INDEX

Page
Sr. No Particulars
No.

1. Background

2. Development of Infrastructure in India

3. Imperative need for private participation in Infrastructure Sector

4. Characteristics of Infrastructure Finance

5. Guidelines on Infrastructure finance by RBI

6. Sources and Methods of Infrastructure Finance

7. Measures taken by RBI

8. Process of Infrastructure finance

9. Financing Infrastructure Project – various models

10. Infrastructure Finance scenario in India

11. Some possible measure and solution to bridge the gap

12. Case study – NOIDA Toll Bridge

13. Conclusion

14. References
1. Background
Infrastructure projects are typically capital-intensive and have long gestation periods, and
so require significantly high levels of long-term financing. With the exception perhaps of
airports and ports, which have an international side to their operations (and power
projects set up for cross border sales of the power generated), the earnings of most
infrastructure projects (energy, telecommunication, roads, railways, urban transportation,
water supply, sanitation and other urban infrastructure) are denominated entirely in their
respective local currencies. Since projects of this nature have very little natural hedge,
their ability to absorb cross-border financing in significant volumes is rather limited,
more so, given the lack of standard long term foreign exchange risk hedging products
(usually not over 2 years) and little market depth for long-term swaps in most developing
countries. Availability of domestic financing of the required magnitude is therefore
critical to the development of infrastructure in any location.

Since capital markets across developing countries are at different stages of development,
the ability to implement projects either as pure private investments or under public
private partnership (PPP) structures also depends on the domestic finance market in each
of these locations. Where markets are reasonably developed, domestic financing by way
of equity and debt, and to a lesser extent mezzanine finance structures, become common
sources of funding for infrastructure projects. Other locations would still need to access
multi-lateral or bilateral credit sources (including export lines of credit) for funding
infrastructure projects, with the exchange risk absorbed by the government, and so
project implementation is usually undertaken by government authorities directly or
through specialised government agencies, although in most instances, not very
effectively.

Availability of domestic finance, of course, is not the only pre-requisite for development
of private infrastructure, though it is certainly a very important one. Other pre-requisites
for the development of a private infrastructure market include putting in place appropriate
legal and policy frameworks, comprehensive project preparation, transparent
procurement processes, equitable concession/ contractual structures, entrepreneurial
resources of the required order and perhaps most importantly, political will in appropriate
measure.

It broadly reviews the experience of India over the last decade in the development and
financing of private infrastructure projects and the role of a specialised institution,
namely, Infrastructure Development Finance Company Limited (IDFC) in policy
advocacy, development and financing of private infrastructure projects during this period.
Admittedly the developments over the last year which have caused a serious meltdown in
global financial markets have altered the financial landscape for private investment in
infrastructure in India. The response so far to these challenges and a possible way ahead
to meet the challenges of developing critical infrastructure in a fund-starved environment,
have been briefly set out at the end of the note.
2. Development of Private Infrastructure in India
Till the nineties, investment in infrastructure was almost exclusively in the public
domain, made by government departments, specialised government agencies (SGAs) and
public sector undertakings (PSUs). These investments were financed by budgetary
allocations, surpluses of SGAs/ PSUs, market borrowings (mainly from the bank market),
borrowings from multi-lateral agencies and a few capital market bond issuances. The
nineties also saw the pursuit of policies of economic liberalisation4 such as de-licensing
of industry, increased market access by reduction in customs duties, freeing of the
exchange rate on the current account and enhancement of the limits for foreign direct
investment, resulting in an increased alignment of the Indian economy to global markets.
Investment in infrastructure, however, continued to be low at levels ranging, over the
years, between 3-6% of the gross domestic product (GDP), well below the investment
levels of comparable economies like China and other East Asian economies, given the
overall inadequacy of public resources. Given this backdrop, it was inevitable that the
government looked at increasing the levels of infrastructure investment through private
investment. To begin with, in 1991, a national power policy was announced which
opened up power generation to the private sector and provided various financial and
fiscal benefits to investors. This was followed by the national telecom policy in 1994,
guidelines for private sector participation in major ports in 1996 and a new civil aviation
policy, all encouraging private investment in these sectors.

Various state governments5 followed suit with the development of sector specific
policies encouraging private investment; some of these states also enacted infrastructure
development legislation6 with the prime focus being infrastructure development through
PPPs. A major fillip was provided by the announcement in 1999 of the National Highway
Development Programme (NHDP) for systematic capacity enhancement
(mainly four-laning) of 13,000 kilometers (kms) of national highways in two phases. This
was followed by a decision to levy a cess on sales of petrol and diesel which would be
deposited in a Central Road Fund specially created for this purpose and which would
fund the development of national highways and rural roads.

The experiences in both the power and telecom sectors were not initially very
encouraging. Creation of power generation assets was limited by the lack of
creditworthiness of the state electricity boards, the main purchasers of the power
generated. Many state governments unbundled and corporatised their power assets –
however, power distribution – the real challenge was opened to the private sector in only
2 states. What helped though was the setting up of electricity regulatory authorities – at
the centre and in a few states, the enactment of the Electricity Act, 2003 - which fully
opened up power generation to the private sector, enabling creation of a new breed of
merchant and captive power plants, envisages power transmission through a national grid
and encourages power trading. Reforms in power distribution, with a significant potential
to reduce commercial power losses, continues to be a key challenge.

The telecom story, which began with investors horribly overpricing the value of the
market and submitting unrealistic bids, was largely redeemed by the new telecom policy
of 1999, migration to a revenue sharing regime, introduction of newer players to enhance
competition and defining rules for access across networks, made possible by an effective
independent regulator for the sector. Some challenges remain – such as ensuring rural
connectivity and allocating spectrum equitably, but all in all it has been India’s success
story. The subscriber base for telecom services has since grown to a level of over 350
million subscribers8 by September 2008 (35% penetration) and currently India is the
fastest growing market in the world, largely driven by private investment. Prices of
mobile telephony have dropped from 33 cents per minute (in 1996) to around 1 cent per
minute.

The first two phases of the NHDP which envisaged smaller levels of private investment
(14% of the number of projects) have still offered around 48 projects to private investors.
Given the initial success and speedy implementation of the private sector projects, the
programme has since been expanded to a 7 phase programme covering 46,000 kms. of
national highways, with the bulk of investment in the ensuing phases expected to come
by way of private investment. Under a PPP framework, new airports have been
established at greenfield locations in Hyderabad and Bangalore; modernisation and
expansion of the existing airports at Delhi and Mumbai are underway. Plans are
underway for developing landside infrastructure at smaller airports under administrative
control of the Airports authority of India through private investment. A few smaller
airports have been handed over by some state governments to private investors for
modernisation and expansion. Several berth concessions (container terminals and some
bulk/ multi-purpose berths), have been awarded to private players at several major ports;
a number of minor ports have been handed over by various state governments (notably
Gujarat and Andhra Pradesh) to private investors for expansion and upgradation. Several
of these facilities are operating successfully, though there have been some regulatory
challenges (over issues such as competition and tariff setting) to overcome in major ports.
A few small sections on the Indian Railways (mainly for port connectivity) and more
recently, container services, have also been developed as private infrastructure projects.

In the urban sector a few bulk water supply projects have been implemented with private
investment, although with mixed success; the attempts to open up water distribution have
been rather tentative and yet to see any significant measure of success. Other areas of
private investment have been in solid waste management, special economic zones, bus
terminals, urban renewal projects, multi level car parks and urban transportation. A few
pilot projects are now being developed in areas such as healthcare and education under
PPP frameworks.

All this has translated to aggregate private sector infrastructure investment of a little over
USD 96 billion over the period 1990-2007. It is estimated that private infrastructure
investment which now contributes to ~ 20% of the total investment in infrastructure10
and therefore around 1% of the GDP11 would increase to a level of 30% of the total
infrastructure investment during the Eleventh Plan period (2007-12), which is expected to
translate to a level of 3% of the GDP12 by 2011-12. In the current context, this could
pose a challenge unless newer sources of funding are channelised for funding
infrastructure investment.
Financing of Private Infrastructure Projects

As mentioned earlier, the feature of long gestation in infrastructure projects - longer

project implementation period due to their capital intensive nature, issues such as land
acquisition and time required to obtain environmental and other statutory clearances, and
the elapse of time to reach operating break even (especially in transportation and telecom
projects), necessitate the provision of long-term funding to these projects. Further, given
their return on equity considerations, private sponsors seek to maximize the quantum of
debt financing for these projects which can vary from levels as low as 40-50% (telecom
and port projects), to more common levels of 60-70% (energy, toll roads, urban sector
projects, airports) and may even go up to 80-90% (projects involving payment for
services by the government authority, for instance road projects where government pays
an annuity over the project life).

