance, have been stipulated by the government.

______________________________________________________________________________

41

7.POWER SECTOR

42

7. ANALYSIS OF POWER SECTOR IN INDIA

7.1 Current Scenario:
While the growth in investment in the power sector has been phenomenal in the last three years, the country is still faced with acute power shortagewith energy and peak shortages of 9.5 per cent (55,000 million units) and 14.2 per cent (14,500 MW) in 20067. Power has been identified as one of the main constraints, which may derail the growth trajectory envisaged in the 11th Five Year Plan. Power generation is the first important component in providing power to consumers. Power generation is broadly classified into thermal, hydro, and non-conventional means of generation based on energy source, which ultimately gets transformed into electricity. THERMAL POWER: Thermal power plants can be of a very small capacity of a few kilowatts to Ultra Mega Power Plants (UMPPs) having generation capacity of a few thousand megawatts. Users for their own use install a substantial part of thermal power in the country in emergency. This capacity is defined as captive capacity. Though about 15,000 MW of captive capacity is connected to the grid, only about 6 per cent of the energy generated actually flows to the grid due to various regulatory issues. HYDRO POWER: The government is targeting to add 16,553 MW of hydropower in the 11th Five Year Plan with an estimated investment of about Rs 78,100 crore. National Hydroelectric Power Corporation (NHPC), the countrys largest hydroelectric power generation company, plans to raise Rs 28,000 crore in equity and debt over the next five years to help fund an increase in its power generation capacity to 10,000 MW by 2012, to keep up with the needs of the economy.

NON-CONVENTIONAL ENERGY SOURCES Wind power, solar power, small hydroelectric units, nuclear power, and co-generation plants are considered to be non-conventional energy sources.

43

 WIND POWER: The present installed wind power capacity in the country stands at 7093 MW and is expected to touch 10,500 MW by 201112, according to the Ministry of New and Renewable Energy (MNRE). The problem with harnessing wind energy is that wind is brisk enough only during monsoons and is also temperature dependent. Being weather dependent, it does not allow for planned addition of wind energy to the grid. This means it cannot be used for meeting the peak demand. Most of the wind power projects are being set up in the captive sector for private use NUCLEAR POWER Nuclear Power Corporation of India Ltd (NPCIL), which accounts for about 3 per cent (4120 MW) of the countrys power generation capacity, is the only company authorized to build nuclear power plants in the country, besides Bharatiya Nabhikiya Vidyut Nigam (Bhavini). The government would like to produce 40,000 MW of power through the nuclear route in ten years. It is a steep target to achieve, not because NPCIL does not have the capability, but because the supply of nuclear fuel is a constraint. According to the government, in the coming years, civil nuclear cooperation between the US and India will offer enormous strategic and economic benefits to both countries, including enhanced energy security, a more environment-friendly energy source, greater economic opportunities, and more robust nonproliferation efforts. A realistic target would be around 30,000 MW by 2020. SOLAR POWER The amount of solar energy produced in India is less than 1% of the total energy demand. The grid-interactive solar power as of December 2010 was merely 10 MW. Governmentfunded solar energy in India only accounted for approximately 6.4 MW-yr of power as of 2005. Solar power is currently prohibitive due to high initial costs of deployment. To spawn a thriving solar market, the technology needs to be competitively cheaper (i.e. attaining cost parity with fossil or nuclear energy). India is heavily dependent on coal and foreign oil, a phenomenon likely to continue until non-fossil/renewable energy technology becomes economically viable in the country. The cost of production ranges from 15 to 30 per unit compared to around 5 to 8 per unit for conventional thermal energy. Some large projects 44

have been proposed, and a 35,000 km2 area of the Thar Desert has been set aside for solar power projects, sufficient to generate 700 GW to 2,100 GW. In July 2009, India unveiled a US$19 billion plan to produce 20 GW of solar power by 2020.Under the plan, the use of solar-powered equipment and applications would be made compulsory in all government buildings, as well as hospitals and hotels. On November 18, 2009, it was reported that India was ready to launch its National Solar Mission under the National Action Plan on Climate Change, with plans to generate 1,000 MW of power by 2013. Fig:5 Current Installed Capacity in India (MW) share

7.2 Constraints in Power Project Financing

Land acquisition for new project is more contentious and poses a big threat to private sector participation in PPP initiatives in the power sector. Issues like resettlement and rehabilitation (R&R) have resulted in several projects being stalled (like UMPPs in Maharashtra and Karnataka) 45

Lack of political will on going for big ticket land acquisition for larger power projects in the backdrop of Nandigram in West Bengal and ongoing Posco agitation in Orissa Lack of proper dispute resolution mechanism. Dispute resolution mechanism in most cases are not at international level thereby leading to lengthy litigation and substantial project delays

Fuel Supply - The fuel supply scenario though looks promising with regards to Coal India Ltds achievement rates. However, the growing demand, slow rate of captive coal production and transportation remain key issues affecting fuel availability for the power sector.

