Sei sulla pagina 1di 138

Draft Final Report

September 2007

for the WORLD BANK

Infrastructure Public-Private Partnership (PPP) Financing in India

pwc
pwc

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Content

Main Report

ACRONYMS

5

CURRENCY EQUIVALENTS

6

1 EXECUTIVE SUMMARY

7

2 INTRODUCTION

10

2.1 SOME POINTS/ASSUMPTIONS TO BE KEPT IN MIND

10

2.2 OBJECTIVE OF THE STUDY

12

OBJECTIVE 1: EVIDENCE BASED DESCRIPTION OF PRESENT FINANCING SOURCES FOR PPP INFRASTRUCTURE

3

14

4

OBJECTIVE 2: ANALYSIS OF THE FINANCING OF PPP IN INDIA

19

4.1.1 Debt financing

19

4.1.2 Equity Financing

25

4.1.3 Significance of Subordinated Debt

27

4.1.4 Strategic Investors and their Investment in the Projects

28

4.1.5 Summary of Major Issues on the Debt and Equity Side

29

4.1.6 What is Happening in Infrastructure Financing in Other Countries?

29

OBJECTIVE 3: TO IDENTIFY CHANGES REQUIRED TO REDUCE AND EASE THE IDENTIFIED CONSTRAINTS

5

31

5.1

NEW AREAS TO FOCUS ON THE DEBT SIDE

31

5.1.1 Bonds as a Source of Fund

31

5.1.2 Funding from Insurance, Pension and Provident Funds

33

5.1.3 Improving Bank capacity to lend to Infrastructure Sector

36

5.1.4 ECB as a Source of Infrastructure Financing

36

5.2

NEW AREAS TO FOCUS ON THE EQUITY SIDE

38

5.2.1 Holding Company Structure Creates Issue in Raising Equity

38

5.2.2 Private Equity Investment to Shore up Promoter Equity

39

5.2.3 Equities Market as a Source

41

5.2.4 Role of International Developers

42

5.3

CONCLUSION

43

7.1

LIST OF INTERVIEWS CONDUCTED

53

7.2

LIST OF PPP PROJECTS

54

7.3

SOURCES FOR PROJECT INFORMATION

60

7.4

ASSUMPTIONS

64

7.4.1 Analysis Assumptions

64

7.4.2 Regions

65

7.4.3 Sample Sizes

66

7.4.4 Approximation of Financial Closure Year from Secondary Sources

66

7.4.5 Approximation of TPC from Secondary Sources

70

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Annexures

ANNEXURE 1 - PROCESS FOR SELECTION OF PPP INFRASTRUCTURE SECTORS FOR THE DETAILED STUDY

6

44

7 ANNEXURE 2 - APPROACH AND METHODOLOGY OF THE STUDY

51

8 ANNEXURE 3: SURVEY COVERAGE

74

9 ANNEXURE 4 - OTHER KEY TRENDS IN PPP INFRASTRUCTURE FINANCING

79

10 ANNEXURE 5 - FUTURE LENDING TO PPP INFRASTRUCTURE PROJECTS FROM

COMMERCIAL BANKS IN INDIA

92

11 ANNEXURE 6 - PROJECT RISK PROFILE AND RELATIONSHIP TO LENDING TERMS 108

12 ANNEXURE 7 - DIFFERENCES IN EQUITY INFUSION

126

13 ANNEXURE 8 - REFINANCING OF PPP PROJECTS

129

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

List of Exhibits

EXHIBIT 1: SAMPLE SIZE FOR PROJECT INFORMATION COLLECTION

14

EXHIBIT 2: TRENDS IN TOTAL 231 PROJECTS AND SAMPLE OF 104 PROJECTS

14

EXHIBIT 3: PPP PROJECTS IN DIFFERENT SECTORS BY NUMBER AND VALUE

16

EXHIBIT 4: TRENDS IN PPP PROJECTS BY AWARDING AUTHORITY

16

EXHIBIT 5: OVERALL FINANCIAL STRUCTURE OF PPP PROJECTS IN INDIA

16

EXHIBIT 6: SOURCE OF SENIOR DEBT FUNDING

17

EXHIBIT 7: SOURCES OF DEBT BY SECTOR AND SHARE OF COMMERCIAL BANKS BY TYPE

17

EXHIBIT 8: LOAN TENURE TO CONCESSION PERIOD RATIO FOR TEN PPP PROJECTS IN LAST TWO YEARS

22

EXHIBIT 9: DSCR REQUIRED BY BANKS

23

EXHIBIT 10: PROJECT RISK CATEGORY AND AVERAGE INTEREST RATE

25

EXHIBIT 11: INCREASED GEARING OVER THE YEARS

26

EXHIBIT 12: DER BY SIZE

26

EXHIBIT 13: SOURCES OF PURE EQUITY

26

EXHIBIT 14: SOURCES OF EQUITY

27

EXHIBIT 15: INSTANCES OF SUB-DEBT BY YEAR AND SECTOR

28

EXHIBIT 16: STRATEGIC INVESTMENT BY SECTOR

28

EXHIBIT 17: INVESTMENT BY LIFE AND NON-LIFE INSURER IN LAST THREE YEARS (USD MILLION)

33

EXHIBIT 18: YEAR ON YEAR FUND COLLECTION BY EPFO

33

EXHIBIT 19: INVESTMENT BY INSURANCE COMPANIES IN RATED SECURITIES

34

EXHIBIT 20: CHINESE INSURANCE REGULATION

34

EXHIBIT 21: ECBS IN INFRASTRUCTURE (MARCH 2004 - FEBRUARY 2007)

36

EXHIBIT 22: HOLDING COMPANY STRUCTURE AND ITS IMPLICATIONS

39

EXHIBIT 23: PE DEALS FOR THE YEAR 2006

39

EXHIBIT 24: PRIVATE EQUITY INVESTMENTS IN THE YEAR 2006

40

EXHIBIT 25: INFRASTRUCTURE FUND BY MUTUAL FUNDS

41

EXHIBIT 26: SECTORS CONSIDERED BY INFRASTRUCTURE DEFINITIONS BY VARIOUS AGENCIES

45

EXHIBIT 27: SELECTION OF SECTORS

49

EXHIBIT 28: PROJECT METHODOLOGY

51

EXHIBIT 29: REGIONAL DISTRIBUTION OF VALUE OF PPP PROJECTS BY STATE

74

EXHIBIT 30: REGIONAL DISTRIBUTION OF PPP PROJECTS BY VALUE AND NUMBER

74

EXHIBIT 31: SECTORAL DISTRIBUTION OF PROJECTS IN THE FOUR REGIONS

75

EXHIBIT 32: REGIONAL DISTRIBUTION OF PROJECTS BY AWARDING AUTHORITY

75

EXHIBIT 33: SECTOR WISE DISTRIBUTION OF STATE AND CENTRE PROJECTS BY NUMBER AND VALUE

75

EXHIBIT 34: SIZE WISE GROUPING OF PPP PROJECTS BY VALUE AND NUMBER

76

EXHIBIT 35: PROJECTS BY SIZE CLASSIFICATION AND SECTOR

77

EXHIBIT 36: AVERAGE SIZE OF PROJECTS

77

EXHIBIT 37: TRENDS IN AVERAGE SIZE OF ALL ROADS & BRIDGES AND NHAI PROJECTS

77

EXHIBIT 38: CENTRE AND STATE BY NUMBER AND VALUE

78

EXHIBIT 39: SECTORAL DISTRIBUTION OF CENTRE/STATE PROJECTS BY NUMBER AND VALUE

78

EXHIBIT 40: SECTORAL COMPOSITION BY VALUE AND NUMBER

79

EXHIBIT 41: SIZE WISE DISTRIBUTION AND REGIONAL DISTRIBUTION

79

EXHIBIT 42: ISSUE OF NEGATIVE GRANT IN ROAD PROJECTS

80

EXHIBIT 43: SECTOR WISE NON GRANT, POSITIVE GRANT AND NEGATIVE GRANT PROJECTS

80

EXHIBIT 44: POSITIVE AND NEGATIVE GRANT PROJECTS – NUMBERS AND AMOUNT

81

EXHIBIT 45: COUNT AND AMOUNT OF POSITIVE AND NEGATIVE GRANT IN ROAD & BRIDGES SECTOR

82

EXHIBIT 46: FINANCING STRUCTURE FOR POSITIVE AND NON-GRANT PROJECTS AND ANNUITY AND NEGATIVE GRANT PROJECTS

82

EXHIBIT 47: FINANCING STRUCTURE BY AWARDING AUTHORITY AND SECTOR

83

EXHIBIT 48: FINANCING STRUCTURE BY SIZE

83

EXHIBIT 50: SOURCES OF DEBT BY YEAR AND SIZE

83

EXHIBIT 52: TREND IN DEBT FROM COMMERCIAL BANKS

84

EXHIBIT 53: AVERAGE TENURE OF DEBT AND CONCESSION PERIOD

84

EXHIBIT 54: SENIOR DEBT TO PURE EQUITY RATIO BY SECTOR

85

EXHIBIT 55: INCREASED GEARING

85

EXHIBIT 56: DER BY AWARDING AUTHORITY AND SIZE

86

EXHIBIT 57: DER BY SECTOR AND SIZE

86

EXHIBIT 58: AVERAGE INTEREST RATE SPREAD OVER 10-YR G-SEC YIELD

87

EXHIBIT 60: INTEREST RATE SPREADS AWARDING AUTHORITY

87

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

EXHIBIT 61: REDUCING RESETS

88

EXHIBIT 62: AVERAGE RESET PERIOD

88

EXHIBIT 63: SOURCES OF EQUITY

89

EXHIBIT 64 : STRATEGIC INVESTMENT BY SECTOR

89

EXHIBIT 65 : FDI ALLOWED BY SECTOR

90

EXHIBIT 66: FDI IN PPP INFRASTRUCTURE

90

EXHIBIT 67: EQUITY RETURNS EXPECTATIONS BY INVESTORS

91

EXHIBIT 68: CREDIT OUTSTANDING OF COMMERCIAL BANKS (USD BILLION)

93

EXHIBIT 69: ROADS, PORTS & OTHERS PPP LENDING/ INFRASTRUCTURE LENDING RATIO BY BANKS IN INDIA TO THESE SECTORS

96

EXHIBIT 70: PRIVATE SECTOR LENDING OUT OF TOTAL BANKS LENDING TO POWER PROJECTS IN USD BILLION

98

EXHIBIT 71: PPP POWER FINANCING CAPACITY OF BANKS IN NEXT 5 YEARS (USD BILLION) AT PRIVATE TO INFRASTRUCTURE LENDING RATIOS OF 15% MEDIUM GROWTH