Since infrastructure projects are exposed to different types of risks – policy and
regulatory risks (tariff setting, competition, legal and policy changes), counter-party risks
(for payment – when services are purchased by a government authority or for supply of
fuel or other vital inputs), implementation risks (construction delays, cost overruns and
contractor failures), operating risks (obsolescence, cost variance, inflation and contractor
failures) and revenue risks (demand/ traffic and inflation), among others, project sponsors
rarely expose their existing operations and balance sheets to these risks. Project
implementation is undertaken through a special purpose company/ vehicle (SPV) set up
exclusively for each project, achieving a bankruptcy-remote structure. Debt financing for
the project is usually raised on non-recourse or in some instances on partial recourse
terms by the SPV – with sponsors limiting risk to their equity investment in the SPV or in
some instances by an additional underwriting commitment to cover cost overruns.

As a result, the underlying project contracts (concession agreements, EPC and

O&M1contracts, fuel supply agreements, purchase agreements etc) and insurances are
assigned to the lenders. The financing structures and agreements are often elaborate and
complex and cash flows secured through structured escrow/ cash retention agreements, so
that financing risks are appropriately mitigated. The process of raising finance is
therefore characterised by intense negotiations between lenders and sponsors.

Domestic Financing of Private Infrastructure Projects

Private infrastructure projects have been mainly financed by equity and debt funding
sources. Till the late nineties, debt financing in India was provided largely by two main
sources – development finance institutions (DFIs) providing long term debt for capital
expenditure and commercial banks providing short term credit to meet the working
capital requirements of projects. The process of economic liberalisation of the early
nineties also resulted in increased exposure of the financial sector to global markets and
trends. As a consequence, the distinctions between DFIs and commercial banks reduced,
with IDBI and ICICI eventually converting to commercial banks. Several new private
sector banks also commenced operations and the propensity of banks to provide long
term credit also increased. This was also helped by easy liquidity conditions that
prevailed over much of the last decade.

The bulk of domestic debt financing so far has been provided in the form of senior
secured debt by commercial banks and non-banking finance companies (which include
some of the erstwhile DFIs like IFCI and specialised entities like IDFC) and to a lesser
extent by insurance companies. With the exception of one public bond offering to retail
investors15, there has been no reliance on the capital markets. The bulk of the credit is
provided in the form of loans which are not easy to sell down, though issuance of debt
securities (more amenable to secondary trading) is popular with some of the market
participants. In practice though, the absence of a deep secondary market for corporate
debt has not enabled sell down and secondary trading in debt instruments of any
significant volume. The few securitisation transactions undertaken have been mainly to
refinance existing debt, taking advantage of a declining interest rate scenario in the period
up to 2007.

While projects need long-term funding, the bulk of the financing raised so far has been of
a relatively short term nature, with projects taking on the refinancing risk. Even where
loans have been given for longer tenures (in some cases even upto 12-15 years), they
would carry re-pricing options at shorter intervals of one, three or five years. This would
pass on interest rate re-pricing risks to projects. While this has worked so far, given the
current financial crisis and the increasing expectations from private financing over the
next few years, this cannot be sustained. Passing on the liquidity/ interest-rate risks to
projects could, beyond a point, result in a “blowback” - severe credit stresses on banks’
portfolios. It has also been argued that banks (even the large players) and NBFCs would
soon reach their prudential exposure limits – both on account of credit exposure and
maturity mismatches16, giving little head room for assuming very significant levels of
new exposure in the near-term. It would, therefore, be necessary to bring in players with
the ability to provide long-term liquidity at affordable costs into debt financing. This
issue has been discussed further in the last section of this paper.

Most PPP projects impose a minimum shareholding commitment on sponsors of projects

– typically 51% of the equity in the first five years and 26% thereafter. After negotiating
with lenders for the maximum possible leverage, equity capital was, initially, entirely
provided by project sponsors out of their existing balance sheets. There have been
instances where minority equity stakes have been placed with EPC/ O&M contractors for
these projects as well as with strategic investors, who would directly benefit from the
project’s operations – but these have not been of a significant order. Increased leveraging
has also been accomplished through mezzanine finance (subordinated debt structures),
but these too have rarely exceeded 10-15% of the cost of project.

A common form of raising capital (initially used in the telecom sector) was by investing
through a holding company which allowed significant dilution in the quantum of equity
funds to be invested by sponsors, more so as these became multi-layered. The minority
stakes at each level were funded through private placements with domestic and
international private equity and venture capital funds. As more and more projects got
successfully implemented these holding companies made successful public offerings at
impressive valuations particularly in the 2005-2007 period, which opened new
institutional and retail equity funding sources for infrastructure investment. With the
currently depressed state of the equity markets, it would be a while before the momentum
of the earlier years of this decade is regained; however, companies with a good track
record of project implementation could always access markets at appropriate
junctures.The clutch of private equity funds set up for infrastructure over the last few
years would now have opportunities to “cherry pick” good quality assets; it remains to be
seen how committed many of these would be to investment in India and whether
investors would be able to bring in the committed levels of funding into these funds. A
new category of funds – targeting international pension funds and “steady return”
investors, are project equity funds which would invest directly into SPVs - either in
equity or mezzanine products. Such funds, which seek steady rather than spectacular
returns, could also provide equity dilution opportunities to sponsors after the project is
implemented. Since the SPVs are unlikely to list, the funds themselves could list after a
few years to provide exit routes for investors.

Specialised Financial Intermediaries: Role of IDFC

It is within this backdrop that the role of a specialised financing intermediary like IDFC
needs to be assessed. In the early nineties, the Government of India (GoI) set up a
committee chaired by Dr. Rakesh Mohan (then Director General, National Council of
Applied Economic Research) to review investment requirements in infrastructure and
issues in commercialisation and financing of infrastructure. The report titled the India
Infrastructure Report (1996), more popularly called the Rakesh Mohan Committee
Report, estimated infrastructure investments of the order of US$ 330 billion over the next
ten years. Given inadequate budgetary resources, it argued for an increasing role for the
private sector in infrastructure. It also highlighted the need for a specialised financial
intermediary which would focus on the development and financing of private
infrastructure in the country.

On the basis of the recommendations made in this report GoI took the initiative to set up
a company focussed on development and financing of private infrastructure. In its budget
for 1996-97, GoI earmarked an amount of Rs. 10 billion as its contribution to this
company. An inter-institutional working group set up to prepare a business plan. IDFC
was conceived as a public private partnership with GoI to hold 40% of the equity. The
group also recommended that IDFC’s Board of Directors should comprise representatives
of shareholders and independent directors and that a professional management team –
hired from the market at private sector compensation levels should be entrusted with the
day-to-day operations of the company. The initial capitalisation of the company was an
amount of Rs. 16.5 billion, Rs 10 billion of equity share capital and Rs. 6.5 billion by
way of subordinated debt from GoI. The equity of Rs. 10 billion was placed with 3 GoI
investors18 (40%), 5 domestic investors(20%) and 9 international investors20 (40%).
India Infrastructure Finance Company Limited (IIFCL)

IIFCL was incorporated in January 2006 with initial capitalisation of Rs. 10 billion as a
company owned by GoI to provide long-term finance to infrastructure projects and to re-
finance existing lenders in infrastructure. IIFCL’s direct finance operations are unique in
that its exposure is limited to 20% of the project cost and it would not undertake the
appraisal of projects on its own but would participate in projects with a designated lead
bank, making it an ideal source of last mile (gap) finance for projects. As on March
31,2008, IIFCL had disbursed funds to the extent of Rs. 27 billion to 52 projects and had
approved, in aggregate, loans of Rs. 184 billion.

Way Ahead
As mentioned earlier a key limitation in the current context would be the ability of the
banking sector to provide financial resources in a sustainable manner to support the
desired levels of investment in private infrastructure projects. For lenders requiring
liquidity support, an active refinance window through IIFCL on attractive terms could
help increase the number of debt providers for infrastructure. The next step would be to
create avenues to enable sell down of assets (that have moved to stable project
operations), without recourse, to create headroom for lenders. Whether undertaken by
IIFCL or in consortium with large banks or whether re-packaged as long term securities
and sold22 to other investors (possibly, high net worth individuals) this would result in
deepening the market for infrastructure debt over the long term.

There is also clearly a need to enhance the role of insurance companies and pension funds
in financing infrastructure. Specialised agencies like IDFC could provide the needed
expertise and help to enable investment decisions. With the savings rate23 (percentage of
the gross domestic savings as a percentage of the gross domestic product at current
market prices) having grown from levels of a little over 20% in 1987-88 to 34.8% in
2006-0724, it is important to channelise some of these into appropriate instruments.
IIFCL could also play the role of a guarantor to passive investors such as pension funds
or to retail investors for capital market instruments.
 Possible

Multilateral Agencies
(World Bank / IFC / ADB)

Guarantees / Ri
insurance / fund
3. The imperative need for Private Sector Participation
There is a need for large and continuing amounts of investment in almost all areas of
infrastructure in India. This includes transportation (roads, ports, railways, and airports),
energy (generation and transmission), communications (cable, television, fiber, mobile
and satellite) and agriculture (irrigation, processing and warehousing). The key issue is
while the need exists, how these projects will get financed. In the past the government
has been the sole financier of these projects and has often taken responsibility for
implementation, operations and maintenance as well. There is a gradual recognition that
this may not be best way to execute/finance these projects. This recognition is based on
considerations such as:

1. Cost Efficiency:
Privately implemented and managed projects are likely to have a better record of
delivering services which are cheaper2 and of a higher quality.3 The India Infrastructure
Report (2003) estimates that the Indian economy’s growth rate would have been higher
by about 2.5% if the delays and cost overruns in public sector projects had been managed
efficiently.4 The report goes on to state that the predominant cause for such delays /
overruns was not under-funding of the projects, but arose, “on account of clearances, land
acquisition problems, besides factors internal to the entity implementing the project”.5

2. Equity Considerations:
Since it is hard to argue that every infrastructure project uniformly benefits the entire
population of the country, it may be more appropriate to impose user charges which
recover the cost of providing these services directly from the user rather than from the
country as a whole (the latter is the effect if the government builds the project from its
own pool of resources). If users are to be charged a fair price then the project acquires a
purely commercial character with the government then needing to play the role only of a
facilitator.