Lack of skilled manpower The Working Group on Power has estimated the need for 0.34 million additional manpower (0.26 million technical and 0.08 million non-technical) during the XII th plan.

Liquidity problem in the market owing to global meltdown makes it difficult for developers to raise equity. Crisil Research states Our interactions with various lenders led us to conclude that in the current scenario equity has become a key issue as private projects are held up at the financial closure stage for the requirement of equity. Lenders find reassurance in the promoters equity being brought in through cash flows or owners funds compared to the equity brought in through the foreign direct investment (FDI) route.

Unavailability of long tenure debt to private sector High cost of guarantees

Equipment Supply - On the whole, boiler turbine generator (BTG) orders of around 70.0 GW have been placed for the Eleventh Plan period. Out of this, around 60 per cent has been placed with BHEL (42.5 GW). Despite best intentions of increasing capacity the completion of orders (42.5 GW) in Eleventh Plan will be stretched. The balance orders have been placed with Chinese and other international players. Chinese players have received orders close to 15.0 GW for the Eleventh Plan period whereas international players have received orders of around 15.5 GW.

Environment, water and forest clearances - The clearances on this front are typically timeconsuming as it involves approvals from state governments as well as the central government. Power generation projects are particularly subject to pronounced environmental concerns. Project sponsors are required to address relevant environmental impacts because environmental problems can result in serious financial losses. Financiers are increasingly 46

focusing on environmental issues resulting from power projects and set strict guidelines for review of the environmental impacts of such projects. On an average it takes 18-24 months to receive all the clearances. 7.3 Trends in Power Project Financing Capital costs Power projects are highly capital- intensive and have a gestation period of 4-6 years. The fixed component of the power tariff is linked to the capital cost of the project. Hence the capital cost of power plants is a very important determinant of the total cost of generation. The capital costs of power plants also vary significantly, based on the source of energy, infrastructure, plant size, technology and equipment and interest during construction (IDC).Hence, it is not possible to set standard benchmark costs for power plants. However, the capital costs of most projects in the private sector are assumed as shown in the table below

Table: 6 Average Power Power Costs Power Project Cost Project Type Coal Gas Hydro Table: 7 Factors affecting costs Rs(Crores)/MW 4-5 3.5-4 5-6

Factors affecting costs Factors

Source of energy

Remarks
The cost of setting up a coal-based plant is lower than nuclear plants and higher than those based on natural gas, naphtha and fuel oil. The high cost of coal-based plants is attributed to the additional equipment required, such as coal-handling and ash-handling plants

Infrastructure

The availability of water ,transportation infrastructure and power evacuation and transmission facilities influence the location of a power plant 47

Size

A large plant costs less, in terms of cost per unit capacity .Larger units also have better thermal efficiency and lower O & M costs

Technology and Equipment

Equipment costs account for 75-80 per cent of the total cost of a thermal plant, However depending on the choice of technology and equipment ,the capital cost of two project of the same size and using the same fuel can be different

Interest during construction

The long gestation period, and the capital intensive nature of power project ,results in accumulation of the interest on debt till the commissioning of the plant which implies that delays in the implementation of a project could raise project costs significantly

7.4 The Tala Experience- Indias first private sector transmission project
Tala Transmission system is the first Private sector transmission project in India, which has already set precedence for other projects to follow. PGCIL established this first Public-Private joint venture in transmission sector with M/s Tata Power in 2001.Powerlinks Transmission Limited, the joint venture company (49:51 between PGCIL and TATA Power) implemented the major transmission lines of Associated Transmission System of Tala hydro electric project in Bhutan, East-North inter connector and northern region at about USD 34 billion. Tala received excellent response from International Funding Institution like IFC, including multilateral financing from private sector arm of ADB, Manila and Indian Financial Institutions like IDFC and SBI. The Joint Ventures Company received its transmission license from CERC, the first such license in Indian power sector. Financial closure of the project was achieved in May 2004.A debt of USD 233 million has been tied up with the consortium of multilateral and domestic financial institutions. Tala Transmission System was completed successfully in August 2006.PGCIL envisages implementing some more transmission projects in Joint Venture with private sector. ______________________________________________________________________________