98

EXHIBIT 72: CALCULATION OF DEBT FINANCING GAP

99

EXHIBIT 73: INFRASTRUCTURE LOAN OUTSTANDING OF IDFC

100

EXHIBIT 74: IDFC’S TRANSPORT PPP LENDING AS ON 31ST DECEMBER IN USD MILLION

100

EXHIBIT 75: PFC LENDING TO POWER PROJECTS IN USD BILLION

102

EXHIBIT 76: FINANCING REQUIREMENT FROM SOURCES OTHER THAN COMMERCIAL BANKS AND FINANCIAL INSTITUTIONS (USD BILLION)

102

EXHIBIT 77: RISK AND INTEREST CHARGED

110

EXHIBIT 78: DEBT ANNUITY PER KM AND RISK CATEGORY

111

EXHIBIT 79: PROJECT CATEGORY AND DATA

126

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Acronyms

ADB

Asian Development Bank

ALM

Asset Liability Management

APIIC

Andhra Pradesh Industrial Infrastructure Corporation

BOT

Build Operate Transfer

DEA

Department of Economic Affairs

DER

Debt to Equity Ratio

DFI

Development Financial Institution

DIAL

Delhi International Airport Limited

DoRTH

Department of Road Transport and Highways

DSCR

Debt Service Coverage Ratio

FII

Foreign Institutional Investor

FPO

Follow-on Public Offer

GDP

Gross Domestic Product

GoI

Government of India

G-Sec

Government of India Securities

HCC

Hindustan Construction Company

HDC

Haldia Dock Complex

HIAL

Hyderabad International Airport Limited

IDBI

Industrial Development Bank of India

IDFC

Infrastructure Development Financial Corporation

IFC

International Finance Corporation

IIFCL

India Infrastructure Finance Company Limited

IL&FS

Infrastructure Leasing & Financial Services

INR

Indian National Rupees

IPPs

Independent Power Producers

IRDA

Insurance Regulatory and Development Authority

JICA

Japan International Cooperation Agency

JBIC

Japan Bank for International Cooperation

KPCL

Karnataka Power Corporation Limited

LIBOR

London Interbank Rate

LIC

Life Insurance Corporation of India

MCD

Municipal Corporation of Delhi

MF

Mutual Funds

MoF

Ministry of Finance

MW

Mega Watt

NBFC

Non Banking Financial Company

NCD

Non Convertible Debentures

NDMC

New Delhi Municipal Corporation

NHAI

National Highway Authority of India

NTBL

Noida Toll Bridge Company Limited

PFC

Power Finance Corporation

PFI

Private Finance Initiative

PLR

Prime Lending Rates

PMGSY

Pradhan Mantri Gram Sadak Yojna

PNB

Punjab National Bank

PPP

Public Private Partnerships

PwC

PricewaterhouseCoopers

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

PWD

Public Works Department

RBI

Reserve Bank of India

RVNL

Rail Vikas Nigam Limited

SBAR

State Bank Advance Rate

SBI

State Bank of India

SCB

Scheduled Commercial Banks

SPV

Special Purpose Vehicle

TOR

Terms of Reference

ULB

Urban Local Body

UNESCAP

United Nations Economic and Social Commission for Asia and the Pacific

USD

United States Dollar

VGF

Viability Gap Funding

WB

World Bank

’00,00,000

Crore

’00,000

Lakh

`

Currency Equivalents

Conversion Factor 1 USD (US Dollars) = 45 INR (Indian National Rupees) Conversion Factor 1 USD (US Dollars) = 0.034 UF 1 (Unidad de Fomento) Conversion Factor 10 USD (US Dollars) = 1MXN (Mexican peso) Conversion Factor 1 USD (US Dollars) = 3 UDI 2 (Unidades De Inversion) All values are at historical value.

1 The Chilean UF (Unidad de Fomento) is a reference currency updated daily in relation to inflation, internal consumer prices, and currency fluctuations. Most long term contracts, mortgages, insurance premiums, house prices etc. are quoted in UF while the actual payments are made in Chilean pesos at the rate of the day. 2 The Mexican UDI is a inflation-adjusting reference currency used to price Investments and loans which is converted to pesos at the time of payment

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

1 Executive Summary

It is being increasingly recognised in India that lack of good quality infrastructure is a bottleneck that must be removed in order to maintain the growth rate shown by the country in the past two years. To achieve the targeted economic growth, there is an urgent need to increase the level of investments in infrastructure. Government estimates peg the total infrastructure investment requirement in the country at about USD320-350 billion over the next five years. Considering the high emphasis on using PPP as an important format for creation and maintenance of infrastructure and considering the realistic levels that PPPs can go upto, about 20% of the total (USD64 to 70 billion) is estimated to come from PPP route.

Though PPP infrastructure development in India is at a nascent stage, recent trends have been very encouraging. Our study has estimated that the total value of PPP infrastructure projects in India that have achieved financial close in the last ten years is about USD15.8 billion (in the study, sectors included are - all transport sectors, urban infrastructure, water & sanitation, power transmission and distribution). Hence, achieving the growth rate envisaged over next five years for investment from private players will definitely require a huge step-up approach to project development and implementation.

Sectoral Distribution of PPP Projects by Value (Total Value USD15.8 billion) Waste Water 0.1% Water
Sectoral Distribution of PPP Projects by Value
(Total Value USD15.8 billion)
Waste Water
0.1%
Water Supply
Solid Waste
2.3%
Management
Airports
0.4%
17.2%
Ports
20.5%
Power
Roads & Bridges
Distribution
53.7%
1.8%
Power
Transmission
Railways
2.3%
1.8%

The good sign is that the year on year the trend is increasing. In the last 3 years alone, PPP infrastructure projects worth USD 8.2 billion (93 in number) have achieved financial close as against USD 5.1 billion (131 in number) projects in the previous 8 years.

Many PPP projects are in Roads & Bridges sector. However, other sectors have also participated in PPP infrastructure growth except for urban infrastructure sector, where success of PPP is yet to be tested. Regionally West along with South dominates in development of PPP infrastructure (accounting for more than 75% by value and also number of projects).

Infrastructure financing not only in terms of amount but also in terms of the cost and terms at which the finance is available to private players is very critical. The study shows that PPP infrastructure projects have so far been largely financed by debt (68% of project costs, on an average). The

USD Billion

Trend in PPP Projects by Value

6.00

5.00

4.00

3.00

2.00

1.00

-

6.00 5.00 4.00 3.00 2.00 1.00 - 1995 1996 1997 1998 1999 2000 2001 2002 2003

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Year of Financial Close

Sources of Senior Debt (Total Value USD7.72 billion) Others 28%
Sources of Senior Debt
(Total Value USD7.72 billion)
Others
28%

Commercial

Banks

72%

Composition of Other Sources of Senior Debt

Insurance Companies Others IFCI 1.9% 5.5% 1.5% HUDCO 2.6% IL&FS 3.1% IIFCL SIDBI 34.4% 3.2%
Insurance
Companies
Others
IFCI
1.9%
5.5%
1.5%
HUDCO
2.6%
IL&FS
3.1%
IIFCL
SIDBI
34.4%
3.2%
ADB
IFC
3.7%
4.9%
IDBI
IDFC
17.3%
22.0%

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Average Tenure and Concession Period 16 Airports 30 13 Ports 28 12 Power Transmission 25
Average Tenure and Concession Period
16
Airports
30
13
Ports
28
12
Power Transmission
25
10
Railways
28
14
Roads & Bridges
23
5
Solid Waste
16
15
Water Supply
28
-
5
10
15
20
25
30
35
Number of Years
Average Concession Period
Average Tenure of Debt

contribution of equity has been 25% with remaining coming from subordinate debt- 3% and grant-4%.

Commercial banks are the major source of debt and constitutes 72% of all debts with other financial institutions such as IDFC, IIFCL, IDBI, IL&FS, etc. constituting the balance 28%. Interestingly, the tenor of term loan by banks is around 50% of concession period length (see charts overleaf).

Unlike the international markets that have a very high gearing, the typical gearing ratio in India is 70:30 though there is a clear trend towards increasing gearing ratios in recent projects, as also in the road sector which has moved the farthest in the PPP market. Commercial banks are comfortable lending to PPP projects despite having limited long term resources, but always with resets. The resets have shown a clear trend of becoming shorter and shorter in duration. In the absence of appropriate interest rate swaps in the market, project developers have limited choice. However, the survey reveals that when interest rates came down substantially, Developers have tried successfully to refinance their loans, particularly when the construction periods were over. This activity also mirrors what happens in the developed markets.

Internationally, banks that are active in the infrastructure PPP market have various options to manage their matching of long term lending with several products. Unlike international banks, which package and sell down their different debts to various types of buyers, the Indian banks do not have many options as yet.

From our survey and analysis of financing of PPP projects, other interesting observations on the debt side of funding are:

Relationship banking or promoters strength is the most important factor that influences lending to PPP projects. Driven by the fact that there is little history of operational PPP projects, banks ask for corporate and sometime personal guarantees from the developers.

Long term sources such as Insurance and Pension Funds are currently not going into PPP infrastructure, as they can invest in only in ‘AA’ rated instruments and there are no ‘AA’ rated instruments available from the SPVs of the PPP projects in the market as of now. Internationally, investment grade “BBB’ is the minimum rating requirement for Insurance and Pension Funds’ investment.

Bonds are not a popular source of funding at all in the PPP market. Apart from the absence of an active market, the developers surveyed also indicated that the cost of issuing and credit enhancement makes these costlier than the term loan from banks. Though not explicitly stated, higher level of disclosure is also a reason. Absence of monoline institutions in India, unlike in the international scenario, is also an important reason.

External Commercial Borrowings (ECBs) in the current scenario have become relatively less expensive and developers are looking at them favourably even with such loans having no option of long term forward cover or convertibility into rupee loan before their maturity. The ECB policies followed in the next few years will determine their contribution to financing of infrastructure projects.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Of the USD11.48 billion investments made in the last 12 years (in the surveyed 104 PPP

projects for which detailed financial information was obtained), the total equity was USD2.93 billion. Of this, the maximum equity (USD1.43 billion) has been funded in Roads & Bridges because of large number of projects being awarded on PPP basis in the last 3-4 years. On the Equity side, our survey reveals that majority of the equity, almost 82% is provided by developers themselves. Financial investors and other strategic sources are small. In a few cases, where the

SPV has been set up as a joint venture between Government and the Developers, Government has made their equity contribution, typically limited to 26% or less. Clearly, if this trend were to continue, there would be big issue on the volume of equity available from the developers when significant up-scaling of PPP activity takes place.

However, there are very significant developments taking place in the market wherein strategic investors in the form of PE funds are entering in. Though the volume of their investments in infrastructure PPP market has been small till now (under USD300 million in the year 2006), it is expected that this will go up very rapidly with recent entry announcements by both Indian and international PE players. Many PE firms are looking at the infrastructure sector favourable and Government too has supported the setting up of a USD5 billion fund to invest in PPP projects.