3. Allocation Efficiency:
Since users are likely to pay for services that they need the most, private participation and
risk-return management has the added benefit that scarce resources are automatically
directed towards those areas where the need is the greatest.

4. Fiscal Prudence:
Both at the centre and state levels, for a variety of reasons, there is a growing concern
that the absolute and relative (to GDP and GSDP respectively) levels of fiscal deficit are
high and that incurring higher levels of deficit to finance infrastructure projects is
infeasible. Given the strength of these arguments, the government has made several
attempts to create the preconditions for a sustainable and scalable involvement of the
private sector in the development of infrastructure within the country. These have
included promotion of Development Finance Institutions (DFI’s) such as the Industrial
Development Bank of India (IDBI), Industrial Finance Corporation of India (IFCI) and
The Industrial Credit and Investment Corporation of India (ICICI) and specialised entities
such as the Power Finance Corporation (PFC), Infrastructure Development and Finance
Corporation (IDFC), Urban Infrastructure Development Fund (UIDF) and Tamil Nadu
Urban Infrastructure Development Fund (TNUDF). For a variety of reasons while each of
the entities mentioned has added value to the system in its own unique way, there is a
concern that, in their current form, the DFI’s no longer appear to be viable (being
undercapitalised and unprofitable) and the specialised vehicles are not growing fast
enough and may not provide a complete answer to the problem. However, while there are
certainly issues surrounding the availability of suitable intermediaries with an adequate
amount of risk capital for infrastructure financing, there does not appear to be a shortage
of funds per se within the economy. This situation of adequate supply of liquidity is of a
relatively recent origin (and is apparently not restricted only to India) and appears to be
the result of the manner in which the Reserve Bank of India (RBI) is managing the
macroeconomy (specifically domestic interest rates and exchange rates), the sluggish
demand for funds from both manufacturing and agriculture sectors and the continuing
high propensity to save amongst Indians with a preference for long-maturity investments.
Individual Indians have shown a great deal of willingness to save and hold those savings
in very long-term assets either as deep-discount bonds, savings linked insurance policies,
savings bank accounts; post-office savings and pension funds. Indian individual investor
appears to be highly risk averse and is prepared to accept even very large negative real
returns by holding large amounts of risk-free investments rather than supplying risk
capital that will earn higher returns. Thus, for infrastructure finance, while the aggregate
supply of funds does not appear to be a problem, there is a need for a layer of credit
enhancement, which can absorb the risks associated with such financing. There is also a
need for intermediaries, instruments and markets that can perform the functions of risk,
maturity and duration transformation to suit the desires of the investors. While Foreign
Direct Investment (FDI) has the potential to provide some of the equity capital, it appears
very likely that the Government itself would have to emerge as the provider of the bulk of
this risk capital with banks and capital markets providing the bulk of the debt finance. In
the past the Government has tried to combine the role of provider of this risk capital and
debt funds within integrated development banks but for a variety of reasons, this
approach has not met with much success. There is therefore an urgent need to examine
the evidence at hand and attempt to discover new ways of addressing the problems that
appear to be retarding the pace at which infrastructure investment is progressing.
4. Characteristics of Infrastructure Finance
Infrastructure projects differ in some very significant ways from manufacturing projects
and expansion and modernisation projects undertaken by companies.

1. Longer Maturity:
Infrastructure finance tends to have maturities between 5 years to 40 years. This reflects
both the length of the construction period and the life of the underlying asset that is
created. A hydro-electric power project for example may take as long as 5 years to
construct but once constructed could have a life of as long as 100 years, or longer.

2. Larger Amounts:
While there could be several exceptions to this rule, a meaningful sized infrastructure
project could cost a great deal of money. For example a kilometer of road or a mega-watt
of power could cost as much as US$ 1.0 mn and consequently amounts of US$ 200.0 to
US$ 250.0 mn (Rs.9.00 bn to Rs.12.00 bn) could be required per project.

3. Higher Risk:
Since large amounts are typically invested for long periods of time it is not surprising that
the underlying risks are also quite high. The risks arise from a variety of factors including
demand uncertainty, environmental surprises, technological obsolescence (in some
industries such as telecommunications) and very importantly, political and policy related
uncertainties.

4. Fixed and Low (but positive) Real Returns:

Given the importance of these investments and the cascading effect higher pricing here
could have on the rest of the economy, annual returns here are often near zero in real
terms.16 However, once again as in the case of demand, while real returns could be near
zero they are unlikely to be negative for extended periods of time (which need not be the
case for manufactured goods. Returns here need to be measured in real terms because
often the revenue streams of the project are a function of the underlying rate of inflation.

The infrastructure projects are characterised by non-recourse or limited recourse

financing, i.e., lender can only be repaid from the revenues generated by the projects
requiring to the large scale of investments. The share of high initial capital and low
operating cost in infrastructure projects explains why financing infrastructure involves a
mix of complex and varied contractual arrangements. Wrong projections, collection risks
of the payables and reneging of the contract are commonly cited as the major risks
associated with an infrastructure projects. As returns from the projects are uncertain and
low in the risk adjusted terms, it also necessitated additional incentives to be created to
attract private investment. The resource flow from pension/insurance companies, which is
potentially a high source of long term debt, is expected to provide resources by less than
per cent. Understandably, these institutions have been restricted by their respective
regulatory authorities from exposing them too highly to the infrastructure sector on
prudential considerations.
5. Guidelines on Infrastructure Finance by RBI
6. Sources and Methods of Financing
Once suitable tariff fixing mechanisms and 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. Telecommunications projects, which face
relatively high market risks, may require a relatively low debt component, with debt to
equity ratios close to 1:1. Power projects with assured power purchase arrangements may be
financeable 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 mix between domestic and external financing also requires careful con-
sideration. Even if external financing is available for well-managed developing countries,
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 (table 6.1).
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 preconstruction, or developmental, costs represent only a small fraction of
total cost in infrastructure projects, they can nevertheless run into several millions of dollars,
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.

Table 6.1 Financing sources for private sector infrastructure

Domestic sources External 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, Asian Development Bank)

Debt
Domestic commercial banks (3-5 years)
Domestic term lending institutions (7-10 years)
Domestic bond markets (7-10 years)
Specialized infrastructure financing institutions
International commercial banks (7-10 years)
Export credit agencies (7-10 years)
International bond markets (10-30 years)
Multilateral agencies (15-20 years)
Bilateral aid agencies
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 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 Asia-Pacific 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 utili-
ties 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. This can be a
useful financing strategy in the case of power projects with more than one generating unit or in
telecommunications projects, in which the build up of line capacity occurs over time.

External debt financing

Several sources of external debt financing are available to well-structured private sector
projects in countries with reasonable credit ratings.

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 funded public sector projects backed by sovereign
guarantees, 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. Of the $22.3
billion raised by developing countries for infrastructure financing in 1995, syndicated
loans accounted for $13.5 billion, bonds for $5.3 billion, and equity for about $3.5 billion
(World Bank 1997). 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 developing countries 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, as discussed later in this section. 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 maturities are available for creditworthy issuers. Bond
financing has been the fastest growing source of finance for developing countries in recent
years, with total flows increasing from $2.3 billion in 1993 to $45.8 billion in 1996 (World
Bank 1997). Its role remains modest, however, with only $5.3 billion provided in 1995
compared with $13.5 billion from syndicated loans.
One reason for the modest scale of bond financing of infrastructure is that access to inter-
national 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, this window can be
effectively tapped only by corporate bodies with relatively high credit ratings. 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 developing
countries, companies engaged in such projects gain financial recognition, and countries
develop track records of successful implementation. Even new infrastructure companies may
be 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.

The pricing of private corporate securities issued in international bond markets depends
partly on corporate financial characteristics and partly on country characteristics. The
efficiency of bond pricing can be enhanced by the existence of sovereign debt actively traded
in the market. This increases country visibility, and therefore the appetite for corporate
securities, and also provides a benchmark against which corporate debt can be efficiently
priced. Issuing sovereign debt, however, implies that countries must be willing to accept
continuous scrutiny of macro-economic performance and economic policies by international
credit rating agencies.