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8.PORT SECTOR

49

8. ANALYSIS OF PORT SECTOR IN INDIA

8.1 Current Scenario:

India has an extensive coastline of 7517 km, excluding the Andaman & Nicobar Islands. Indian ports handle around 95% of the total volume of countrys trade and about 70% in terms of value. India has 12 major ports and 200 non-major ports (minor and intermediate ports) spread across nine (coastal) maritime states. Ports are under the concurrent list of the Indian Constitution. Major ports are under the jurisdiction of the Union Govt., managed by the Port Trust of India while minor ports are under the jurisdiction of the respective State Governments. While major ports handle 75% of the total cargo traffic, minor ports account for 25% of the traffic. Global merchandise trade is growing by around 15 per cent a year. Containerization has helped in handling this trade in a secure and efficient manner. Vessel sizes have increased to cater to increasing volumes. The draft (depth of sea) required to service these vessels have increased from 9.1 m to 15 m in the last 38 years. As the length of these vessels has increased from 180 m to 399 m, the facilities available in the existing ports such as berths, turning circle, channel and so on have ceased to match vessel size. Economies of scale have pushed bulk cargo transportation container ships to the limits set by natural oceanic features. The existing major ports such as Mumbai Port and JNPT face formidable obstacles because the draft is not deep enough, berths are not large enough, turning circle cannot be wider, and approach channels are required for newer container ships which can carry 11,000 or more twenty feet equivalent units (TEUs). Dhamra Port in Orissa is expected to be the deepest all-weather port in India with a draft of 18.5 m, located between the mainland and the Konica Sandheads on the confluence of the Dhamra river and the Bay of Bengal.

Lack of Capacity Historically Indian Major Ports have suffered on account of low capacity creation. Chart 9.1 below shows how capacity and traffic almost touched each other over the years 1999 to 2005. As can be seen capacity constraints had eased marginally between years 2001-02 to years 2003-04. In year 2004-05 traffic again equals the capacity. Further Chart 9. 2 below for the current years 2007-08 and 2008-09 shows that traffic almost matches the capacity created. Since there has been a consistent growth in cargo traffic further capacity creation to match demand in the coming years seems inevitable. In terms of cargo composition, petroleum-oil-lubricants (POL) is the dominant commodity carried through major ports. It accounted for 32.54% of the total cargo in 2007-08. 50

Container cargo was the next largest commodity in the mix, accounting for 17.73%, closely followed by iron ore at 17.72%.

Chart 8: Growth of Capacity & Traffic 2000-2005

Chart 9: Comparison of Growth in Capacity & Traffic during 2008-09

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8.2 Investment Opportunities

These are the sub-sectors that offer wide opportunities for investors: 1. Major Ports: This refers to new terminals added to the existing 12 major ports, which is a very attractive proposition. Availability of adequate space may be a constraint. 2. Minor Ports: Minor port project sizes are higher since these are Greenfield projects that require capital

dredging as well as development of on-shore infrastructure. Strategic location and operational efficiency are going to be critical factors.

3. Connectivity Projects: Structural demand stemming from ports benefit both rail and road connectivity projects

4. Port Services: Private sector participation has been allowed in a variety of ports services, which includes construction, and operation of terminals/berths, warehousing/storage facility, dry-docking and ship repair facilities. The areas identified for privatization or investment by the private sector includes: Leasing out of existing port assets & creating of additional assets Construction or operation of container terminals, multipurpose and specialized cargo berths Warehousing, container freight stations, Storage facilities, carnage and handling equipment Setting up captive power plants, Dry docking and ship repair frailties Leasing of equipment and floating craft from the private sector Captive facilities for port based industries.

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8.3 Trends in Port Project Financing

The four critical elements that determine the financial ability of a port terminal are traffic volumes, port tariffs, concession period and capital costs.

Method of Project Sanction: The projects are made on the Build, Operate, Transfer (BOT) model or Build, Operate, Share Transfer (BOST) model.

Concession Period: The concession period typically granted by the Port Trusts is 30 years. This timeframe is considered adequate to enable a robust project structure .Any further extension is given at the option of the Project Company to improve the financial viability of the project. This would however only marginally improve the viability as the present value of projected revenues after 30 years would be comparatively low from the Project Company's perspective.