Our survey identified certain key equity side constraints in PPP infrastructure financing. For example, FDI cannot come into Holding Companies (typically created by Developers combining a few infrastructure projects) under automatic route thus requiring specific Government approvals (FIPB). This restrains holding company to raise capital outside India. Given the fact that the Government has removed most hurdles for FDI into infrastructure in the country, this still remains a road block for FDI into PPP infrastructure.

Also, a two tier structure of holding & SPV companies (again typical of Indian infrastructure developers) results in cascading effect of Dividend Distribution Tax. The two tier structure is important for attracting equity investors to the PPP infrastructure projects because there are

a number of exit restrictions to direct equity investments into SPVs as also the SPV’s existence is co-terminus to the concession period.

Sources of Pure Equity (Total value USD2.93 billion)

Strategic

Inverstors

6% Government 10% Financial Institution 2%
6%
Government
10%
Financial
Institution
2%

Developer

82%

Accepting the recommendations of the Patil Committee Report, the Government has already taken some steps to develop the Bond Market. Also, the Government is actively looking at the initial recommendations of the Parekh Committee to address several constraints identified. The role of an important financing institution (IIFCL) is being examined for playing the role of a monoline institution.

It is therefore, our suggestion that on all these issues, namely bond market development,

FDI into holding companies, cascading effect of dividend tax, and accessing insurance and pension funds, the Government should give preferential and liberal treatment as far as

infrastructure investments are concerned.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

2

Introduction

The Indian economy is going through its most remarkable phase of growth - with GDP growth rate at an average of 7.6% in the Tenth Plan Period (2002-03 to 2006-07) as compared to the average of 5.5% in the Ninth Plan Period (1997-98 to 2001-02). The Eleventh Five Year Plan projects an even higher average annual growth rate of 9%.

This rapid growth of the Indian economy has brought into focus the poor state of infrastructure in India. Congestion can be seen everywhere, be it roads, ports or airports and reports show that all sections of the Indian society, from the business community to the common man, feel constrained by the lack of adequate infrastructure. Their concern is highlighted in the approach paper to the 11 th plan, put out by the Government of India (GoI), which states that, “The most important constraint in achieving a faster growth of manufacturing is the fact that infrastructure, consisting of roads, railways, ports, airports, communication and electric power, is not up to the standards prevalent in our competitor countries. This must be substantially rectified within the next 5-10 years if our enterprises are to compete effectively.”

The message coming from all quarters is that the continuation of the growth momentum of India will require significant improvement in infrastructure. Several estimates have been made about the level of infrastructure requirement in the next five years required to sustain a growth rate of 9 percent. The most widely quoted of these estimates is a GoI estimate which projects that, during the 5 years of the 11 th plan period, USD 320 billion of infrastructure (in 2005-06 prices) will be required. The estimate also breaks down this requirement sector wise and projects that a majority of this investment will go in the power sector followed by railways and national highways.

In this report we deal with the likely challenges that will be encountered in financing of this infrastructure requirement. In recent times there have been several committees, individuals and interest groups that have given their recommendations on how to increase the level of financing for infrastructure projects. This report does not aim to replicate their work. Instead the focus of this report is on providing evidence based descriptions on the challenges of infrastructure financing- how infrastructure projects are being financed currently and the sufficiency of the existing means to finance future infrastructure requirements. In this report we present an extensive amount of primary data on the current situation in infrastructure financing, and this sets apart this report from others which mostly offer viewpoints of experts on the situation of infrastructure financing in India. In addition to the primary data we also present views from prominent stakeholders in the infrastructure sector on the challenges of financing infrastructure. Based on an understanding of the challenges we highlight our views on how infrastructure financing is going to evolve, especially in the near term. However, before we get into the analysis we need to clarify some important points/assumptions that we have made in the report.

2.1 Some Points/Assumptions to be Kept in Mind

Future Infrastructure requirement: As already stated earlier in the report, GoI estimates the level of infrastructure requirement in India in the next five years to be around USD 320 billion. However, it is difficult to determine the accuracy of this estimate.

This requirement is based on an estimate of infrastructure capacity expansion required in some chosen infrastructure sectors during the eleventh plan period. Projects chosen are mostly in the Central sector, for example in roads the estimate accounts explicitly for only National Highways and not for State Highways or Rural Roads. There is an ‘Other’ category which possibly encompasses infrastructure needs in the states and in sectors such as Special Economic Zones, telecommunication etc. However, estimating that only 17 percent of the USD 320 billion pie will go for these is definitely an underestimate. Also many estimates of infrastructure requirements even in the chosen sector are only preliminary and

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

the financing requirements for the infrastructure are just ballpark. It is therefore, difficult to know what the actual requirements will be.

However, at the same time many experts doubt that the Government will be able to implement USD 320 billion worth of projects even if financing was available. They point to the limited capacity of Government departments and agencies and question their ability to formulate such a large number of projects. Because of this lack of capacity, they claim that while USD 320 billion of financing need might be projected, the actual financing need will be significantly less. In this sense the USD 320 billion figure is an overestimate.

Because it is difficult to pinpoint the actual future infrastructure requirement we will take the figure of USD 320 billion for analysis in this report. While it is clearly not the right number it does show that the infrastructure financing requirement is very large and that significant improvements need to be made to infrastructure financing in India to meet this large demand.

Focus on Public Private Partnership: Infrastructure development in India has largely been in the Government domain. However, in recent years Government of India (GoI) and State Government(s) have been putting an increasing focus in involving the private sector in infrastructure creation under the public private partnership (PPP) framework 3 . Two commonly cited reasons for this are as follows:

1. Funding the infrastructure deficit: Given the large investment required for infrastructure development in India and the scarce Government resources, it is unlikely that public funds would be adequate to meet the needs in this context. In addition, the Fiscal Responsibility and Budget Management Act 4 and steps towards fiscal prudence adopted by both the Centre and State Governments have also contributed to the thought process of involving the private sector in the process of infrastructure development in the country.

2. Value addition: Apart from being an alternate source of finance, private sector participation is also viewed as a possible way of value addition in the various aspects of the value chain of infrastructure development including innovation, managerial efficiency in the project management process, adoption of better technology in key infrastructure areas etc.

PPPs are thus being seen as an important tool for producing an accelerated and larger pipeline of infrastructure investments, and catching up with the infrastructure deficit in the country.

In this report we will concern ourselves with the financing of infrastructure projects under the PPP framework. Government financing of infrastructure is done primarily from budgetary resources and public debt and Government provides guidance on its investments in many of its documents like the Union and State budgets, annual plans etc. In contrast PPP projects in India are not well documented and only very limited information is available on their financing in the public domain. Given that PPP projects are being looked at as an important means of meeting the infrastructure requirement in India we have focused this study on the financing of PPP infrastructure projects (in consultation with the GoI and World Bank).

Definition of Infrastructure: Infrastructure is defined differently by different reports/estimates and by different agencies. Currently there is no consensus on the sectors to be included in infrastructure. For example, the Economic Survey of India

3 GoI has specifically defined PPP in the “Scheme for financial support to Public Private Partnerships in Infrastructure” (also commonly known as Viability Gap Funding or VGF) as follows – “PPP means a project based on a contract or concession agreement between a Government or Statutory entity on the one side

and a private sector company on the other side for delivering an infrastructure service on payment of user charges.”
4

The FRBM bill, passed in August 2003, makes the government responsible for elimination of revenue deficit by 2008-09 and a fiscal deficit of 3 percent.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

published by the Reserve Bank of India includes “Storage Infrastructure” as a part of Infrastructure while it is not included as Infrastructure by most other agencies. Also most reports do not drill down to the sub-sectors which they include. For example while the Economic Survey includes inland waterways in its definition of transport sector some other agencies do not. Because of the diversity of definitions available we also need to clearly define the infrastructure sectors we will look at so as to not confuse the reader.

For defining Infrastructure for the purpose of this report we start with taking a comprehensive approach to the definition of infrastructure, basing it on as many relevant sectors as is done commonly by the Government agencies. However, for analysis in this report we have excluded some sectors as the focus of this report is on PPP infrastructure projects in particular and not on all infrastructure projects as in India PPP have not taken place in all infrastructure sectors and not all sectors are looked upon as equally amenable to PPP.

To come to our definition of PPP we developed some criteria and then subjected the infrastructure sectors to these criteria. Annexure 1 gives the details of the process we used for selecting PPP infrastructure sectors for the detailed study. Based on the process our definition of PPP infrastructure involves projects in the following:

1. Roads

2. Railways

3. Airports

4. Ports

5. Power including generation (to a limited extent), transmission and distribution

6. Urban water supply including treatment, transmission and distribution

7. Waste water including disposal and treatment

8. Solid waste management

These sectors include all prominent sectors highlighted by GoI in their estimation of the infrastructure financing requirement. Keeping the above points/assumptions as boundaries for this report the objectives of this study are described next.

2.2 Objective of the Study

The primary objectives of the study is to identify issues and constraints to Public Private Partnership (PPP) infrastructure financing which are foremost on the minds of market players/ stakeholders in the infrastructure financing market, and to elicit feedback to identify efforts required to ease the constraints. Specifically the objectives of the study are as follows:

1. To provide evidence-based descriptions of present financing sources for PPP infrastructure projects in India with an idea to specifically identify and assess financing constraints associated with such projects.

2. To analyse the financing of PPP in India in detail. The analysis will be used to identify:

Constraints to expanding the range of investors in infrastructure;

Constraints to financing faced by current investors; and

Financial innovations in India and abroad for infrastructure financing and their applicability in Indian context.

3. To identify changes required to reduce and ease the identified constraints.

To meet these objectives a detailed approach and methodology was developed and agreed upon in consultation with GoI and the World Bank. This approach and methodology is highlighted in Annexure 2. The key elements of our methodology are as follows:

1. We prepared a detailed list of PPP projects in the sectors chosen for the study.

2. We met key stakeholders including sponsoring agencies, project developers and financial institutions to obtain detailed information on the mode of financing of the chosen

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

projects. The data was then analyzed to bring out trends in Infrastructure financing in India. We also carried out detailed interviews with over 80 individuals representing the above institutions as well as some other developers, financial institutions, rating agencies and Government agencies. The interviews focussed on their perception of the issues with the current mode of PPP infrastructure financing and ways to ease the constraints.

The following sections detail out the objective listed above.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

3 Objective 1: Evidence Based Description of Present Financing Sources for PPP Infrastructure

PPP projects have begun to take off in the infrastructure sector in India. In the infrastructure sectors chosen for the study we estimated that as many as 231 projects have already achieved financial close with a combined value of USD 15.80 billion. We were able to get detailed financial information for 104 of these projects, which form nearly 45 percent of the total PPP projects by number, but with a total value of USD 11.48 billion form more than 72 percent of the total PPP projects by value. This indicates that we have been able to capture detailed financing information for most large PPP projects in our sample. We could not obtain information for all the projects as for many projects the stakeholders refused to share financing details citing confidentiality or commercial reasons. In spite of that our sample of 104 projects is large enough to highlight the trends in financing of PPP infrastructure projects. Even for projects where we were not able to obtain detailed financial information we did manage to obtain other project information. Exhibit 1 & Exhibit 2 below highlight our coverage. Annexure 3 highlights the coverage of our survey in greater detail.

