Financing Infrastructure Projects Through Public-Private Partnerships ...

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that are plaguing infrastructure finance in India. The recent improve ments such as infrastructure debt bonds, relaxed norms for external commercial borrowing ...
Financing Infrastructure Projects Through Public–Private Partnerships in India T. S. Ramakrishnan The 12th FYP spanning 2012 to 2017 has an ambitious infrastructure target of US$1 trillion, with the private sector contributing 50% (4). India would like to augment its infrastructure spending between 5% and 8% of its GDP during the 11th FYP period to between 8% and 11% of its GDP during the 12th FYP period (7). Achieving the targeted investment as per the 12th FYP period plan presents many challenges. The ability to finance infrastructure through the budget is limited, given the many other demands on budgetary resources, especially social sectors such as school education and primary and preventive health care. The solution to this imbroglio lies in private-sector participation, which not only provides the much needed capital, but also helps to lower costs and improve efficiencies in a competitive environment. This paper discusses types and characteristics of infrastructure finance; public–private partnership (PPP), its variants, and how it works in the Indian context; emerging trends in PPP for infrastructure development; and the issues in financing PPP projects in India. After highlighting the recent improvements that have occurred in infrastructure financing in India, the paper concludes by listing various financial reforms needed for PPP financing in India.

India has been suffering from a huge deficit in infrastructure facilities. The Indian government perceives the public–private partnership (PPP) model as the preferred mode to bridge this deficit and has initiated several measures in that regard. This paper discusses the basic aspects of PPP and how it works in India. Financing for infrastructure is one of the major issues. This paper explains various issues such as over­ dependence on commercial banks for debts; inadequate financing from infrastructure finance companies; issues in external commercial borrowing; nonavailability of mezzanine financing; partial availability of insurance, pension, and provident funds; and nonfinancing issues that are plaguing infrastructure finance in India. The recent improve­ ments such as infrastructure debt bonds, relaxed norms for external commercial borrowing, and reasonable exit options are also exam­ ined. The paper suggests various financial reforms that are needed for PPP financing in India such as tapping into savings, allowing foreign direct investment, increasing the cap on viability gap funding, allowing balloon payments, giving impetus for corporation bonds, and building infrastructure corpus.

India’s population is estimated to peak at 1,700 million in 2060 as per a United Nations study (1). With the liberalization of the economy, India’s average growth rate was about 7% to 8% between 2003–2004 and 2008–2009. Goldman Sachs predicts the per capita gross domestic product (GDP) growth rate to be in the 7.2% to 8.9% range between 2005 and 2050 (2). But weak infrastructure has been a key impediment to India’s growth. Poor infrastructure adds 3% to 6% to the Indian manufacturer’s cost of doing business (3). The World Economic Forum noted that India’s annual investments in infrastructure between 1998 and 2005 averaged just 4% of GDP. Although the country’s infrastructure investment doubled to 8% of GDP between 2004–2005 and 2009–2010, it was much less than the ambitious target of infrastructure forming 9% of GDP during the 11th Five Year Plan (FYP) period of 2007 to 2012 (4). Comparatively China spends about 20% of its GDP annually on infrastructure (5). Low levels of investment on infrastructure have rendered India’s physical infrastructure incompatible with the anticipated growth, adding to the production costs, denting productivity of capital, and eroding the competitiveness of its productive sectors (6). As a result, India has been, and is likely to remain in the foreseeable future, a supply-constrained economy.

Infrastructure Finance Types of Infrastructure Finance There are three principal types of finance for infrastructure service delivery: public finance, corporate finance, and project finance. Public finance consists of equity financing (seed capital) provided by the government through general budget reserves, earmarked reserves, self-raised funds (such as licensing fees), intergovernmental grants, and fiscal transfers in addition to debt finance. Debt financing is done through policy loans at concession rates, supplier credits, and fixed income securities in the form of tax-secured bonds and revenue bonds secured by project-related revenue streams. In some cases, public debt financing is guaranteed by governments either explicitly or implicitly (5). Corporate finance consists of corporations providing equity financing through retained earnings and shareholders’ equity. Debt financing comprises commercial bank borrowing; subordinated debt, which includes convertible debentures and preferred stocks; privately placed borrowing; and the issuance of fixed income securities. These securities can be short term (such as commercial paper) or of longer duration (such as corporate bonds) (5). Project finance essentially comprises investments from corporations, public sectors, and finance institutions such as the Infrastructure Development Finance Corporation (IDFC) and India Infrastructure Finance Company Limited (IIFCL) without sovereign guarantee. The revenue stream comes primarily from the tolling of