Traffic Volumes: The capacity constraints currently faced by major ports mean that there is effectively no competition in the port sector. As a result, cargo movement at each port is virtually captive and volumes are not normally volatile. There is also wide scope for availability of non captive cargo depending upon the location of the port. Improved Rail and Road connectivity have also contributed to increased hinterland cargo. Over time, efficiencies at the port level would contribute to traffic diversion across competing ports, but that would pre-suppose creation of sufficient capacity at the respective ports.

Port Tariffs: In view of the limited competition between ports today, the Government determines the tariff but the same has been capped in line with the tariffs prevailing in the region. A pre-determined tariff structure has led to a greater predictability of the revenue streams for the Project Company, besides incentivising efficiency and cost reduction. In the medium Term, tariffs are expected to find their own levels through competition. This is expected to happen only once adequate capacity has been created. Hence the government is keen on promoting much such minor/major port across the Indian peninsula. 53

Technical Parameters: There has been a reduced focus on construction specifications and more on technical parameters that are based mainly on output specifications. These parameters are assumed to have a direct bearing on the level of service for users. The core requirements of design, construction, operation and maintenance of the airport terminal are specified by the government and/or the project sanctioning authority, and enough room is left for the Project Company to innovate and add value. This provides the requisite flexibility to the Project Company in evolving and adopting cost-effective designs without compromising on the quality of service for users. Cost efficiencies because of the shift to output-based specifications provide the private sector with a greater opportunity to innovate and optimize designs in a way normally denied under conventional inputbased procurement specifications.

Performance Standards The Project Company is required to procure the civil works and equipment, along with services in the form of cargo handling. The efficiency of its services would normally reflect in the dwell time of cargo at the port terminal. The key performance indicators are dwell time, berth productivity, vehicle service time and ship handling productivity. Specific penalties are stipulated for failure to achieve the requisite levels of performance, especially in relation to user services.

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9. RECOMMENDATIONS & CONCLUSION

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9. RECOMMENDATIONS & CONCLUSION

Infrastructure growth is a critical necessity to meet the growth requirements of the country. Government led infrastructure financing and execution cannot meet these needs in an optimal manner and there is a need to engage more investors for meeting these needs. Even though the Indian financial system has adequate liquidity, the risk aversion of Indian retail investors, the relatively small capitalization (compared to the large quantum and long duration funding needs of infrastructure finance) of various financial intermediaries requires adoption of innovative financial structures and revisiting some of the regulations governing the Indian financial system. Banks and other financial institutions must help the project companies to reach financial closure, the delay in which increases the costs for the project company. There has to be a concerted efforts by the Indian finance providers to ensure infrastructure projects are given the required thrust through project finance.

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BIBLIOGRAPHY
Ajeet K Choudhary ,Deepak Dangayach,A Report on Road Sector in India
John D Finnerty, Project Financing -Asset-Based Financial Engineering, 2nd Edition. K.P Gupta, 2008, Gujarat Electricity Regulatory Commission KPMG POWER SECTOR _2010.PDF Position Paper On The Airports Sector In India, May 2009, Department of Economic Affairs Position Paper On The Ports Sector In India, May 2009, Department of Economic Affairs Saugata Bhattacharya, Urjit R. Patel, 2007 "The Power Sector in India: An Inquiry into the Efficacy of the Reform Process" July. www.nhai.org/ www.worldbank.org.in /WBSITE/EXTERNAL/COUNTRIES/SOUTHASIAEXT

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APPENDIX A

The Electricity Act 2003

The Electricity Act (2003) is a revolutionary piece of legislation enforced in India that aims to transform the power sector in India. The act covers major issues involving generation, distribution, transmission and trading in power. Before Electricity act 2003 the electricity sector was guided by The Indian Electricity Act, 1910 The Electricity (Supply) Act, 1948. Generation distribution and transmission were carried out mainly by State electricity board. Due to politico economic situation the cross subsidies reached at unsustainable level. For purpose of distancing state govt. form tariff determination The Electricity Regulatory Commissions Act, was enacted 1998. So as to reform electricity sector further by participation of private sector and to bring in competition Electricity act in enacted in 2003. The Act de licenses power generation completely (except for hydro power projects over a certain size) as per the act, 10% of the power supplied by suppliers and distributors to the consumers has to be generated using renewable and non-conventional sources of energy. The Act de licenses distribution in rural areas and brings in a licensing regime for distribution in urban areas. However, as per the Act, only 16 states in India have notified what constitutes as rural areas and therefore the rural distribution is yet to be freed up in nearly one third of the country. A critically important change that the Act sought to encourage was replacing the present Single-Buyer model to a Multi-Buyer model. This would lead to a paradigm change in the environment whereby monopoly of the SEBs for buying/selling power would cease, thus leading to a market determined tariff structure. Towards harmonisation of regulation, the Act specificates that the principles laid out by the Central Electricity Regulatory Commission (CERC) in generation and transmission should guide SERCs. The Act wrote the code for the sector from a national perspective with regard to grid discipline and rationalised dispatch of power.