Exhibit 1: Sample Size for Project Information Collection

 

Number

Value (USD billion)

Number

% of total

Value

% of total

Project Information*

231

100%

15.80

100%

Detailed Financing Information

104

45%

11.48

72%

Notes:

*Considered only those projects that have achieved Financial Close

 

*As agreed with World Bank during inception phase, we have not considered:

 

Urban projects less than USD1 million; cities less than 1 million population

 

Smaller road projects in states (below USD1 million) in MP, Maharashtra and Rajasthan (about 20 numbers.)

Select power distribution projects such as Noida, Ahmedabad and Mumbai; Real estate oriented projects such as Nandi Corridor (NICE), Mumbai Car Park, etc.

We have also made assumptions in a very small number of projects about project costs, financial closure, etc

Exhibit 2: Trends in Total 231 Projects and Sample of 104 Projects

USD Billion

6.00

5.00

4.00

3.00

2.00

1.00

-

Value of PPP Projects
Value of PPP Projects

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Year of Financial Close

Detailed Financial Information

All PPP Projects

Number of PPP Project

50 40 30 20 10 0 Number
50
40
30
20
10
0
Number

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Year of Finanacial Close

Project 50 40 30 20 10 0 Number 1995 1996 1997 1998 1999 2000 2001 2002
Detailed Financial Information All PPP Projects

Detailed Financial Information

All PPP Projects

If we look at the temporal trend of the PPP projects in India we find that PPP projects clearly show an increasing trend in the past 10 years with a sharp increase particularly in the last 3 years. Out of the total projects more than 93 PPP infrastructure projects have

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

achieved financial close in the last three years. This is as compared to a total of 131 projects in the previous 8 years 5 . If we look at a sector wise distribution, as can be seen from the graph below, road sector (especially National Highways) has seen the maximum activity in terms of the number of projects.

PPP Projects in India by Number (Total Number 224) 50 40 30 20 10 0
PPP Projects in India by Number
(Total Number 224)
50
40
30
20
10
0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Number

Year of Financial Close

Roads & BridgesRailways Solid Waste Management Ports Power Distribution Waste Water Airports Power Transmission Water Supply

RailwaysRoads & Bridges Solid Waste Management Ports Power Distribution Waste Water Airports Power Transmission Water Supply

Solid Waste ManagementRoads & Bridges Railways Ports Power Distribution Waste Water Airports Power Transmission Water Supply

PortsRoads & Bridges Railways Solid Waste Management Power Distribution Waste Water Airports Power Transmission Water Supply

Power DistributionRoads & Bridges Railways Solid Waste Management Ports Waste Water Airports Power Transmission Water Supply

Waste WaterRoads & Bridges Railways Solid Waste Management Ports Power Distribution Airports Power Transmission Water Supply

AirportsRoads & Bridges Railways Solid Waste Management Ports Power Distribution Waste Water Power Transmission Water Supply

Power TransmissionRoads & Bridges Railways Solid Waste Management Ports Power Distribution Waste Water Airports Water Supply

Water SupplyRoads & Bridges Railways Solid Waste Management Ports Power Distribution Waste Water Airports Power Transmission

In value terms we find that growth has been even steeper in the recent years. In 2006 projects worth USD 6 billion achieved financial close as compared to projects worth only USD1.8 billion in 2005. However, when looked at sector wise we find that road projects are not as dominant as they are by numbers. Roads sector which forms more than 81% of the total PPP project by number accounts for approximately 54% of the total projects by value (please refer to Exhibit 3). Even though the Port and Airport projects are fewer by number they are usually large by value and constitute 20.5% and 17.2% of the total PPP projects by value respectively.

PPP Projects in India by Value (Total Value USD13.32 billion)

6,000 5,000 4,000 3,000 2,000 1,000 - 1995 1996 1997 1998 1999 2000 2001 2002
6,000
5,000
4,000
3,000
2,000
1,000
-
1995 1996 1997
1998
1999 2000 2001 2002 2003 2004 2005 2006
USD Million

Year of Financial Close

Roads & BridgesRailways Solid Waste Management Ports Power Distribution Waste Water Airports Power Transmission Water Supply

RailwaysRoads & Bridges Solid Waste Management Ports Power Distribution Waste Water Airports Power Transmission Water Supply

Solid Waste ManagementRoads & Bridges Railways Ports Power Distribution Waste Water Airports Power Transmission Water Supply

PortsRoads & Bridges Railways Solid Waste Management Power Distribution Waste Water Airports Power Transmission Water Supply

Power DistributionRoads & Bridges Railways Solid Waste Management Ports Waste Water Airports Power Transmission Water Supply

Waste WaterRoads & Bridges Railways Solid Waste Management Ports Power Distribution Airports Power Transmission Water Supply

AirportsRoads & Bridges Railways Solid Waste Management Ports Power Distribution Waste Water Power Transmission Water Supply

Power TransmissionRoads & Bridges Railways Solid Waste Management Ports Power Distribution Waste Water Airports Water Supply

Water SupplyRoads & Bridges Railways Solid Waste Management Ports Power Distribution Waste Water Airports Power Transmission

5 Project achieving financial closure in the year 2007 (7 in number – 2 Airport, 5 Roads & Bridges) have been excluded in this trend analysis because the analysis cannot be done for the whole year in 2007. That is why in the graphs showing yearly trends the number of projects comes to 224 instead of 231 and the project value comes to USD 13.32 billion rather than USD15.8 billion.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Exhibit 3: PPP Projects in Different Sectors by Number and Value

Sectoral Distribution of PPP Projects by Value (Total Value USD15.8 billion) Waste Water 0.1% Water
Sectoral Distribution of PPP Projects by Value
(Total Value USD15.8 billion)
Waste Water
0.1%
Water Supply
Solid Waste
2.3%
Management
Airports
0.4%
17.2%
Ports
20.5%
Power
Roads & Bridges
Distribution
53.7%
1.8%
Power
Transmission
Railways
2.3%
1.8%

Sectoral Distribution of PPP Projects by Number (Total Number 231)

Water Supply

2% Airports Ports Solid Waste 2% 8% Power Management Distribution 2% 2% Railways 2% Roads
2%
Airports
Ports
Solid Waste
2%
8%
Power
Management
Distribution
2%
2%
Railways
2%
Roads & Bridges
82%

We also find that the number of projects awarded by Central Government agencies is only slightly higher than those of State projects. This bears testimony to the widespread acceptance of PPP projects in India. However, by value PPP projects awarded by Central agencies dominate over those in the states.

Exhibit 4: Trends in PPP Projects by Awarding Authority

PPP Projects Awarded by Centre/State by Number (Total Number 224)

60 50 40 30 State 20 10 Centre - 1995 1996 1997 1998 1999 2000
60
50
40
30
State
20
10
Centre
-
1995
1996
1997
1998
1999 2000 2001 2002 2003
Year of Financial Closure
2004
2005
2006
Number

PPP Projects Awarded by Centre/State by Value (Total Value USD13.32 billion)

6,000 5,000 4,000 3,000 2,000 State 1,000 Centre - 1995 1996 1997 1998 1999 2000
6,000
5,000
4,000
3,000
2,000
State
1,000
Centre
-
1995
1996
1997
1998
1999 2000 2001 2002
Year of Financial Closure
2003
2004
2005
2006
USD Million

If we look at the financing of these projects we find that PPP projects in India have been largely financed by plain vanilla debt 6 . On an average across all projects 68 percent of the project cost is usually financed by debt, 26 percent by promoter’s equity while only 2 percent comes from sub-debt. The remaining 4 percent of the project cost comes from Government grants of different kinds. The grants are mainly in the form of monetary support given by both the State and the Central Government to make the projects viable.

Exhibit 5: Overall Financial Structure of PPP projects in India

Financial Structuring of PPP Infrastrutcure Projects (Total Value USD11.48 billion) Grant Sub-Debt 4% 3% Equity
Financial Structuring of PPP Infrastrutcure Projects
(Total Value USD11.48 billion)
Grant
Sub-Debt
4%
3%
Equity
25%
Debt
68%

6 The analysis hereon is done for a sample of 104 projects for which we have detailed financing information.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

The institutions which dominate infrastructure financing in India are commercial banks. Out of a total debt financing done for PPP projects nearly 72 percent can be attributed to term loans from banks while other institutional lenders provide the rest. This is slightly higher than what is prevalent in the financing of infrastructure in developing countries overall, where World Bank estimates suggest that nearly 62 percent of the financing comes from this source.

Out of the debt financing of USD7.72 billion, 72% can be attributed to term loans from commercial banks. USD1.93 billion, which forms 28% of the total debt funding, is from sources other than banks. Players like IIFCL (34.4%), IDFC (22%) and IDBI 7 (17.3%) dominate in the funding from other sources.

Exhibit 6: Source of Senior Debt Funding

Sources of Senior Debt (Total Value USD7.72 billion) Others 28%
Sources of Senior Debt
(Total Value USD7.72 billion)
Others
28%

Commercial

Banks

72%

Composition of Other Sources of Senior Debt

Insurance

Companies Others IFCI 1.9% 5.5% 1.5% HUDCO 2.6% IL&FS 3.1% IIFCL SIDBI 34.4% 3.2% ADB
Companies
Others
IFCI
1.9%
5.5%
1.5%
HUDCO
2.6%
IL&FS
3.1%
IIFCL
SIDBI
34.4%
3.2%
ADB
IFC
3.7%
4.9%
IDBI
IDFC
17.3%
22.0%

Banks and other institutional lenders provide debt on a syndicated basis, especially for large projects. There are nearly 30 lenders which are active in the infrastructure financing market and participate in the lending syndications. However, only 6-7 of these play the role of lead banks in the syndicate and have the capacity to appraise projects. Others rely on the appraisal carried out by the lead bank for lending to projects.

Within commercial banks we find that a majority of the senior debt funding is done through public sector banks in India. The project database shows that public sector banks dominates with a share of 82 percent, while share of private sector banks and foreign banks are only 13% and 5% respectively 8 .