Multilateral Institutions: Multilateral institutions, such as the World Bank and the Asian
Development Bank, 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 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.
The International Finance Corporation (IFC), the private sector arm of the World Bank Group,
could play an important role in financing private sector infrastructure, but its scale of
operations is relatively modest. The IFC's own commitments for infrastructure projects have
increased from a little less than $200 million in 1990 to $727 million in 1996, and IFC
syndication provided an additional $700 million in 1996. An important feature of IFC
syndication in financing private sector infrastructure is that it has brought in nonbank
financial institutions, including international insurance companies, to finance infrastructure
projects in developing countries. A strong case can be made for much more extensive IFC
involvement in financing private sector infrastructure projects in developing countries.

An innovative role played by multilateral institutions is the use of their guaranteeing

capacity to extend the maturities of commercial loans to private sector infrastructure
projects. The World Bank's partial credit guarantee is an example of such assistance. It was
used to guarantee principal repayment from year eleven to year fifteen for a $150 million
commercial bank loan for the Zhejiang project in China. Since China had access to
commercial loans of only about six-year maturities at the time, the partial credit guarantee
helped to extend even the uncovered period of commercial lending beyond the normal six-
year period to ten years, after which the guarantee period extended it further to fifteen
years. In the Philippines the partial credit guarantee has been used to support a $100 million
ten-year bond issue by the National Power Corporation in the form of a put option that
enables the investors to present the bonds to the World Bank for principal repayment at matu-
rity. The Asian Development Bank has also provided loan guarantees.

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 most developing countries. Analysis of 140 private
sector infrastructure projects from the IFC's portfolio shows that only a sixth of debt
financing (which represented 61 percent of total project cost) was domestic debt (Inter-
national Finance Corporation 1996). 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 domestic debt markets in developing countries
develop.

Development of domestic debt markets: Domestic debt markets in developing countries are
underdeveloped for many reasons, and action to develop these markets has to be taken on
several fronts. A high rate of domestic savings is the most important structural prerequisite
for ensuring an adequate flow of domestic finance for private infrastructure. High savings
rates are not enough, however. Most East Asian economies, for example, have very high rates
of savings, and yet debt markets in these economies are underdeveloped, with long-term
debt particularly scarce.
A critical requirement for well-functioning debt markets is a sound macroeconomic bal-
ance, as reflected in modest fiscal deficits. High fiscal deficits have significant negative effects.
If monetized they lead to inflation, which discourages savings in general and long-term
saving in particular. If not monetized they put pressure on interest rates, which discourages
investment, especially in projects with long gestation periods, such as infrastructure. High
interest rates also tempt governments to intervene in financial markets to reduce the cost of
government borrowing by forcing banks, insurance companies, provident funds, and
pension funds to invest a high proportion of their assets in government securities. This
reduces the cost of government borrowing, but it obviously does not eliminate the crowding
out effect of high levels of government borrowing for non-government borrowers. In fact, the
artificial lowering of interest rates on government securities distorts the government debt
market, discouraging active trading in government securities and preventing the emergence
of a reliable yield curve, all of which work against the development of an efficient debt
market. Effective control over fiscal deficits is therefore an important element in any
strategy for developing debt markets.

Another factor that helps to develop deep and liquid domestic debt markets is the existence of
strong long-term contractual savings institutions, such as insurance companies and pension
funds. These institutions have long-term liabilities and therefore have a natural interest in long-
term debt instruments of high quality. Unfortunately, the insurance and pension funds sector
is in an early stage of development in most developing countries. Statutory pre-emption of
resources is high in many countries. In India insurance is also a public sector monopoly,
although the government has recognized that reform of the insurance sector is linked to
financing of infrastructure and has initiated a process of reform in this sector. An ideal
environment for domestic debt markets is one in which domestic savings rates are high, fiscal
deficits are low, and there is a strong insurance and pension fund segment in the financial sector.
Tax incentives for Infrastructure Financing: Faced with weak debt markets, many
developing countries have sought to use tax incentives to stimulate a larger flow of domestic
savings to infrastructure development. A wide variety of incentives are in use in many
countries:

• The most popular incentive, available in China, India, and Thailand, 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
can also be directed at individual holders of equity or debt. In India, for example,
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. In
a similar vein, 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 they will help to
attract debt financing into infrastructure.

• Tax incentives can also be 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. Tax incentives are criticized by purists on the grounds that
they are indirect subsidies, which are usually not justifiable. But a good case can be
made for such incentives, at least in the early stages of attracting private investment.
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 such
a 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, can sometimes 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 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 helps to improve the quality of senior debt and therefore its
marketability.
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. 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
The role of specialized financial Institutions: Many countries have sought to address
deficiencies in their domestic debt markets by creating specialized institutions to deal with
infrastructure financing. Examples of such institutions are the Pakistan Private Sector
Energy Development Fund, established in 1988, which provides subordinated loans to
private sector power projects, and the Jamaica Private Sector Energy Fund, established in
1992, which was set up to provide long-term finance. In India the Infrastructure
Development Finance Company was recently set up as a private company, in which the
government has a minority stake, with the objective of playing a catalytic role in
channelling resources into commercially viable infrastructure projects (see box 6.3). A
similar institution is being set up in Colombia.
Skepticism is sometimes expressed about whether creation of a specialized institution will
improve financial intermediation. A new institution adds little if it only redirects resources
that would have flowed from existing institutions to target sectors. Specialized institutions
may appear to contribute additional resource flows if they are a conduit for government
resources earmarked to support private sector infrastructure or if they are able to use
government guarantees to obtain funds from the market at lower rates. However, the same
subsidies could be extended just as effectively by channelling this support through existing
financial institutions. It can be argued that because of their special mandate, specialized
institutions will ensure a larger flow of funds to target sectors. If more financing flows to target
sectors because these institutions are better able to find bankable infrastructure projects,
then these institutions are providing valuable financial intermediation. If, however, more
funds flow to target sectors because these institutions simply apply lower standards of
credit appraisal in order to achieve some externally set target, the institutions may end up
financing infrastructure projects that other financial institutions regard as unfinanceable on
conventional criteria, and they will not be contributing to the efficiency of the financial
markets.

The case for establishing a new institution therefore depends on whether it fills some criti-
cal gap in the financial environment facing infrastructure projects. Several such gaps justify
creating a specialized financing institution:
• Identification of financeable projects.: Specialized financing institutions may be able to
identify financeable infrastructure projects more effectively and proactively than
multipurpose financing institutions. Moreover, they may be able to help structure
projects in a manner that makes them financeable, taking care to meet the complex risk
mitigation requirements of different types of investors.
• Take-out financing: Infrastructure projects may need financing arrangements in which the
project can be financed initially on the basis of shorter-term debt (such as credit from sup-
pliers to finance equipment purchase) that is refinanced later by longer-term debt. A spe-
cialized institution could help guarantee such refinancing within a predetermined financing
cost. This amounts to giving the project an assurance that if refinancing is not available on
specified terms when needed, it will either be provided directly by the institution or the
difference between the predetermined cost of financing and the cost at which funds can be
raised will be reimbursed to the project. A commercial fee should, of course, be charged
for this service.
• Liquidity support: Bond issuance by infrastructure projects can be encouraged by pro-
viding liquidity support for such bonds in the form of a put option prior to maturity or in
the form of market making.
• Securitization: A specialized financing institution could securitize the cash flow from
loans in a pool of successfully operating a wider market for such assets. Assets would
help reduce risk through diversification and thus create a high-quality asset that could be
effectively marketed to both domestic and international institutional investors.
Box 6.3 India’s infrastructure development finance company

The infrastructure Development Finance Company (IDFC) was incorporated in

January 1997, with 40 percent of the equity held by the government of India
and the Indian Reserve Bank and 60 percent held by non government domestic
financial institutions, foreign investors, and multilateral agencies. the IDFC
will operate on a commercial basis to finance viable projects in power,
telecommunications, roads, ports, and urban services. It will not compete with
existing financial institutions as a direct lender but will engage in innovative
financing to help other institutions raise funds for infrastructure or provide
support for infrastructure projects in critical areas.

The IDFC will provide direct lending, purchase of loans, and co-financing;
take-out financing, standby finance, and refinancing of longer maturities;
partial credit guarantees and other forms of credit enhancement for
infrastructure projects; securitization of infrastructure loans and market making
for these loans; and mezzanine finance.

The initial capitalization is $530 million. The IDFC’s capitalization and

commercial practices will enable it to achieve a high credit rating. It will also
be able to benefit from credit enhancement through credit risk guarantees
provided by multilateral development banks.
• Direct financing:. Conventional direct financing of infrastructure projects on a limited
scale by a specialized institution may give confidence to other investors, which could
leverage larger flows from other sources. This is especially true if the institution aims to fill
critical financing gaps. The provision of subordinated loans, for example, helps to
improve the quality of senior debt and may stimulate a larger flow of total resources at
lower cost than would otherwise be possible. A specialized institution can also play a very
useful role as an interface between the government and new private investors in
infrastructure. Many practical problems are likely to arise in the course of implementing
private sector projects that may require constant review and modification of announced
policies and also of the regulatory framework. A specialized financing institution with direct
involvement in individual projects and with knowledge of domestic and international
financial markets can help to identify problems and work cooperatively with government
agencies to find solutions consistent with the requirements of financeability on the one
hand and public concerns on the other.