Public Systems Group, MSH 101, Indian Institute of Management, Vastrapur, Ahmedabad, Gujarat State, India. [email protected]. Transportation Research Record: Journal of the Transportation Research Board, No. 2450, Transportation Research Board of the National Academies, Washington, D.C., 2014, pp. 118–126. DOI: 10.3141/2450-15 118

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infrastructure projects. Project finance is made available mostly by project-specific companies (otherwise called the “project company”) with equity held by sponsors. Equity normally takes the form of sponsor investment in the share capital of the project company. Debt is fully secured through the revenue stream of the infrastructure project; this stream is assigned to lenders through security agreements with trustees. Debt financing is usually a combination of bank loans, sponsor loans, subordinated loans, suppliers’ credits, and bonds of the project company (5). Public finance projects cater to public goods, whereas the corporate and project finance projects cater to private and club goods. Characteristics of Infrastructure Finance Infrastructure projects differ significantly from manufacturing projects and the expansion and modernization of companies. Essentially, infrastructure financing has the following characteristics: 1. The gestation period of infrastructure finance varies between 5 and 20 years depending on the type of project. The life cycle can vary as well, between 10 to 50 years. Lending institutions do have great difficulty in managing asset–liability mismatches, which are essentially for a period of 5 to 10 years. 2. While there are exceptions, a mega-infrastructure project involving a PPP entails a huge investment. For example, the development of Hyderabad Metro Rail with a PPP cost rupees (Rs) 118 billion and had a concession period of 35 years. 3. The risks are high when large amounts are invested for long periods of time. Risks arise from a variety of factors, including demand uncertainty (as in transport projects), environmental transformations (working from home enabled by better information and communication technologies), technological obsolescence (in some industries such as telecommunications), and political and policyrelated uncertainties (the state administration unwilling to help in toll collection or cancelling toll charges altogether for political reasons). Flyvbjerg studied 210 transportation infrastructure projects across the globe (comprising 27 rail and 183 road projects) and found that for rail projects, the actual traffic was on average 39.5% lower than the forecast traffic. The average cost escalation for rail projects, bridges and tunnels, and roads was 44.7%, 33.8%, and 20.4%, respectively (8). 4. High pricing could lead to less patronage from users and may not contribute to the economy as much as was expected. Returns here need to be measured in real terms because often the project’s revenue streams are a function of the underlying rate of inflation (5). For example, the financial internal rate of return of the Thiruvananthapuram–Ernakulam High Speed Rail project was estimated to be 2.21% (9). Moreover, a higher return from the project in the initial years of operation reduced lenders’ risk. Public–Private Partnership Origin of PPP and Its Variants Historically, the government has been developing the infrastructure, but the large and widening gap between infrastructure needs and the resources available created artificial scarcity in accessing goodquality infrastructure facilities. This issue resulted in congested roads and bridges, long waits for telephone connections, poor mass transport systems, interrupted power supply, lack of hospitals and

educational institutions, inadequate waste treatment facilities, and so on. These problems, in turn, impose huge costs on society, lower productivity, reduced competitiveness, and more accidents. The then–finance minister of India highlighted in his 2004–2005 budget speech that the most glaring deficit in India was the infrastructure deficit. In the 11th FYP, the Planning Commission recognized that the total resources required to meet the deficit in infrastructure exceeded the capacity of the public sector. It was therefore necessary to attract private investment to meet the overall investment requirements. Although the PPP has gained ground since then, it is still confined to a few sectors such as telecom, ports, airports, and roads (10) The United Kingdom pioneered the PPP model. Through its Private Finance Initiative, the UK government used partnership models to develop infrastructure facilities (11). Private Finance Initiative projects in 2004 represented between 10% and 13% of all UK investment in public infrastructure, a sea change from a little more than 10 years ago when PPPs were barely a blip on the radar screen (12). The world emulated the United Kingdom. Privatesector financing, design, construction, and operation of infrastructure emerged as one of the most important models governments used to close the infrastructure gap. An umbrella definition of PPPs in India defines a PPP as an arrangement between a government or statutory entity or government-owned entity on one side and a private-sector entity on the other for the provision of public assets, related services, or both for the public benefit, through investments being made by management or undertaken by the private-sector entity or both for a specified time period; there is substantial risk sharing with the private sector and the private sector receives performance-linked payments that conform to specified, predetermined, and measurable performance standards (13). Compared with traditional procurement models, a greater role is assumed by the private sector in the planning, financing, design, construction, operation, and maintenance of public facilities. Some of the most common PPP models as evidenced in a Deloitte research study are as follows (12): 1. Build–transfer or design–build. Under this model, the government contracts with a private partner to design and build a facility in accordance with the requirements set by the government. On completion, the government assumes responsibility for operating and maintaining the facility. 2. Build–lease–transfer. The completed facility is leased to the private-sector entity. The asset is transferred to the public-sector entity at no additional cost after the lease period. The publicsector entity retains responsibility for operations during the lease period. 3. Build–transfer–operate or design–build–operate. Under this model, the private partner designs and builds and operates the facility for a specified period. However, once the facility is completed, the title for the new facility is transferred to the public-sector entity. 4. Build–operate–transfer or design–build–operate–maintain. This model combines the responsibilities of build–transfer with those of facility operations and maintenance by a private-sector partner only for a specified period. At the end of the period, the public-sector entity assumes operating responsibility. 5. Build–own–operate–transfer. Here the government grants the private partner a franchise to finance, design, build, and operate a facility for a specific period of time. Ownership of the facility goes back to the public-sector entity at the end of that period.