Exhibit 7: Sources of Debt by Sector and Share of Commercial Banks by Type

Sources of Debt by Sector

Water Supply Solid Waste Management Roads & Bridges Railways Power Transmission Ports Airports 0% 20%
Water Supply
Solid Waste Management
Roads & Bridges
Railways
Power Transmission
Ports
Airports
0%
20%
40%
60%
80%
100%

Commercial Banks

Institutions

Others

Share of Commercial Banks by Type (Value USD5.6 billion)

Foreign Bank 5% Private Sector Bank 13% Public Sector Bank 82%
Foreign Bank
5%
Private Sector
Bank
13%
Public Sector
Bank
82%

7 IDBI has become a bank only after the 2004 we have therefore,, considered it to be an institutional lender in this report 8 Lenders break-up into banks or institutional investors is only available for debt amounting to USD4.18 Billion

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Equity contribution in projects, the next highest means of financing a project comes mostly in the form of promoter’s equity. In the past year a number of private equity players have been showing keen interest in financing a portion of the equity. However, the difficulty in being able to take out equity from the project SPV has slowed down the extent of private equity deals in the sector.

The only financial innovation of any sort that has

taken place is the issuing of sub-debt to cover a portion of the equity. A unique aspect of the sub debt issue in India is that as much as 86 percent of the sub debt is lent from institutions which syndicate the issue of senior debt. If we look at the financial structuring of infrastructure projects over the years we find that the level of or senior debt has been increasing over the years while the level of equity has been going down 9 . What the trend demonstrates is that bankers seem to be getting more confident on the infrastructure projects. From 2004 we find an increased optimism for infrastructure projects with a drop in equity required below the commonly accepted 30 percent. In some projects, especially in the road sector, promoter equity even went below 10 percent. However, to compensate for the lower levels of equity banks often insist on sub debt to be taken by the promoter, with the level of sub debt going to as much

as 25 percent in some cases 10 .

Sub-Debt from Commercial Banks by Source & Value

Not Known

14%
14%

Lead

64%

Member

22%

Changes in Financial Structure Over the Year 80% 70% 60% 50% 40% 30% 20% 10%
Changes in Financial Structure Over the Year
80%
70%
60%
50%
40%
30%
20%
10%
0%
1995
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Senior Debt
Equity
Sub-Debt
Grant

Other key trends and analysis are presented in

9 The trend in 2000 and 2001 of relatively low debt levels and high equity levels is because of the closing of a few port projects during those years which had high levels of equity.

10 Some experts have raised the concern that developers are using grants from Government for reducing their equity contribution rather than reducing the debt component of the project. Annexure 8 highlights this issue in more detail.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

4 Objective 2: Analysis of the Financing of PPP in India

PPP projects in India are predominantly small in size (less than USD 50 million) by number of projects and these small projects are able to reach

financial closure without much difficulty (given that they are viable and carry reasonable levels of risk). However, there are also

a small number of large

PPP projects (project

size greater than USD

100 million), the financing

Size Wise Grouping of PPP Projects by Value and Number (Value USD15.8 billion, Number 231)

by Value 11% 20% 69% by Number 61% 18% 21% 0% 20% 40% 60% 80%
by Value
11%
20%
69%
by Number
61%
18%
21%
0%
20%
40%
60%
80%
100%
<USD 50 Million
USD 50-100 Million
>USD 100 Million

of which is significantly more complicated. As can be seen from the accompanying graph

while only 21 percent of the total PPP projects (or about 48 projects) are large projects, they account for nearly USD 11 billion in project size 11 . The average size of such large projects is approximately USD 230 million and financing each of such projects requires significant

coordination between markets players involved in infrastructure financing.

In this section we analyze in detail the present modalities and issues in infrastructure financing particularly bringing out issues in the financing of large projects. The discussion is divided in two parts- first we analyze the modalities and issues in the use of Debt to finance infrastructure and second we analyze the modalities and issues concerning the use of equity and sub debt in financing of infrastructure projects. A discussion on grants is also incorporated in this section, where appropriate.

4.1.1 Debt financing

On the debt side we present the current trends on the basis of detailed information on debt financing information for the 104 projects, as indicated earlier. We also present views

obtained from our interaction with the key financial institutions and developers. The value of total senior debt, for the 104 projects, aggregate to USD7.72 billion.

Box 1: Institutions Operating in Debt Financing of PPP Projects

The accompanying diagram gives a schematic representation of the types of institutions presently providing debt financing for PPP projects. As can be seen from the diagram PPP debt financing is dominated by commercial banks in India (the size of the circle depicts the size of lending to infrastructure). These banks offer mainly plain vanilla loans and sub debts where needed. However, as we will explore in detail later, the commercial banks are hampered by the lack of availability of long term finance as well as lack in providing innovative financial instruments.

The second group of institutions are DFI’s (development finance institutions) like IDBI, IDFC, HUDCO, PFC, and IL&FS etc. Some of them like IDFC have comparatively long term finance available from the Government and most of them were keen to introduce a portfolio of innovative financial products (like some initial use of take out financing by IDFC).

11 World Bank has estimated that 20 percent of the Infrastructure Financing requirement of USD 320 billion will come from PPP projects. This works out to a financing requirement of USD 64 billion for PPP infrastructure projects in the next 5 years. If the same trend in value and number of PPP projects continues in the future then it would be fair to assume that out of the USD 64 billion nearly 45 billion will come from a small number of large projects, financing of which will require significant financial innovation

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Availability of Long Term Finance

However, today their lending behaviour has become (for most purposes) not much different from commercial banks. They also are not prominent players as they lack size.

Finally there are bilateral and multilateral institutions. While they too have long term loans available and can offer innovative financial products (like political risk insurance, currency risk insurance etc.) their participation in lending to PPP projects is insignificant as of now.

High

Low

IDBI Commercial Banks IL&FS IDFC in the financing pie

IDBI

IDBI Commercial Banks IL&FS IDFC in the financing pie

Commercial

Banks

IDBI Commercial Banks IL&FS IDFC in the financing pie

IL&FS

IDBI Commercial Banks IL&FS IDFC in the financing pie

IDFC

in the financing pie

*Size of circle indicates relative size

Bilateral and Multilateral Institutions

Specialized Institutions -PFC, HDFC, HUDCO, Indian Railway Finance Corporation etc.

High

Use of Innovative Financial Instruments

The project database shows commercial banks to be the predominant source of long term debt. However, this has not always been so. Historically requirements of long term debt by industry were predominantly met from development finance institutions (DFI’s) promoted by the GoI. The financial sector reforms started in the 1990s allowed the private sector to raise long term finance from banks and international capital markets. At the same time it made DFIs unable to raise long-term resources at reasonable cost due to changes in the SLR requirements by banks and disqualification of investment by banks in DFI bonds to meet their SLR requirements. Since then banks have become the largest source of financing for long term debt, with some erstwhile DFI’s like ICICI and IDBI have also converted themselves into banks. This raises questions on the future role of DFIs in financing of infrastructure projects.

Bank lending to the infrastructure sector has grown rapidly over the last few years. However, the growth in lending to infrastructure is not unique. In fact it is concomitant with a sharp rise in non food credit provided by banks, with strong growth in credit off take being observed in both the corporate and retail segments (more detailed projections for the PPP infrastructure lending by commercial banks is presented in Annexure 5). Also infrastructure projects are not unique in the need for long term loan. Significant proportion of the credit demand for the long term exists in other sectors like real estate. This demand for long term loan from multiple sectors will eventually hamper the lending by commercial banks due to the issue of Asset Liability Mismatch. This issue is explored next.

Asset Liability Mismatch (ALM): Long term financing by banks exposes them to the risk of asset liability mismatch. The major source of fund for Indian banks is saving bank deposits and term deposits, the maturity profile of which ranges from less than 6 months to 5 years. Such deposits account for over 80 percent of the liabilities of Public Sector banks and around 73 percent for Private Sector banks. Lending long term with such a short term asset base exposes the banks to ALM risks.

One manifestation of ALM is in terms of liquidity risk. This is the risk that excessive long term lending growing faster than the growth in credit will result in banks failing to repay its short term depositors. As long as there is surplus liquidity in the banking system there is very little liquidity risk. This situation prevailed in the Indian banking system for a long time when the deposit growth was much higher than the credit off-take. However, in the past 2-3 years the situation has reversed, with credit off-take (including long term credit off-take) far exceeding

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

deposit growth. This has resulted in banks liquidating their statutory reserves with the RBI to fund the credit demand.

While this is unlikely to cause banks to fail in India, yet there are some worrying signs. Firstly there is a rapid reduction in excess Statutory Liquidity Ratio 12 (SLR) in the banking system. ICRA estimates that SLR has reduced to around USD 13 billion (Rs. 600 billion) as on March 2007 from over USD 55 billion (Rs. 2.5 trillion) as on March 2005 and around USD 26 billion (Rs. 1.2 trillion) as on March 2006. As a result the ability of the banks to repo these excess securities to meet liquidity pressures have reduced. Also by lending long term banks expose themselves to the risk of reduction in margins. To service liabilities and to meet credit demand banks need deposits. The scarcity of deposits in such a situation leads them to pay ever higher premium for them. In India this has been seen in the form of high interest rate time deposits being issued by banks to improve their liquidity situation.

RBI view on the ALM issue is that in the future banks role will have to be confined to supplementing long term lending rather than remain as the primary lenders. The development of other avenues for long term funding is important in the light of the fact that RBI is pushing the banks to become more stringent in lending long term. Internationally many banks avoid ALM by participating in infrastructure projects through bridge loans and mini perm loans during the riskier construction period of infrastructure projects. After the operations begin and the risks are lower then financing is sought from other less expensive long term lenders (like insurance firms) as well as from bond issues. In India the absence of such lenders makes such a situation difficult at present.

Another way in which International banks are able to manage their long term Asset Liability matching issue is selling down their loans in a variety of ways, sometimes packaging several project debts together, to buyers with different risk appetite. Typically these buyers include other banks, pension funds, insurance companies, other institutional investors etc. Since, the market is very liquid for such products, banks or the buyers of such products do not have major issue of asset-liability mismatches. The timing of such sell downs also range from immediate to few years depending on the risk profile of projects as well as the risk appetite of buyers.

Commercial banks in India are not able to meet their ALM mismatch in the same way. The market for such products is not liquid and hence not preferred by many investors. Banks can raise long term Bonds to provide long term debt to PPP projects. RBI through its annual Policy statement for the year 2004-05-issue of long-term Bonds by banks 13 has allowed for this. The circular allows banks to raise rupee denominated long term bonds to the tune of bank’s exposure to infrastructure projects with residual maturity of more than 5 years. However, the cost of these long term funds to banks and ultimately to the PPP project is high and there is not much demand for expensive credit. Some institutions/ banks like IDBI, ICICI, UTI, and IDFC etc have raised long term funds through bonds for lending long term. However, competition with commercial banks, who lend long term using cheap retail assets (cost of assets being less than 5 percent in some cases), forces even the more prudent banking institutions to price below what is necessarily prudent.

In addition, to ALM issues another issue with the present financing of the debt component of infrastructure projects relates to the short tenure of loans and the reset periods on offer.

Tenure and Reset Period of Infrastructure Loans: Presently the tenure of infrastructure loans is nearly half of the concession period. Our interviews with banks indicate that the short tenure is possibly given by the banks to give them enough time for restructuring the infrastructure asset in the event that something goes wrong with the project.