The role of government guarantees: A general issue that arises in the context of
financing private sector infrastructure projects \S the I0\e to be played by government
guarantees. Private investors seek guarantees to cover a variety of circumstances. However,
indiscriminate use of the government's guarantee power is not justifiable, since it involves
a potential cost to the exchequer that becomes a real cost if the guarantee is invoked. Many
projects that face financing problems are denied finance because of genuine deficiencies in
financial viability. In such cases, the deficiencies must be remedied at the source rather
than being covered by government guarantees.

In some situations, however, extension of government guarantees is necessary and

appropriate. The most logical use of government guarantees is to cover events over which
the government has full control, such as nationalization, government action that forces
interruption of the project, or non-performance of specific government obligations. In all
these cases extension of government guarantees reduces the perception of risk and
therefore costs. Government guarantees may also be sought to backstop obligations of
government-controlled entities when the guarantees of these entities are not
commercially acceptable. For example, private power producers selling power to public
utilities may insist on guarantees from the government to cover non-payment for power, or
they may expect the government to backstop guarantees of public sector fuel suppliers
against defaults in fuel supply agreements. In both cases government guarantees are
insisted on because of the lack of financial credibility of the buying and supplying organi-
zations directly involved. The ideal solution in such cases is to improve the financial
viability of these organizations so that their own guarantees can be credible. This
transformation is bound to take time, however. In fact, it may take several years after a
credible restructuring process has been initiated before these organizations gain full
financial credibility in financial markets. During this period the guarantees of these
organizations may not be acceptable, and government guarantees may have to be
provided as an interim arrangement. Extension of government guarantees in these circum-
stances can be justified; provided the projects meet high standards of viability and the
more fundamental corrective steps are under way. In order to minimize the extent of
guarantee exposure, the guarantees can be structured to include "fall-away" provisions,
which are triggered as soon as certain credit benchmarks are achieved (Johnston, Mody, and
Shanks 1996).
7. Measures taken by the Reserve Bank of India
Several new initiatives have been initiated by the central government and the Reserve
Bank in the recent years. RBI initiated a number of regulatory concessions for
infrastructure finance, such as
a) Allowing banks to enter into take out financing arrangement.
b) Freedom to issue long term bonds by banks for financing infrastructure.
c) Relaxation of single and group borrower limit for additional credit exposure in the
infrastructure sector.
d) Flexibility to invest in unrated bonds of companies engaged in infrastructure activities
within the overall ceiling of 10 percent.
e) Excluding the promoters’ shares in the SPV of an infrastructure project to be pledged
to the lending bank from the banks’ capital market exposure and
f) Permitting banks to extend finance for funding promoter’s equity where the proposal
involves acquisition of share in an existing company engaged in implementing or
operating an infrastructure project in India. Let me make some additional remarks on two
of these areas.

To stimulate public investment in infrastructure, a special purpose vehicle – India

Infrastructure Finance Company Limited (IIFCL) was set up for providing long-term
financial assistance to infrastructure projects. The Union Budget for 2009–10 announced
that IIFCL in consultation with banks will evolve “take out financing” scheme to
facilitate lending to the infrastructure sector. To ease the financing constraints for
infrastructure projects under the PPP mode, the Government has decided that IIFCL
would refinance 60 per cent of commercial bank loans for PPP projects in critical areas
over the next fifteen to eighteen months. The IIFCL was authorised to raise Rs.10,000
crore through Government guaranteed tax free bonds by the end of 2008–09 and an
additional Rs.30,000 crore on the same basis as per the requirement in 2009–10. The
refinancing option is expected to leverage bank financing for PPP programmes to the
extent of about Rs.1,00,000 crore. As the experience suggests, the take out financing
failed to become popular as the cost of borrowing turn out to be high. As IIFCL sources
banks substantially for its funding requirement as well as refinances banks for their
infrastructure lending, the cost of finance goes up through the layers of intermediation. In
view of the limited availability of resources, there is a limit to which IIFCL will be able
to deliver a favourable leverage effect by extending equity support and credit
enhancement.

Single and group exposure limits turn out to be binding for lending banks in view of the
huge funds requirement. There is not much scope to increase them from prudential
viewpoints going by the internationally accepted norms. The capital funds of Indian
banks are small in size. The exposure limits of banks are fixed in relation to their capital
funds. Even though we have allowed relaxation of 5 percent in case of single borrower
limit and 10 percent in case of group borrower limits, banks find it difficult to lend to
infrastructure projects set up by big industrial houses as they have already reached the
maximum group exposure limit to such borrowers. Also, there is a tendency among
borrowers to limit their borrowing to a few large banks which compounds the exposure
limit constraints. As not all banks are active in infrastructure financing, the consolidation
of banks could potentially provide higher exposure limits. However, such mergers and
acquisitions may not serve the purpose as risk remains the same for the sector. Typically
a bank may not like to take upon itself the entire financing risks but try to attract co-
financer by syndication of loans, which would entail multiple lenders discouraging the
borrower.
8. Process of Infrastructure Finance
Infrastructure finance is the long term financing based upon the projected cash flows
of the project rather than the balance sheets of the project sponsors. Usually, a project
financing structure involves a number of equity investors, known as sponsors, as well as a
syndicate of banks that provide loans to the operation. The loans are most commonly
non-recourse loans, which are secured by the project assets and paid entirely from project
cash flow, rather than from the general assets or creditworthiness of the project sponsors,
a decision in part supported by financial modeling. The financing is typically secured by
all of the project assets, including the revenue-producing contracts. Project lenders are
given a lien on all of these assets, and are able to assume control of a project if the project
company has difficulties complying with the loan terms.
Generally, a special purpose entity is created for each project, thereby shielding other
assets owned by a project sponsor from the detrimental effects of a project failure. As a
special purpose entity, the project company has no assets other than the project. Capital
contribution commitments by the owners of the project company are sometimes
necessary to ensure that the project is financially sound. Project finance is often more
complicated than alternative financing methods. Traditionally, project financing has been
most commonly used in the mining, transportation, telecommunication and public utility
industries. More recently, particularly in Europe, project financing principles have been
applied to public infrastructure under public–private partnerships (PPP) or, in the UK,
Private Finance Initiative (PFI) transactions.
Risk identification and allocation is a key component of project finance. A project may
be subject to a number of technical, environmental, economic and political risks,
particularly in developing countries and emerging markets. Financial institutions and
project sponsors may conclude that the risks inherent in project development and
operation are unacceptable (unfinanceable). To cope with these risks, project sponsors in
these industries (such as power plants or railway lines) are generally completed by a
number of specialist companies operating in a contractual network with each other that
allocates risk in a way that allows financing to take place.[2] The various patterns of
implementation are sometimes referred to as "project delivery methods." The financing of
these projects must also be distributed among multiple parties, so as to distribute the risk
associated with the project while simultaneously ensuring profits for each party involved.
A riskier or more expensive project may require limited recourse financing secured by a
surety from sponsors. A complex project finance structure may incorporate corporate
finance, securitization, options, insurance provisions or other types of collateral
enhancement to mitigate unallocated risk
Project finance shares many characteristics with maritime finance and aircraft finance;
however, the latter two are more specialized fields.
 SPONSOR/S

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PROCESS OF INFRASTRUCTURE FINANCE

