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FINANCING INFRASTRUCTURE
PROJECTS
OUTLINE
Private initiative
Project contracts
PRIVATE INITIATIVE
Private initiative in infrastructure projects can take many forms, ranging from
contracted operation of public utilities to full ownership, operation and
maintenance of these facilities
For a road project, the private sector may be invited simply to build the
facility, operate it during Concession Period and finally, at the end of the
concession period, transfer the facility back to the government (BOT) without
actually ever owning the same.
The dependence on debt is usually high and lenders generally lend on a nonrecourse basis. This means that project lenders would not have any fall-back on
the resources/assets of the sponsors if the SPV fails to meet debt servicing
obligations.
Project Contracts
Shareholders Agreement
EPC Contract
O & M Contract
Many argue that the essence of project finance is the web of contracts meant
to ensure that all parties work in concert for the success of the project, to
distribute risks efficiently, and to prevent the abuse of monopoly power.
This argument is valid but incomplete because it does not explain why a
project is handled as a separate company, why project parties participate in
the equity of the company, and why the project company relies heavily on
debt in the form of non-recourse financing and limited recourse financing
Fuel
Supplier
Sponsors/Other
Shareholders
O and M
Contractor
Project Lenders
State Electricity
Board (Offtaker)
State Government
The PPA establishes the conditions under which the SPV would sell power to
the SEB
The SEB guarantees a minimum offtake from the SPV or, if it fails to do, a
minimum payment
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Letter of credit
Escrow account
Irrevocable guarantee of the state government
Telecommunication Projects
In general, telecom projects incur cash losses in initial years and these need to
be funded. Unlike a power project which generates reasonably flat revenues
and profitability over its life, telecom projects, by virtue of their continued
implementation and increase in subscriber base demonstrate increases in
profitability over a period of time.
Competitive environment
In general, telecom projects incur cash losses in initial years and these
need to be funded. In determining a telecom projects cost, lenders
follow the concept of peak Negative Cash Flow Period, which
determines the maximum period over which the project requires
external cash infusion and the total external financing requirements
during the period.
Given the long gestation periods and the commercial risks, project
lenders in India have funded telecom projects on a lower debt-equity
ratio (DER) such as around 1:1
Due to their complex nature, infrastructure projects have historically been funded by
banks and financial institutions, SBI, IDFC, ICICI, IDBI, and PFC being the key
financiers.
In recent times, there has been an increasing interest from the capital markets in
financing equity requirements in well-structured infrastructure projects.
Banks have become more responsive and are now willing to lend upto tenors of 12
to 20 years.
There has been a fair amount of action in seaports in the last few years
The Government of India has recently approved five ultra- mega power projects to
come up in the private sector.
Telecom operators in the private sector have been funded by debt and equity, coming
in good measure from foreign sources.
Construction Risk
Operating Risk
Payment Risk
Regulatory Risk
Political Risk
What Is a PPP?
Broadly a PPP refers to a contractual partnership between the public and
private sector agencies in which the private sector is entrusted with the
task of providing infrastructure facilities and services that were
traditionally provided by the public sector. An example of a PPP is a toll
expressway project financed, constructed, and operated by a private
developer.
According to the Government of India, a PPP project is a project
based on a contract or concession agreement between a government or
statutory entity and a private sector company for delivering an
infrastructure service on payment of user charges. A private sector
company is a company in which 51 percent or more of equity is owned
and controlled by a private entity.
A stronger policy and regulatory framework has to be created, both at the centre
and the states. The US-India CEO forum has called for a policy and regulatory
framework that fosters efficiency and transparency in the bidding process,
ensures sanctity of contracts, encourages competition, promotes market-driven
tariffs, and separates regulatory and adjudication authorities.
The availability of long term equity and debt for PPPs has to be augmented
through suitable instruments and mechanisms.
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SUMMARY
While traditionally infrastructure projects in India were owned and managed by the
government undertaking, there is now a broad consensus that private sector
participation in this activity must be encouraged.
The key features of project finance which appears to be the principal arrangement
for private sector participation in infrastructure projects are as follows: (i) The
project is set up as a separate company which is granted a concession by the
government. (ii) The sponsor company which promotes the project usually takes a
substantial stake in the equity of the project and enjoys the overall responsibility
for running the project. (iii) The project company enters into comprehensive
contractual arrangements with various parties like contractors, suppliers, and
customers. (iv) The project company employs a high debt-equity ratio, with lenders
having no recourse or limited recourse to the sponsor company or to the
government in the event of default.
The key differentiating feature of project finance is the manner in which project
risks are allocated to various parties involved in the project. Through a
comprehensive web of contracts, every major risk inherent in the project is
allocated to the party/parties that is best able to assess and manage that risk.
The key project parties are project sponsors, project vehicle, project lenders, EPC
contractors, O & M contractor, and the government.
The main project contracts are : shareholders agreement, EPC contract, project
loan agreements, and O & M contract.
In the case of a power project, the power purchase agreement (PPA) establishes the
conditions under which the SPV would sell power to the SEB, the SEB guarantee
for a minimum takeoff, the payment and security mechanism, the formula for
computing tariffs, and the provision for termination.
Due to their complex nature, infrastructure projects have historically been funded
by banks and financial institutions. In recent times, there has been an increasing
interest from the capital markets in financing equity requirements in wellstructured infrastructure projects.
Broadly, a PPP refers to a contractual partnership between the public and private
sector agencies in which the private sector is entrusted with the task of providing
infrastructure facilities and services that were traditionally provided by the public.
To give impetus to PPPs in India, several initiatives have been taken. However, a
lot more needs to be done.