12 SLR is that amount which a bank has to maintain in the form of cash, gold or approved securities with the Reserve Bank of India (RBI). The quantum is specified as some percentage of the total demand and time liabilities of a bank. This percentage is fixed by RBI and the minimum stands at 25 percent at present. 13 Circular number RBI/2004/236-DBOD No. BP.BC. 90 /21.01.002/ 2003-04 dated June 11, 2004

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Average Tenure and Concession Period

Airports

Ports

Power Transmission

Railways

Roads & Bridges

Solid Waste

Water Supply

16 30 13 28 12 25 10 28 14 23 5 16 15 28 -
16
30
13
28
12
25
10
28
14
23
5
16
15
28
-
5
10
15
20
25
30
35

Number of Years

Average Concession Period Average Tenure of Debt

Average Concession Period

Average Concession Period Average Tenure of Debt

Average Tenure of Debt

As compared to India internationally the debt tenure is typically 80-90% of the concession period. For example, some of the PPP deals in the international market as presented in Exhibit 8 have average debt tenure to concession period ratio of 80%.

Exhibit 8: Loan Tenure to Concession Period Ratio for Ten PPP Projects in last Two Years

   

Year of

 

Debt

 

Debt

 

#

 

Project

Financial

Close

Concession

Period (years)

Amount

(million)

Currency

Tenure

(years)

Ratio

1.

Lancashire

Waste

Project

2007

29

320

Pound

25

86%

(UK)

2.

The Keppel Seghers Tuas Project (Waste to Energy Project – Singapore)

2006

25

105

US Dollar

23

92%

3.

The

Uijeongbu

light

rail

2006

30

132

Euro

18

60%

Project (Korea)

58

W

20

67%

 

51

W

23

77%

4.

Limerick

Tunnel

conduit

2006

36

258

Euro

34

94%

(Ireland)

 

5.

The

Brussels-North

2006

20

167

Euro

18

90%

Wastewater

Project

(Belgium)

100

Euro

19

95%

6.

Cyprus

Airports

Project

2006

25

542

Euro

19

76%

(Cyprus)

 

7.

Calle 30 (Madrid) Ring-road Project (Phase-1) (Spain)

2005

35

1350

Euro

30

86%

8.

Madrid's

flagship

ring-road

2005

35

1350

Euro

30

86%

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

 

project, Calle 30 (Spain)

   

1150

Euro

20

57%

9.

E18 Grimstad-Kristians and road project (Norway)

2006

35

399

Euro

28

80%

10.

Richmond Airport-Vancover

2005

35

600

(Canadian

25

71%

rapid

transit

project

Dollar)

(Canada)

 

Average

         

80%

Source: Project Finance Magazine various issues

However, it must be noted that in UK too PPP loans, in the initial years, were of shorter period when compared to concession lengths, the reason being little known history of performance of PPP projects. Even now real toll projects, where the traffic risk is borne by the project companies, have relatively smaller debt tenure to concession length ratios.

The significant issue with debt financing in India is that in addition to short tenure banks also ask for short resets and high Average Debt Service Cover Ratio (DSCR) from promoters. In our interviews banks have indicated that they prefer a 1.5 DSCR or more, except for (NHAI) annuity projects where they are willing to look at lower DSCR (near 1.2) due to lower risk on projected revenues.

Exhibit 9: DSCR Required by Banks

Minimum DSCR Desired by Banks

1.2-1.5 More than 1.5 24% 26%
1.2-1.5
More than 1.5
24%
26%

Around 1.5

50%

In mature markets like UK, the Average DSCR in PPP projects range from 1.05-1.1. However, banks attributed this difference to the lack of history of PPP projects in India which forces the banks to keep a higher margin for repayment. Another reason for a higher DSCR in India is because the traffic risk in the project is also factored in by banks.

Along with high DSCR requirements banks in India also push for short reset period in projects. Volatile interest rate regime 14 in India has been one of the factors that have led to

14 In order to assess the volatility we have analysed the four rates viz State Bank Advance Rate (SBAR), LIBOR, 5 Year Government Securities Rate & 10 Year Government Securities Rate. The accompanying exhibit shows a decline in average reset periods across years. From the point of view of projects short reset periods are potentially risk for infrastructure projects as an upward movement in rates can worsen project viability.

The volatility of the interest rate is also evident from the Standard Deviation of each of the above rates, presented in table below:

Benchmark Rates

Standard Deviation

SBAR

0.013

3

year G-Sec

0.024

5

Year G-Sec

0.025

10 Year G-Sec

0.026

Libor

0.019

Source- RBI, SBI, Moneycafe website

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

banks to become cautious on interest rates. The accompanying exhibit shows a decline in average reset periods across years. From the point of view of projects short reset periods

are potentially risk for infrastructure projects as an upward movement in rates can worsen

viability.

project

3.5

3.0

2.5

2.0

1.5

1.0

0.5

-

Average Reset Periods

3.0 3.0 2.7 2.6 2.0 2002 2003 2004 2005 2006 Year
3.0
3.0
2.7
2.6
2.0
2002
2003
2004
2005
2006
Year

The reset period for some of the recent projects have become yearly. Yearly reset periods are a way of passing the entire interest rate risk to the project. However, our interactions surprisingly showed that many developers actually preferred shorter resets. This is because the experience in India has been one of falling interest rates and projects being refinanced at a lower rate. Having said this we have not come across any project in our survey where there was an increase in interest rates because of the reset clause. The possible reason for this phenomenon is that in general the interest rates have been falling over the years of the survey and also that banks generally perceive a lower risk when the project construction period is over.

Post construction, when the majority of the risks have been covered, the developers frequently renegotiate the loan terms with the commercial banks to more favourable terms. However, in the present system renegotiations have to be carried out for individual projects which can be both time consuming and expensive. There is no availability of institutions which actively seek projects to take up on their own once the construction risk is over. (Annexure 8 presents some of the case studies and international examples on refinancing of PPP infrastructure projects)

One view that we commonly encountered during our interviews was that despite some obvious safeguards adopted by banks in lending to the infrastructure sector it was doubtful whether the banks were pricing all the risks correctly. Some market participants felt that commercial banks were showing a lot of exuberance in lending to infrastructure sector and in the process was ignoring several project risks during lending. They felt that the situation of not building in risks in the lending terms was not sustainable and a tightening of lending conditions as well as the implementation of the Basel II norms might result in a reduction in lending by banks to the sector. It is important to analyze this claim because one of the significant criticisms of infrastructure development in China has been that banks have lent without prudence thereby saddling them with huge levels of Non Performing Assets.

Risk pricing by banks: To test whether risks are being priced appropriately by commercial banks we decided to analyze the lending terms of one set of projects all belonging to one sector (in our case the road sector) but with differing risk profiles (Annexure 6 details out our

It can be seen above that 5 Year G-Sec and 10 Year G-Sec have been more volatile than LIBOR and SBAR. SBAR is much less volatile and because of that, State Bank of India, the leading infrastructure lender in the country, has now linked its interest rate to SBAR instead of G-Sec.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

methodology and findings). Based on our analysis we categorized our sample of projects into high risk, medium risk and low risk. We analyzed the average interest rate charged to an infrastructure project belonging to the three categories for the years 2002 and 2006 (where a large set of projects were available). Separate analysis was done for 2002 and 2006 because the interest rate charged differs across years due to the variation in the rate of government securities. The following results were obtained from the analysis:

Exhibit 10: Project Risk Category and Average Interest Rate

Financial Closure Year

Risk Category

Average Interest Rate

2002

Low Risk

12.00

Medium Risk

13.00

High Risk

10.00

2006

Low Risk

9.09

Medium Risk

9.39

High Risk

9.79

Note: Higher risk category number means higher project risk.

As can be seen from the table there does not seem to be any significant correlation between the level of risk in the project and the interest rate charge. It is easy to see why a perception can arise that risks are not being taken into account. However, that might not entirely be true.

Based on our data it is difficult to comment the level to which risks are taken into account. However, there does not seem to be any significant reason to believe that risks are not being taken into account during lending. Also the imminent implementation of the Basel II norms will require banks to become even more stringent on project lending.

A bigger cause of worry for lending by banks is that RBI exposure norms may constraint the lending to some developers by banks. RBI classifies infrastructure financing to SPV’s in India as forming part of the group exposure of the parent company. Beyond a certain point banks are not allowed to take further exposure to these companies. In the current situation large companies with varied interests are likely to hit the group exposure norms in the next 2-3 years preventing banks from lending to them. Institutions such as the IIFCL have been actively lobbying the RBI and Finance Ministry to do away with the group exposure norms for infrastructure. However, till now the RBI has stuck to not making any changes to the group exposure norms. But if no changes are made then companies will be forced to look at additional means of financing the debt component of the projects. This situation might become a driver for change in the project finance market as existing commercial banks will be forced slow down the growth in lending to the infrastructure sector. (Though is difficult to assess the lending capacity of banks given the limited amount of information available still an attempt has been made to assess the PPP lending capacity of banks. The detailed methodology and findings of the assessment are presented in Annexure 5).

The next section discusses the trends and issues in equity financing in India.

4.1.2 Equity Financing

In our interviews with key stakeholders we found repeated reference to one key issue- the amount of equity required to attract large volume of debt in the infrastructure sector is not available. The lack of adequate amounts of risk capital is leading promoters of large infrastructure projects to push for ever higher leverage from commercial banks. The commercial banks on their part have largely acquiesced to their demands realising that reaching financial closure would be difficult otherwise.

If we look at the numbers we find that Senior Debt to Pure Equity Ratio (DER) over the years for all sectors has increased has increased from 2.1 in the year 2002 to 4.3 in the year 2006.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Exhibit 11: Increased Gearing over the Years

Debt to Equity Ratio

(Senior Debt to Pure Equity)

5.0 4.3 4.5 4.0 3.5 3.0 2.6 2.3 2.5 2.1 2.0 2.0 1.5 1.0 0.5
5.0
4.3
4.5
4.0
3.5
3.0
2.6
2.3
2.5
2.1
2.0
2.0
1.5
1.0
0.5
-
2002
2003
2004
2005
2006
Year
Ratio

Also while we find that DER has increased across the board for all project sizes, the maximum increase has been in the case of large projects. This indirectly hints at the problem identified by stakeholders- large volumes of equity capital are not easily available.