Hypothetical project finance scheme
Acme Coal Co. imports coal. Energen Inc. supplies energy to consumers. The two
companies agree to build a power plant to accomplish their respective goals. Typically,
the first step would be to sign a memorandum of understanding to set out the intentions of
the two parties. This would be followed by an agreement to form a joint venture.
Acme Coal and Energen form an SPC (Special Purpose Corporation) called Power
Holdings Inc. and divide the shares between them according to their contributions. Acme
Coal, being more established, contributes more capital and takes 70% of the shares.
Energen is a smaller company and takes the remaining 30%. The new company has no
assets.
Power Holdings then signs a construction contract with Acme Construction to build a
power plant. Acme Construction is an affiliate of Acme Coal and the only company with
the know-how to construct a power plant in accordance with Acme's delivery
specification.
A power plant can cost hundreds of millions of dollars. To pay Acme Construction,
Power Holdings receives financing from a development bank and a commercial bank.
These banks provide a guarantee to Acme Construction's financier that the company can
pay for the completion of construction. Payment for construction is generally paid as
such: 10% up front, 10% midway through construction, 10% shortly before completion,
and 70% upon transfer of title to Power Holdings, which becomes the owner of the power
plant.
Acme Coal and Energen form Power Manage Inc., another SPC, to manage the facility.
The ultimate purpose of the two SPCs (Power Holding and Power Manage) is primarily
to protect Acme Coal and Energen. If a disaster happens at the plant, prospective
plaintiffs cannot sue Acme Coal or Energen and target their assets because neither
company owns or operates the plant.
A Sale and Purchase Agreement (SPA) between Power Manage and Acme Coal supplies
raw materials to the power plant. Electricity is then delivered to Energen using a
wholesale delivery contract. The cashflow of both Acme Coal and Energen from this
transaction will be used to repay the financiers.
Complicating factors
The above is a simple explanation which does not cover the mining, shipping, and
delivery contracts involved in importing the coal (which in itself could be more complex
than the financing scheme), nor the contracts for delivering the power to consumers. In
developing countries, it is not unusual for one or more government entities to be the
primary consumers of the project, undertaking the "last mile distribution" to the
consuming population. The relevant purchase agreements between the government
agencies and the project may contain clauses guaranteeing a minimum offtake and
thereby guarantee a certain level of revenues. In other sectors including road
transportation, the government may toll the roads and collect the revenues, while
providing a guaranteed annual sum (along with clearly specified upside and downside
conditions) to the project. This serves to minimise or eliminate the risks associated with
traffic demand for the project investors and the lenders.
Minority owners of a project may wish to use "off-balance-sheet" financing, in which
they disclose their participation in the project as an investment, and excludes the debt
from financial statements by disclosing it as a footnote related to the investment. In the
United States, this eligibility is determined by the Financial Accounting Standards Board.
Many projects in developing countries must also be covered with war risk insurance,
which covers acts of hostile attack, derelict mines and torpedoes, and civil unrest which
are not generally included in "standard" insurance policies. Today, some altered policies
that include terrorism are called Terrorism Insurance or Political Risk Insurance. In
many cases, an outside insurer will issue a performance bond to guarantee timely
completion of the project by the contractor.

Publicly-funded projects may also use additional financing methods such as tax
increment financing or Private Finance Initiative (PFI). Such projects are often governed
by a Capital Improvement Plan which adds certain auditing capabilities and restrictions to
the process.
Typical Infrastructure Project Configuration:

The project moves from the development stages to financing and thereafter to
construction and finally to operations, several parties get involved with the project. some
like the financial advisors , exit once the financing is fully tied up and the project has
drawns down loans from the lenders and equity from the investors , while others like the
EPC contractor is extensively associated with the project during the construction phase
and by contract during the “ Defect liability Period” post commercial operations .

Project Parties - Fundamental Responsibilities

Project Sponsors: There are responsible for converting a concept into a project and
have a role in setting up a project vehicle, identifying and recruiting right managerial
talent to implement and to run the project and finally subscribing to a significant
proportion of equity in the project vehicle.

Project vehicle (SPV): The SPV is responsible for delivering a bankable project during
the financing phase, implementing the project and thereafter operating it in a manner that
is financially viable. It selects and appoints all the project contractors, negotiates and
executes the contract throughout the contractors.

Project Lenders: Project lenders provide debt to finance the construction of the project.
typically a consortium project lenders , led by a lead bank ascertains a bankable project
cost and in consultation with spy and the project sponsor a “ Means of Finance “ to
finance the same , disburses debt and performs monitoring role during the construction
phase, and add on commissioning monitors the performance and operation of the project
till all debt is repaid. Lenders are secured by the project assets and don not interfere day
to working of the SPV. However under conditions of default, the project lenders rights
increase substantially and in extreme cases of default, and if provided for the Project loan
Documents, project lenders can take over the management of the project as will as the
sponsor’s equity.

EPC contractors : Typically an EPC contractor designs the project , procures all the
engineering skills and equipment to construct the project , erects ass the project facilities
ensures that test and trial runs are completed . The EP contractor‘s key objective is to
deliver a project as per predefined specifications within certain cost and time frame. It
also provides performance guarantee to the spy, it may choose to subcontract certain
portions of the assignment to other contractors but such subcontracting dose not relevant
from its sole responsibility of delivering a constructed project to the SPV.
O and M Contractor: As the name indicates, the O and M contractor is 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 O &M contractor provides managerial skills and operations experience to
achieve and possibly surpass the agreed parameters.

Government: The government is a key party. It provides a Concession to the SPV to

set up the project and ensures that a proper legislative and regulatory framework exists
that allows the concerned SPV to compete on a “level playing field” along with existing,
possibly government owned entities, in the same field.

In some cases, like in the electricity generating sector , state government have counter
guaranteed the performance of off take obligations of the SEB’s (State Electricity Board)
and in certain cases , the central government has counter guaranteed the performance of
the state government

S P V p re se n ts in vo ice

def
9. Financing Infrastructure Project - Various Models
1. Government funded and owned

These investments were financed by budgetary allocations, surpluses of SGAs/ PSUs,

market borrowings (mainly from the bank market), borrowings from multi-lateral
agencies and a few capital market bond issuances. Mostly it funds socially and politically
important projects where user charges are not defined

Eg : Irrigation Projects

2. Private Funded and Owned

Government issues licensees for the services to be rendered or to allot the resources,
licensees develops and provides service and charges to open market rates dictated by the
competition

Eg: Telecom and mining, airline business

3. Public Private Partnership (PPP) Project

Means a project based on a contract or concession agreement between the govt. or

statutory entity on the one side and a Private company on the other side, for delivering an
infrastructure service on payment of user charges

Infrastructure projects have long gestation periods and, in most cases, are not financially
viable on their own. It may not be possible to fund the very large investment
requirements of these projects fully from the budgetary resources of the Government of
India alone. In order to remove this shortcoming and to bring in private sector resources
and techno-managerial efficiencies, the Government is promoting Public Private
Partnerships (PPP) in infrastructure development

4. BOOT

Annuity based model / Toll based

The project is given out as a BOOT concession for certain number of years being the
implementation period and next 15 years the operations period. The concession
agreement is a composite contract under which all risks pertaining to design,
construction, operations and maintenance of the road are transferred to the private
investor. In return the investor would be paid a composite payment (annuity payment) in
30 equal semi-annual installments over the operations period. The payment commences
only after the project is completed and so all stakeholders are incentivised to ensure
completion of the project facility. The contract has a built-in incentive for early
completion in that the annuity payment obligation starts from the actual project
completion date. In case of toll base toll is collected from the users till the cost plus profit
is recovered as per the agreement.

5. BOO

BOO (Build Own Operate) is a scheme which combines private finance, design and
construction with private operation after completion of a project. Operation and
ownership of the project is usually continued with no transfer back to the government.
However the government is usually entitled to a certain amount of shared revenue within
a specified period10. Thus in a BOO scheme the project remains in the private sector
without the requirement of transfer to the host government, and thus is very close to the
free market ideal. Under this method the private entity is allowed to recover its total
investment, operating, and maintenance costs, plus a reasonable return by collecting fees
and other charges from facility users.

6. Viability GAP funding

The Viability Gap Funding Scheme provides financial support in the form of grants, one
time or deferred, to infrastructure projects undertaken through public private partnerships
with a view to make them commercially viable. GoI has established a Viability Gap Fund
to aid the PPP infrastructure projects which face the viability gap due to inherent nature
of the project. The Scheme is administered by the Ministry of Finance.

Viability gap funding can take various forms, including but not limited to capital grant,
subordinated loans, O&M support grants or interest subsidy. A mix of capital and
revenue support may also be considered. The funding is to be disbursed contingent on
agreed milestones, preferably physical, and performance levels being achieved, as
detailed in funding agreements. The funding is to be provided in installments, preferably
in the form of annuities, and with at least 15 per cent of the funding to be disbursed only
after the project is fully functional.

7. Revenue Sharing Model :

Projects are awarded based on how much % of revenue will be shared by the
concessionaire. Highest bidder wins. Upfront payment is not required and govt. will be
paid from accruing revenue. More suitable for brown field expansion where government
hand over existing facility to the winning bidder.
Mumbai and Delhi airport modernization has been carried out on this model

8. Tariff Based Bidding

Tariff based bids are invited by government to supply a particular service or facility for
fixed tenure and fixed quantity. Lowest bidders are awarded the contact. Demand and
purchase is ensured in terms of PPAs (Pre Purchase Agreements) Bidders risk is limited
to implementation and operation. There is no upper limit set for RoI or profit. Success
fully implemented in Electricity generation and Water treatment sector
10. Infrastructure Financing Scenario in India:

It may be worthwhile to note the salient features of infrastructure financing in India “

1) Due to their complex nature, infrastructure projects have historically been funded
by banks and financial institutions, SBI, IDFC, ICICI, IDBI and PFC being the
key financers in infrastructure. Funding from banks and financial institutions have
been complemented to a smaller extent by Export Credit Agencies and
Multilateral agencies.

2) In recent times there has been as increasing interest from the capital markets in
financing equity requirements in well structured infrastructure projects. While
equity from capital markets remains relatively rare for start up infrastructure
projects, capacity expansions from reputed and experienced sponsors are now
well received from capital market investors.

3) India’s first public private initiative – the $100 million Delhi Noida Toll Bridge
conceived as a build own transfer project suffered from low traffic when it was
opened in 2001 . In 2004, a financial restructuring was approved by the lenders
under the corporate debt recovery mechanism to ensure its feasibility.