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APPENDIX B
Take-out finance
Take-out financing is a method of providing finance for longer duration projects (say of 15 years) by banks by sanctioning medium term loans (say 5-7 years). It is understanding that the loan will be taken out of books of the financing bank within pre-fixed period, by another institution thus preventing any possible asset-liability mismatch. After taking out the loans from the banks, the institution could off-load them to another bank or keep it. Under this process, the institutions engaged in long term financing such as IDFC, agree to take out the loan from books of the banks financing such projects after the fixed time period, say of 5 years, when the project reaches certain previously defined milestones. On the basis of such understanding, the bank concerned agrees to provide a medium term loan with phased redemption beginning after, say 5 years. At the end of five years, the bank could sell the loans to the institution and get it off its books.

Benefits - This ensures that the project gets long-term funding though various participants.

Process of Take Out Financing The original lender participates in a long term project (say 15-20 years) by granting a medium term loan (of say 5-7). On completion of the pre-decided period, this loan is taken over by another institution subject to fulfillment of the conditions stipulated in the orignal arrangement Original lender receives the payment from the 2nd lender who has taken over the loan

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APPENDIX C
Mezzanine Debt
Mezzanine capital, in finance, refers to a subordinated debt or preferred equity instrument that represents a claim on a company's assets which is senior only to that of the common shares. Mezzanine financings can be structured either as debt (typically an unsecured and subordinated note) or preferred stock.Mezzanine capital is often a more expensive financing source for a company than secured debt or senior debt. The higher cost of capital associated with mezzanine financings is the result of its location as an unsecured, subordinated (or junior) obligation in a company's capital structure (i.e., in the event of default, the mezzanine financing is less likely to be repaid in full after all senior obligations have been satisfied). Additionally, mezzanine financings, which are usually private placements, are often used by smaller companies and may involve greater overall leverage levels than issuers in the high-yield market; as such, they involve additional risk. In compensation for the increased risk, mezzanine debt holders require a higher return for their investment than secured or other more senior lenders. Uses of mezzanine capital In leveraged buyouts, mezzanine capital is used in conjunction with other securities to fund the purchase price of the company being acquired. Typically, mezzanine capital will be used to fill a financing gap between less expensive forms of financing (e.g., senior loans, second lien loan, high yield financings) and equity. Often, a financial sponsor will exhaust other sources of capital before turning to mezzanine capital.Financial sponsors will seek to use mezzanine capital in a leveraged buyout in order to reduce the amount of the capital invested by the private equity firm. Because mezzanine lenders typically have a lower target cost of capital than the private equity investor, using mezzanine capital can potentially enhance the private equity firm's investment returns. Additionally, middle market companies may be unable to access the high yield market due to high minimum size requirements, creating a need for flexible, private mezzanine capital.

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In real estate finance, mezzanine loans are often used by developers to secure supplementary financing for development projects (typically in cases where the primary mortgage or construction loan equity requirements are larger than 10%).These sorts of mezzanine loans are often collateralized by the stock of the development company rather than the developed property itself (as would be the case with a traditional mortgage). This allows the lender to engage in a more rapid seizure of underlying collateral in the event of default and foreclosure. Standard mortgage foreclosure proceedings can take more than a year, whereas stock is a personal asset of the borrower and can be seized through a legal process taking as little as a few months.
There are several examples of the use of mezzanine debt in infrastructure financing in Asia. The Zhuhai Highway Company Ltd. raised $200 million in international capital markets, consisting of $85 million in senior notes and $115 million in subordinated notes. The Manila Skyway project relied on a combination of senior debt and mezzanine capital. The demand for mezzanine debt is also reflected in the emergence of dedicated mezzanine debt funds, such as the Asian Infrastructure Mezzanine Capital Fund, sponsored by the Prudential Capital Insurance Company.

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