Exhibit 12: DER by Size

Debt to Equity Ratio by Project Sizes

(Senior Debt to Pure Equity) 6.0 5.0 4.0 3.0 2.0 1.0 - 2002 2003 2004
(Senior Debt to Pure Equity)
6.0
5.0
4.0
3.0
2.0
1.0
-
2002
2003
2004
2005
2006
Year

<USD 50 Million

USD 50-100 Million

>USD 100 Million

As per our analysis, total equity infused in PPP infrastructure projects (sector wise) is USD2.93 billion by the Year 2006. The maximum equity (USD1.43 billion) has been brought in Roads & Bridges which is due to the large number of projects being awarded on PPP basis in the last 3-4 years. As can also be seen from the accompanying graphic nearly 80 percent of this equity at the SPV level is infused by the promoter’s themselves. This is because due to the lack of exit options at the SPV level, lock-in etc. very few equity providers are willing to participate at the SPV level. Annexure 7 explores the differences in equity infusion by strong and small developers and looks at the restrictions on equity dilution in concession and loan agreements. However, equity from other sources does come in at the Promoter company/Holding company level through IPOs, private placements etc.

Exhibit 13: Sources of Pure Equity

Value of Pure Equity for sectors (Total value USD2.93 billion)

Water Supply,

Solid Waste 102.3 Management, 7.8 Airports, 511.0 Roads & Ports, 648.3 Bridges, 1,429.5 Power Transmission,
Solid Waste
102.3
Management,
7.8
Airports, 511.0
Roads &
Ports, 648.3
Bridges,
1,429.5
Power
Transmission,
107.6
Railways,

119.8

Sources of Pure Equity (Total value USD2.93 billion)

Strategic

Inverstors

6% Government 10% Financial Institution 2%
6%
Government
10%
Financial
Institution
2%

Developer

82%

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

One major reason for the predominance of equity infusion by developers is that currently there are several restrictions on equity investments. The way rules are structured in India makes taking out of the equity by the developers very expensive. This issue is discussed in detail later in the report.

The ability of a developer to reduce their equity in the project is important so that it can recycle the equity into other projects. Equity can be shared at the beginning of the project or it can be sold off later in the project. However, in India many concession agreements do not allow the developer to sell off their equity in the project. Internationally it is common for financial investors to take over the project once the construction phase is over. This is because once the construction risk is over financial institutions are more adept at increasing the returns on the project equity as compared to a developer. The financial investor in turn hires a contractor/s to provide for O&M. In the Indian situation this can especially work as no developer really has the experience to claim that they adept at operating the assets in comparison to some one else. While some movement has been seen in this direction, with the new NHAI agreements allowing for more selling down of the equity, many concession agreements still do not even provide for such a possibility 15 . In the projects analyzed we have not seen financial investors become a part of the bidding consortium. However, the situation is slowly changing with IDFC, SREI and Macquarie showing some interest in infrastructure projects in India in recent times.

Despite these restrictions our data clearly shows that developers have been able to reduce the level of own equity invested in projects.

Exhibit 14: Sources of Equity

Source of Equity by Year

2006 77% 12% 11% 2005 56% 24% 20% 2004 61% 11% 29% 2003 73% 27%
2006
77%
12%
11%
2005
56%
24%
20%
2004
61%
11%
29%
2003
73%
27%
2002
86%
3%
11%
2001
84%
15%
1%
2000
92%
8%
0%
20%
40%
60%
80%
100%
Year

Developer Own Equity

Other Source of Equity

Sub-Debt

Source of Equity by Sector

3% Railways 40% 36% 21% Airports 65% 15% 20% 3% 2% Ports 90% 5% 2%
3%
Railways
40%
36%
21%
Airports
65%
15%
20%
3%
2%
Ports
90%
5%
2%
Roads & Bridges
76%
5%
17%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Developers
Financial Institution
Government
Strategic Inverstors
Sub-Debt

It can be seen that there has been substantial reduction in the percentage of equity provided from developer’s own source for three years after the year 2002. A sector wise analysis shows that equity funding by developers has been supplemented by Government equity as well as sub debt in Airports & Railways projects while developer’s equity has been supplemented primarily by sub debt in the Roads & Bridges projects. As can be seen, sub debt has emerged as the primary means by which developers reduce their equity infusion. The next section explores the role of this important mechanism in reducing equity.

4.1.3 Significance of Subordinated Debt

As mentioned above taking on sub debt has been an important avenue through which developers try to reduce their equity stake. Sub-debt infusion in infrastructure PPP projects since Year 1998 has been presented below-

15 In some Port Sector projects like in Pipava, Mundra etc. the original promoter has been able to exit.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Exhibit 15: Instances of Sub-Debt by Year and Sector

Instances and Value of Sub-Debt

(Total Value USD333 million) 25 139.0 20 93.3 15 10 48.0 44.3 5 3.1 3.1
(Total Value USD333 million)
25
139.0
20
93.3
15
10
48.0
44.3
5
3.1
3.1
2.2
0
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Year
Number of Instances

Sub-Debt Across Sectors by Value (Total Value USD333 million)

Solid Waste Ports Management Railways 4% 1% 9% Roads & Bridges 86%
Solid Waste
Ports
Management
Railways
4%
1%
9%
Roads &
Bridges
86%

It may also be noted that there has been an increasing trend in sub-debt since the Year 2004. It can also be seen above that since 1998 an amount of USD333 million has been infused as sub-debt, in PPP infrastructure projects. It is also important to mention that majority of sub-debt (86%) has come in Road & Bridges PPP projects which is a matured and more active sector now in terms of PPP initiative.

Our analysis of detailed financing information on the sample of 104 PPP projects reveals that against the popular perception, sub-debt is not limited to annuity projects in Roads & Bridges sector and only about 7% of projects having sub-debt are annuity projects.

Analysis of the data shows that most of the sub-debt has been provided by the senior lenders themselves. This clearly means that sub debt is not really considered as quasi equity, providing the lenders with the requisite amount of risk capital, but more as a way to assist developers in putting less equity in the projects. In return for ‘conserving’ the equity of the developers banks charge a higher rate of interest on the sub debt thereby improving the overall yield on the project debt. We also found that sub-debt arrangement becomes easy if the project IRR is comfortable and the developer is reputed.

In addition to sub debt we also found a limited number of strategic investors participating in a few PPP infrastructure projects. However, going forward their presence is likely to increase significantly.

4.1.4 Strategic Investors and their Investment in the Projects

Based on the survey information collected we found strategic investor in infrastructure sector in only 9 PPP projects. The exhibit below presents more details-

Exhibit 16: Strategic Investment by Sector

Sectors

No of project with strategic investor

Equity Infused (USD Million)

Ports

4

29.89

Airports

3

102.15

Water Supply

1

30.00

Railways

1

4.89

Total

9

166.93

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

It can be seen that a total of USD166.93 million has come as strategic investment in the PPP infrastructure projects and this investment is mainly in Ports & Airports sector. In addition to the lack of strategic investors there is also little Foreign Direct Investment in the infrastructure sector.

4.1.5 Summary of Major Issues on the Debt and Equity Side

We find that on the debt side the major lenders are commercial banks. Going forward relying on commercial banks as major lenders is precarious as banks are likely to be constrained in their future lending due to the issue of asset liability mismatch. Also banks have not been able to offer very long tenure loans and the reset period on these loans is very short. Finally the exposure norms may prevent banks from lending to large developers in India thereby stymieing the growth of PPP infrastructure in India.

On the equity side we find that promoter’s of PPP infrastructure projects have to put in most of the equity requirement of an infrastructure project. There is an acute shortage of equity with private developers and if the present trend continues then they will not be able to attract the requisite amount of debt for the projects. Use of sub debt has eased the equity requirement somewhat. However, restrictions on taking out of the equity by developers remain a cause for concern. Involvement of financial investors in bidding for infrastructure projects is also limited at present as is the involvement of strategic investors and international companies.

4.1.6 What is Happening in Infrastructure Financing in Other Countries?

With an understanding of what is happening in India it is important to compare it with how infrastructure projects are financed in other countries. This will help to highlight the gaps faced by the infrastructure financing market in India and will also point to what can be done about them, based on the experiences in other countries. This review is predominantly focussed on infrastructure project development in other developing Asian countries (especially China, Indonesia, Malaysia and Thailand where a majority of the private sector investment in infrastructure have taken place) as the situation in many of these countries is similar to the situation in India.

India is not unique in having a substantial infrastructure creation requirement. In fact as early as the ninth five year plan (over the period 1996-2000) China had projected an infrastructure requirement of nearly USD 305 billion, close to the infrastructure financing requirement being projected in India for the 11 th five year plan. And like India commercial banks have been the major source for financing this infrastructure requirement. The role of other financial institutions and capital markets has not been significant. It has also been seen that Chinese banks are also resorting to using the corporate finance model as opposed to project finance model for some infrastructure projects to bring in increased comfort.

As far as other Asian countries are concerned the infrastructure financing situation is also not much different from India. Before the Asian economic crisis there was a significant flow of foreign currency infrastructure financing, which was arranged by international banks. International bank participation was high in a lot of countries as banks followed international developers who participated significantly in developing infrastructure in these countries. The long term relationship between international banks and developers helped to give an additional sense of comfort in financing projects. Comfort was also got from various guarantees given by Governments to reduce the risk of the lenders. However, the experience of this first round of infrastructure development was bitter after the East Asian economic crisis hit. Some countries like Indonesia defaulted on the guarantees offered to project sponsors 16 as they were hit by devaluation of the local currency. It was also realized during the crisis that many projects had been financed on the basis of questionable viability

16 India (famously in the Dhabol case) too defaulted but it was not because of the East Asian crisis.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

and under pressure from the economic downturn a lot of the projects suffered. As infrastructure projects floundered in the wake of the crisis the increased risk perception led to a significant reduction in the flow of capital for infrastructure projects in these countries.

With international capital flows drying up there has been an increased reliance on domestic markets and commercial banks in many countries to provide the financing needed for infrastructure projects. Infrastructure sector in countries with high liquidity in the banking system have been able to tide the crisis as local commercial banks in these countries have started to take a lead in infrastructure financing. The major reason for reliance on the banking system has been that other avenues for financing are not significantly developed in these markets.

China has seen the consequences of excessive reliance on commercial banks to lend to the infrastructure sector. Chinese banks are saddled with very high levels of NPAs and as a consequence very low returns on average assets. The returns on average assets for Chinese banks are in the below .20 as compared to Indian banks where these returns range from just below 1 to significantly more than 1. Banks are surviving only because of the high levels of liquidity in the market and because the Chinese Government is strongly backing them.

Confidence of international lenders has also slowly been returning. However, in their second coming international banks have often been beaten by highly liquid local banks which have been able to out price international banks as well as shown willingness to take higher levels of risk while giving out plain vanilla products. International banks with higher financing cost as well as currency risks have not been able to offer the kind of products needed by the markets in these countries. Another issue for the lack of financing products from international banks has been that the attendant legal underpinning necessary for such transactions is either absent or not easily enforceable in many countries.

If we contrast the above with the situation prevailing in India we find that there are many similarities. Commercial banks lead infrastructure financing in India like elsewhere. Also like India most other developing countries lack alternative means of financing infrastructure. There are some countries like Chile and Malaysia which also have a strong corporate bond market which helps in raising infrastructure bonds. But even in these countries the tenure of the bonds is not significantly more than the tenure being offered by the banks to infrastructure projects in India.