4) A large part of the golden quadrilateral the country’s largest expressway project is
based on a fixed annuity payment to contractors on a build operate transfer (BOT)
model.

5) An (OMT) operate maintain transfer model is emerging for road financing. Under
this arrangement the government funds the road while the contractor operates and
maintains it for a fee.

6) There has been a fair amount of action in seaports in the last few years. Apart
from the privatisation of some berths in Mumbai, Chennai and Tuticorin,
privately owned ports such as Ganavarm in AP Dharma in Orissa and Mundra in
pipavav in gujrat have come up or are in the implementation stages. Hence a
public private initiatives has emerged for laying rail line s to the ports.
11. Some possible measures and solutions to bridge the gap
Some specific measures are being talked about to bridge the gap in financing by
extending the funding base for infrastructure projects.

a) One such measure is the participation of pension funds and insurance companies in
funding the long term infrastructure projects. Pension funds are increasingly moving into
new asset classes in a search for yield. Infrastructure is one type of investment being
frequently discussed, given its potential to match long-term pension assets and provide
diversification. Some larger funds globally are beginning to invest in infrastructure via
private-equity funds, or, occasionally, even directly. Australian, Canadian and Dutch
pension funds may be considered as leaders in this field.

b) The development of domestic long-term capital markets will be critical for private
sector investment in infrastructure, but these markets must have much better regulation as
well. In India, there is a need to improve the depth and liquidity of the corporate bond
market to provide an additional source of funds for infrastructure companies. Limited
investor base, limited number of issuers and preference for bank finance over bond
finance are the main macro barriers for development of a deep and liquid corporate bond
market. RBI has issued the guidelines on repo in corporate bonds, which would be
effective from March 2010. Further, syndication of loans would diversify the risk in
infrastructure financing, given the fact that a bank would not like to take upon itself the
entire financing given the risks involved and the capital and consequent exposure
constraints.

c) Also credit enhancement to infrastructure by way of risk transfer and risk reduction
could help bridge the gap in the Indian context. Lenders tend to look for credit
enhancement from government like policy guarantees, refinancing and maturity extension
guarantees, grants/viability gap funding, etc. Similarly, non-government mechanisms like
bond insurance, credit rating, etc. provide risk mitigation to the lenders. Providing credit
enhancement by way of insuring the debt payment by insurance companies to banks for
the loans extended by them towards infrastructure projects is a concept considered in the
North American infrastructure market.

d) Comprehensive infrastructure development calls for simultaneous improvement of all

infrastructure sectors, like power, telecommunications, irrigation, transport, housing,
commercial complexes, water supply, sanitation and other urban amenities. In the current
situation, it may no longer be possible for the Governments to develop, upgrade and
maintain infrastructure and provide all civic amenities on their own. It is in this context
that governments are involving the private sector in the area of infrastructure
development to bridge the gap between demand and supply. The Public-Private
Partnership is being actively pursued in India to meet the gaps in the provision of basic
infrastructure services. The PPP model, where the state shares the risks and
responsibilities with private firms while retaining the control of assets is generally
expected to improve services while avoiding some of the pitfalls of privatization such as
higher prices and corruption. However, for such partnerships to be successful, the
framework of PPP including pricing has to be transparent. The development finance
model has to be characterized by good planning, strong commitment of both the parties,
effective monitoring, regulation and enforcement by the government. A separate Ministry
for Infrastructure Development could help immensely in channelising government’s
efforts. The issue of pricing is crucial in view of the political sensitivities, while also
simultaneously ensuring the viability of the project. If we are looking at world class
infrastructure, then we will have to pay for it. Managing the transition from state
subsidised services to market based pricing is crucial as a fine balance has to be
maintained between allowing companies to raise prices rapidly on existing, cheap public
utility services and suppressing price hikes by ignoring market forces. Whenever PPP
with proper pricing is not possible, then Government has to chip in. Rural areas and
hinterland infrastructure development could be the responsibility of the government. So
pricing on commercial consideration is a key issue and I hope the convention will discuss
these key issues.
e) Additional flexibility for long term bonds issued by banks as regards the tenor of bond
issuance or allowing Zero Coupon Bonds for infrastructure with income tax benefits are
some of the other incentives that can be thought off in the years ahead. Another option is
to treat the advances as unsecured so long as receivables from the project is the only basis
of tangible primary security, as is normally the case for road project, provided cash flows
generated are adequate for repayment of the advance.
12. Noida Toll Bridge - Case Study
Opportunities:

Noida has seen the emergence of major shopping and recreational activities with the
opening of the Centre Stage Mall/Multiplex. Various other recreational and commercial
projects are on the anvils that are slated for completion by end 2006. Existing BPO’s and
Call Centres have drawn up major expansion plans and new BPO’s and other IT related
companies are setting up shop in Noida. Whereas, the focus in 2003-2004 was in
emergence of shopping and entertainment developments in Noida, the year 2004-2005
saw an exponential growth in residential developments both in Noida, Greater Noida and
Indirapuram area on the Delhi-Ghaziabad border. It is estimated that approximately
77,000 new dwelling units along the Noida-Greater Noida Expressway and within
Greater Noida are likely to be constructed by 2009 end. It is conservatively estimated that
these dwelling units once fully occupied will provide an incremental traffic of 25,000 to
30,000 trips per day. The development of the Mayur Vihar District Centre is also
progressing satisfactorily and that will also add to the traffic. The commissioning of the
Srinivaspuri Flyover has had a positive impact on the traffic on the DND Flyway as it has
decongested, to some extent, the approach to DND Flyway. The underpass under
construction at Moolchand, once completed, will also improve the throughout of traffic
that will have a positive impact on the traffic on DND Flyway.

Delhi has expanded rapidly beyond the natural boundary and now about 30% of the
population of the city resides in the eastern side of the river, as the trend of living in the
suburbs and working in South and Central Delhi caught on. The New Okhla Industrial
Development Authority (NOIDA) established a new integrated industrial township also
called ‘Noida’ in close proximity to Delhi. During the 1980s and 1990s employment and
the disposable incomes rose significantly resulting in a large rise in the sale of
automobiles, scooters and other private forms of transport. As a consequence traffic
density on Delhi’s roads increased substantially particularly during rush hours on all
arterial routes leading into/out of South and Central Delhi. However transportation links
between Noida and Delhi were inadequate.

Introduction

1. The Delhi Noida bridge is one of three bridges across the Yamuna
river connecting Noida with Delhi and the only one that is tolled.
Popularly known as the DND Flyway, the bridge is 552.5 meters long
and includes the approach roads on the Delhi and Noida ends. It has
eight lanes with a capacity of around 222,000 vehicles per day. The
main advantage of using the bridge is the savings in time, distance
and fuel consumption for travellers between South Delhi and Noida.
2. The bridge, which opened to traffic in February 2001, was among the first few projects
to have been developed as a Public Private Partnership (PPP) in India. The project was
structured as a Rs. 408.2 crore (US$ 100m) 30-year BOOT concession, which was
financed through equity of Rs. 122.4 crore (US$ 30m) and debt of Rs. 285.8 crore (US$
70m). Debt financing consisted of term loans from various Indian banks and financial
institutions totalling Rs. 235.8 crore (US$ 58m) and the issue of deep discount bonds
totalling Rs. 50 crore (US$ 12m) by the Noida Toll Bridge Company Limited (the
concessionaire).

3. The Delhi Noida bridge project is often presented as a path-breaking project which
showed that private capital could indeed be attracted to provide public infrastructure
services in India – despite having to deal with multiple authorities and a fragile political
environment. The project was completed within budget and ahead of schedule. It was also
successful in raising investment funds from capital markets (including an issue of GDR’s
overseas). Following significant shortfalls in projected traffic and revenues, it was also
successful in restructuring its debt after the first year of operation. It is the only toll road
in the country listed on the stock exchange.

4. On 12 November 1997, a concession agreement was entered into by NOIDA, NTBCL

and IL&FS granting the right of building and operating the Delhi Noida toll bridge to
NTBCL. Under the concession agreement, NTBCL has been given the right to
commercially exploit the Delhi Noida toll bridge by levying tolls. The concession
agreement provides that the concession shall last until the concessionaire has recovered
the total project cost plus a return, which is 20% per annum of the total project cost. At
the end of the concession period all of the NTBCL’s interest in the Delhi Noida toll
bridge is to be transferred back to NOIDA for the nominal sum of Rs 1.

5. In the initial years of operation, the revenue from collection of toll fees at the Delhi
Noida toll bridge fell below originally projected levels and below break-even level. The
shortfall was attributed to a number of factors including the rate of growth of Noida being
lower than expected. As a result of the financial losses incurred, NTBCL approached its
lenders for the restructuring of its debt after its first year of operation. The restructuring
was carried out in 2002. The State Bank of India in conjunction with NTBCL, IDBI and
IL&FS prepared the corporate debt restructuring proposal, the key features of which
were: (i) rescheduling of interest and repayments; (ii) reduction in interest rate for loans;
and (iii) construction of new links in order to augment NTBCL’s revenues (to be funded
by additional equity capital).
• Sponsors - IL & FS, Noida & Delhi Administration (DA)

• SPV - Noida Toll Bridge corporation Ltd. ( NTBCL)

• EPC @O & M Contractor: Intertoll Management Services BV, Netherlands, a

100% subsidiary of M/s Intertoll Holdings (Pty) Ltd,
South Africa.
• Lenders : ICICI bank , SBI .

Key aspects of the concession agreement are discussed below.

1. Guaranteed returns on total project cost

The contractual provision of a guaranteed return on the total cost of the project has
several implications. The fact that a specific percentage return has been guaranteed leads
to the need to understand (a) on what base the return must be calculated and what this
implies in terms of concessionaire incentives, and (b) whether the level of the return is
justified. These aspects are addressed in turn.

(a) Base upon which the return is calculated

11. The concessionaire is guaranteed a return on the Total Cost of the Project, which is
defined as the aggregate of (i) Project Cost; (ii) Major Maintenance Expenses; and (iii)
shortfalls in the recovery of Returns in a specific financial year. Project Cost is further
defined as, collectively, (a) the Cost of Construction and (b) the Other Costs of
Commissioning. It is stated that the Independent Auditor shall, in consultation with the
Independent Engineer, determine the Project Cost as on the Project Commissioning Date.

(b) Justification for the level of return awarded

13. The level of return, at 20% per annum on the total cost of the project, cannot be
assessed as appropriate without knowing whether such returns are the norm.
(i) In the absence of benchmarks or data on comparable projects in the sector and country
at the time – since this was among the very first BOOT projects in the roads sector in
India – the return can be judged to have been justified only if it was the outcome of
competitive bidding for the contract. However, the concession for the Delhi Noida bridge
project was not awarded competitively.

(ii) High returns are also considered a reward for high risk. In this concession agreement,
however, the guarantee of a return (whether through extension of the concession period
or through tariff adjustments or through the exercise of Development Rights) means that
the concessionaire does not bear any significant commercial risk.

(iii) In addition, since the base upon which returns are paid is the total cost of the project,
i.e., equity plus debt, equity holders are effectively earning substantially more than 20%
per annum given the rate of interest on debt is less than 20% per annum. In effect, the
margin between the average interest rate payable on the company’s Term Loans (14.7%
per annum) and the assured return of 20% would accrue as an additional return to equity
holders, who would receive about 32% per annum on their equity holding. In fact, returns
to equity are likely to be higher than described above on two accounts. First, carrying
forward the annual deficit in returns and payment of compounded returns on this deficit
means that while the debt burden on the concessionaire would only be compounded by
the rate of interest, a major share of the compounding of returns would be allocated to
equity, resulting in an extraordinary rise in the return on equity. Second, debt has been
restructured to reduce the average interest rate payable. This implies a sharp rise in the
return on equity as there is no mechanism in the concession agreement for the conceding
authority or users to ‘claw-back’ these gains.

To illustrate debt was 70% of the capital cost of the project assuming a capital base of Rs.
100 crore and a rate interest of 14.7 % per annum, the interest payment due the first year
would be 0.147 X 70 = Rs. 10.29 crore. Thus of the total return on the capital cost of
Rs.20crore (20% of Rs.100 crore), Rs.9.71 crore would be available as return on equity,
which amounts to a rate of return approximately 32% to equity (Rs. 9.71 crore on an
equity base of Rs.30crore)

In addition, any increase in total project cost (due to shortfall in returns) would result in
higher return being due to the concessionaire (since the base upon which returns are due
would increase). As the amount payable to debt is fixed, the returns allocated to equity
would increase disproportionately.

According to the case study, the average interest payable has declined from 14.7 % to 8.5
% per annum. Assuming a capital base of Rs.100 crore and retaining a 70:30 debt to
equity ratio, the interest payment due would now be Rs. 0.085 * 70 = Rs.5.95 crore.
Thus, of the total return on capital Cost of Rs. 20 crore (20% of Rs.100 crore), Rs. 14.05
crore would be available as return on equity, which amounts to a rate of return of
approximately 47 % to equity (Rs.14.05 crore on an equity base of Rs. 30 crore.)

The accrued return (inclusive of project cost) due to the concessionaire was Rs. 953.4
crore (US$ 234m) on March 31, 2006, an amount more than double the original project
cost. The magnitude of this financial liability would make it very difficult for NOIDA to
terminate the contract if it concluded that the contract was no longer in the public interest.
While there should be costs to unilateral abrogation of any contract, the size of the
penalty imposed on the public partner in this case seems disproportionate to the risk of
capricious repudiation by the public sector. To the extent that the liability faced by
NOIDA would increase with future shortfalls in returns (see footnote 20), it would be
increasingly difficult for the public partner to terminate the contract as time goes by. In
the case of termination following a concessionaire event of default, NOIDA is obligated
to compensate the concessionaire for the debt and debt service outstanding. In the Delhi
Noida bridge project no distinction is made in terms of compensation between a
concessionaire event of default which occurs prior to entry into operation of the bridge
(i.e., before construction has been completed) vs. one that occurs after commercial
operation has commenced (i.e. post-construction). In both cases NOIDA pays off the total
debt (including interest accrued and any other amounts due and payable) outstanding. As
a result the construction completion risk, which should more appropriately fall to the
concessionaire, is substantially shifted to NOIDA. In contrast, the MCA for National
Highways provides for no payment to the concessionaire in the event of concessionaire
default prior to completion of construction. This maximizes the concessionaire’s
incentive to complete the work and to do so swiftly. Further, the concessionaire is entitled
to payment of only 90% of debt outstanding (less insurance) for termination due to
concessionaire default during the operation period (MCA 37.3.1). This exposes lenders to
concessionaire performance risk – creating an incentive for lender due diligence on
concessionaire performance.
13. 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 capitalisation (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. The risk capital required in the
infrastructure sector can be understood as the Explicit Capital brought in as equity by the
project sponsors and the Implicit Risk Capital provided by the project lenders. Implicit
Capital providers seek to manage their risk-return reward by ensuring availability of
adequate Explicit Capital and diversification across various projects. Given this profile of
the Explicit Capital, greater flow of this risk capital can be ensured by removing the
effects of controllable uncertainties in the policy environment and making available the
benefits of diversification through alternate mechanisms. New sources of this risk capital
can be sourced by providing partial risk guarantees (in form of First Loss Deficiency
Guarantees), formation of highly capitalized financial intermediaries and encouraging
securitization transactions. In addition to above, various regulatory initiatives and market
reforms are required to enable the commercial banking system to participate more
vigorously in providing infrastructure financing.

Sciion of Indian retail investors, the relatively small capitalisation (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. The risk capital required in the
infrastructure sector can be understood as the Explicit Capital brought in as equity by the
project sponsors and the Implicit Risk Capital provided by the project lenders. Implicit
Capital providers seek to manage their risk-return reward by ensuring availability of
adequate Explicit Capital and diversification across various projects. Given this profile of
the Explicit Capital, greater flow of this risk capital can be ensured by removing the
effects of controllable uncertainties in the policy environment and making available the
benefits of diversification through alternate mechanisms. New sources of this risk capital
can be sourced by providing partial risk guarantees (in form of First Loss Deficiency
Guarantees), formation of highly capitalized financial intermediaries and encouraging
securitization transactions. In addition to above , various regulatory initiatives and market
reforms are required to enable the commercial banking system to participate more
vigorously in providing infrastructure financing.
14. References

[1] Gray, Philip, and Timothy Irwin; “Exchange Rate Risk: Reviewing the Record for
Private Infrastructure
Contracts”, Viewpoint, World Bank, Private Sector and Infrastructure Network,
Washington, D.C., June 2003.
[2] Hess Ulrich, Kaspar Richter, Andrea Stoppa (2000); “Weather Risk Management for
Agriculture
and Agri-Business in Developing Countries”, 2000
[3] Malhotra, Sandeep and Kamal Nigam (2003); “Infrastructure Finance in India”,
ICICIresearchcentre.
org and CAFS Working Paper, July 2003
[4] Mohan, Rakesh (2003); “Infrastructure Development in India: Emerging Challenges”,
Working
Paper presented at the World Bank Annual Conference on Development Economics,
Bangalore, May 2003
[5] Morris, Sebastian (2003); “Efficacy of Government Expenditures”, India
Infrastructure Report,
2003
[6] (2003); “India Infrastructure Report”, 2003
[7] Williams, Julie L. (2003); “Regulatory Considerations In the Evolution of Risk
Management”,
Speech by the 1st Senior Deputy Comptroller of the Currency and Chief Counsel Office
of
the Comptroller of the Currency, at Risk USA 2003 Conference, Boston, Massachusetts,
June 10, 2003
[8] Zhou Xiaochuan(2004), Governor of The People’s Bank of China (2004); “Some
Issues Concerning
the Reform of the State-owned Commercial Banks”, Speech made at the IIF Spring
Membership Conference, Shanghai, April 16, 2004