As the Chinese example shows large involvement of the banks in financing infrastructure can lead to deterioration in bank finances. Thus if the health of the banking sector has to be maintained (or improved upon in light of Basel II guidelines) then alternatives to bank lending in infrastructure projects will need to be found.

Also, going forward, a large proportion of the infrastructure financing will be local currency based even though other countries have successfully implemented projects with external commercial borrowing. This is because in India the RBI fears that a significant rise in liquidity in the market will increase the inflation rate which it wants to keep in check. Also RBI is quite stringent on exchange risk management.

While it is imperative that other sources of infrastructure financing will need to be tapped in India there are very few successful templates that exist in the developing world for developing markets for such financing. As a consequence India will have to largely chart its own course on the matter taking cognizance of developments elsewhere. The aim of the reforms will have to be to ease the constraints that are faced in infrastructure financing. In the next section we discuss some of the changes required.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

5 Objective 3: To Identify Changes Required to Reduce and Ease the Identified Constraints

As discussed in the previous section, from a financing point of view there are several changes required to help ease the requirements of the infrastructure sector in the long run. Many of these issues are already recognized by the GoI and in particular the Ministry of Finance. It is important to understand that these changes, even if forthcoming, will not yield dramatic results. It is highly unlikely that the requirement of USD 320 billion will be financed if the constraints are removed as results of many of these changes will only be seen in their full force in the long run. That is why the changes required should be viewed at as forward looking activities which need to be rolled out to streamline the financing requirement in the future.

Changes are required both on the debt side and the equity side. On the debt side new sources of funds need to be developed to reduce the reliance of infrastructure financing on commercial bank lending. Also to continue the momentum of bank financing of infrastructure changes need to take place so that banks do not concentrate risks from long term lending. On the equity side as well new sources of equity need to be explored to ease the scarcity being faced by excessive reliance on promoter’s equity.

It is important to keep in mind that changes required should not be such that they compromise on risk assessment of projects or give out bad loans. India already has had experience with such lending by development finance institutions to the corporate sector. These institutions where saddled with large amounts of bad loans and fiscal imperatives post the reform in 90’s led to a fading away of many such institutions. Thus while infrastructure development is critical we assume that the Government will not take it up at the cost of prudence.

This section will highlight the areas where we feel changes are needed. It will also present some areas in which changes are already taking place. However, as already indicated at the beginning this report does not involve giving recommendations on the policy changes required as various other reports already describe them. Instead focus will be on detailing out the possibility for change in various areas and then leave it to the Ministry of Finance and other concerned stakeholders to decide on the exact path they want to follow to bring about changes.

5.1 New Areas to Focus on the Debt Side

On the debt side the major changes required are the introduction of new sources of financing to supplement bank lending to infrastructure projects and reducing the risk of bank lending to infrastructure. Large volumes of funds are locally available in India both with institutional investors as well as with the common public. Also funds can be accessed via external commercial borrowings. Development of the bond market, securitization, syndicated loans from international markets etc. are some of the ways of tapping the funds. In addition selling down of the infrastructure loans held by banks will help in maintaining the level of lending by banks. In this section we explore some of these issues in more detail.

5.1.1 Bonds as a Source of Fund

Bond market in India is one of the largest in the Asia and includes issuances by the Government (Central & State Governments), public sector undertakings, other Government bodies, financial institutions, banks and corporate. Despite there being a large number of players bond issuances are dominated by Central and State Governments through the issue of Government Securities (G-Sec). Current outstanding G-Secs are more than 25 percent of our GDP. In direct contrast the corporate bond market is not that well developed with a total bond issuance in 2005-06 of less than USD 20 billion. Also out of the total corporate bond

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

issuance more than 90 percent are privately placed with institutions because of the onerous legal and regulatory requirements for attracting retail investors. The market for corporate bonds are dominated by issues from financial institutions and bond issues by private sector companies is limited. The lack of development of corporate bond market is an issue of special concern as they are a strong alternative source for finding of infrastructure projects.

India has short history of infrastructure bond issuance by financial institutions. Many development finance institutions used to issue infrastructure bonds for retail investors which were made attractive by an option of saving taxes. However, these issues have become limited. ICICI, one of the largest issuers of infrastructure bonds, has turned into a bank and now has access to significantly cheaper funds from retail deposits. Therefore, it has almost ceased any new issues of infrastructure bonds as the cost of the issue works out to more than 9 percent. Some other financial institutions like IDBI and Rural Electricity Corporation continue to issue infrastructure bonds but the volumes are not large.

Internationally project bonds are a significant source of financing in a few countries such as Chile and Malaysia. Chile has a developed corporate bond market and most infrastructure projects (particularly road projects) involve the issue of wrapped bonds or bonds that are secured by an additional guarantee viz., monoline insurers. In Mexico there is some activity in the issue of wrapped bonds However, the market is still in a nascent stage of development with a promising future (as financial institutions are increasingly looking at Mexico as the next market to develop after slowing down of concessioning activity in Chile). Malaysia too has a strong infrastructure bond market which differs from the Chilean bond market in that the market is dominated by Government Linked Companies who act as the project sponsors or demand off takers. These institutions typically have implicit Government guarantee which reduces the risk perception for investors. Unlike Chile bonds are not wrapped in Malaysia with Malaysia lacking a monoline. Also while project bond market in Chile is dominated by international banks as book runners and international rating agencies and monolines the infrastructure bond market in Malaysia is almost completely controlled by local banks and rating agencies. A separate paper has been prepared for the analysis of bond market development in India and its comparison with the bond market in emerging economies like Chile, Mexico and Malaysia. The paper highlights the role of bond markets in emerging economies in more detail. Our analysis and experience from Chile, Mexico and Malaysia suggests that there are four areas of reform that would provide a boost for bond market development in India:

Improving market efficiency through strengthening trading, clearing and settlement systems for debt securities

Lowering the regulatory burden and cost of raising debt

Increasing institutional investor participation (insurance companies, pension funds and provident funds)

Credit enhancement/guarantee framework for the development of infrastructure bond market

The Finance Ministry in India has already accepted the recommendations of the Patil committee report on Corporate Bond Markets in India which goes a long way in discussing the issues related to development of corporate debt securities market. Many of these are also relevant for the infrastructure debt securities like development of a trading platform for bond and securitised instruments as well as lowering the reporting burden for issuing debt securities. Government has taken steps to implement the recommendations. BSE and NSE have already been mandated to develop the trading platform for debt instruments within the guidelines issued by SEBI (Reference SEBI Circular number SEBI/CFD/DIL/BOND/1/2006/12/12 dated December 12, 2006). The Securities Contracts (Regulation) Amendment Bill, 2007 has been passed by the parliament facilitating dematerialisation of PTCs and hence paving the way for their listing and online trading.

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

However, despite reforms infrastructure bond markets are unlikely to develop unless there is

a pool of large institutional investors willing to invest. Next we discuss the role that

insurance, pension and provident funds, large institutional investors in India, can play in the development of alternative means of financing.

5.1.2 Funding from Insurance, Pension and Provident Funds

Insurance, Pension and provident funds in India hold large volumes of long term funds. However, they have not been large scale players in the funding of infrastructure projects in the private sector.

Insurance sector in India was largely dominated by public sector insurance companies. The Government of India liberalised the insurance sector in March 2000 with the passage of the Insurance Regulatory and Development Authority (IRDA) Bill which resulted in a host of private insurance companies operating in both life and non-life segments. As on 31st March, 2006, total fund invested by insurance market (both life and non-life) in India was to the tune

of USD 97.7 Billion (please refer to Exhibit 17).

Exhibit 17: Investment by Life and Non-Life Insurer in Last Three Years (USD Million)

 

Insurer

 

Infrastructure/ Social Sector

 

Total

Financial Year Ended

           

(as on 31 st March)

 

2004

2005

2006

2004

2005

2006

Public Sector Life Fund - LIC

8,475.8

9,924.5

10,707.2

67,652.6

80,317.5

86,543.9

(A)

Private Sector Life Fund (B)

 

110.2

191.2

323.6

638.2

1,064.7

1,720.3

Total Life Fund (A+B)

 

8,586.0

10,115.8

11,030.8

68,290.9

81,382.2

88,264.1

Public Sector Non-Life Fund (C)

735.4

889.1

980.7

7,161.0

7,745.9

8,559.9

Private

Sector

Non-Life

Fund

64.6

86.3

126.4

411.2

567.9

847.3

(D)

Total Non-Life Fund (C+D)

800.1

975.5

1,107.1

7,572.2

8,313.8

9,407.2

GRAND TOTAL (A+B+C+D)

9,386.0

11,091.3

12,137.9

75,863.1

89,696.0

97,671.3

Percentage of Total

 

12.4%

12.4%

12.4%

     

Source: IRDA Annual reports

The major pension fund in India is the Employee Provident Fund Organisation (EPFO) which has a total investment of USD49.67 billion (as on 31 st March, 2006) and year on year fund collection of USD5.26 billion under different schemes.

Exhibit 18: Year on Year Fund Collection by EPFO

Financial Year Ended

FY 2003-04

FY 2004-05

Total Investment as on 31 st March 2006

FY 2005-06

Infrastructure Public-Private Partnership (PPP) Financing in India Draft Final Report September 2007

Provident Fund (USD Million)

2745.8

2870.7

3683.7

33,295

Pension Fund (USD Million)

1320.6

1447.1

1530.1

16,251

Deposit Linked Insurance Fund (USD Million)

39.0

42.6

49.0

122

Total (USD Million)

4105.3

4360.4

5262.8

49,668

Source- EPFO Website

Regulations mandate life insurance companies to keep invested a minimum of 15% of their fund in infrastructure or social sector and non-life insurance companies to keep invested minimum 10% of their fund in infrastructure or social sector. However, much of the investment by the insurance companies is in infrastructure created by the public sector and almost none in the private sector. This is because of a very high degree of risk averseness dictated largely by regulations.

Current regulations essentially prevent insurance and pension funds from participating in the bond market. Insurance funds are currently prohibited from investing in debt securities rated below ‘Very Strong’ i.e. AA. Most of the PPP infrastructure projects are implemented through SPV route. Hence, credit rating of a paper from a new company is unlikely to get AA or higher rating.

Internationally, insurance companies (Exhibit 19) do invest in securities rated below AA. On average 25% of the total investment by top ten insurance companies in the world is in securities rated A or BBB.

Exhibit 19: Investment by Insurance Companies in Rated Securities

 

Total

Life/

 

AA

 

BBB+

Non -

 

Investment

(USD billion)

General

Insurance

AAA

to

AA-

A+ to

A-

to

BBB-

Investment

Grade

Not

Assigned

Allianz

285

L.I & G.I

46%

18%

21%

5%

2%

9%

AIG

418

L.I & G.I

31%

27%

23%

14%

4%

1%

NYL

103

L.I