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6. Build–own–operate. In this model, the government grants the private-sector entity the right to finance, design, build, operate, and maintain a project, as well as ownership of the project. 7. Design–build–finance–operate–maintain. Under this model, the private-sector entity designs, builds, finances, operates, and/or maintains a new facility under a long-term lease. At the end of the lease term, the facility is transferred to the public-sector entity.

controlling fiscal deficit as enumerated in the Fiscal Responsibility and Budget Management Act, 2003. 6. Unleashing of entrepreneurial energy. Countries in transition have an enormous entrepreneurial energy that has been untapped for a long time. The synergy between the user and provider of infrastructure services would spur the economic development of the country.

The same study indicated the following PPP models for existing services and facilities (12):

How PPPs Work in India

1. Lease. The government grants a private entity a leasehold interest in an asset. The private partner operates and maintains the asset in accordance with the terms of the lease. 2. Concession. The government grants the private entity exclusive rights to provide, operate, and maintain an asset over a long period in accordance with performance requirements set out by the government. The public-sector entity retains ownership of the asset, but the private operator has ownership over any improvements made during the concession period. 3. Divestiture. The government transfers all or part of an asset to the private-sector entity. Generally, the government includes certain conditions on the sale to require that the asset be improved and services provided.

PPP—Preferred Mode of Financing The private sector in the PPP model assumes a greater role in planning, financing, designing, constructing, operating, and maintaining public facilities. Project risk is transferred to the party best positioned to manage the same. PPP projects have been found to be sources of various efficiencies. Some of them are listed below. 1. Reduced cost overrun. PPP projects are less expensive compared with projects implemented under engineering procurement and construction as there is an incentive for the concessionaire to use cost-effective measures in implementation. 2. Reduced economic distortion. “User has to pay and polluter also has to pay” has been gaining ground throughout the world. If infrastructure services are retained as public goods (with nonrivalry and nonexcludability clauses applicable), people who do not use the services pay as much as those who use them. PPP enables the concessionaire to collect charges only from the users, thereby eliminating distortion. 3. Production and allocation efficiency. Resources for a specific application can be used more effectively. The construction and operation of infrastructure may be completed in less time, with lower overall cost, or both by using market-tested techniques and incentives for innovation. Since users pay for the services they seek, the most deserved infrastructure projects are allocated over other projects. 4. Economic and social efficiency. Access to more capital allows more projects to be funded on a fixed capital budget. Social benefits accrue faster as infrastructure is built sooner (the concessionaire has an incentive to finish the project well before the scheduled date and commission it for revenue generation). Improved quality of life results from increased access to infrastructure. 5. Fiscal prudence. With limited resources at their disposal, governments have the tendency to ignore fiscal deficit concerns. A larger share of PPPs in infrastructure development would help in

The Indian government has now endeavored to create a facilitating environment for large-scale involvement of the private sector (either fully or in part) in developing infrastructure. PPP projects are based on concession agreements between the developer and the government as has been done for toll roads, ports, and airports. Purely private-sector projects are market based such as in telephony and merchant power stations. The benefits of PPP do not accrue to the system unless governments enhance their capacity to execute and manage PPPs. Governments need to develop the proper framework and instruments and play a proactive role in addressing issues arising in the PPP model. The transition from the traditional procurement model to PPPs involves a change in procedural formalities, perceptions, and also mind-set. PPPs would be more acceptable if they are seen as a way of attracting private investment into public projects transparently and fairly with the objective of enhancing the welfare of all stakeholders concerned. In the past decade, the government of India has taken a number of initiatives and measures in that regard. Some of them are discussed below. The information on these initiatives has been sourced from the compendium of PPP projects in infrastructure and the midterm appraisal of the 11th FYP (14, 15).

Constitution of the Committee on Infrastructure The Committee on Infrastructure was constituted on August 31, 2004, under the chairmanship of the Prime Minister and renamed the Cabinet Committee on Infrastructure (CCI) in 2009 (16). CCI’s agenda is to initiate policies that ensure the time-bound creation of world-class infrastructure, develop structures that would maximize the role of PPPs and monitor the progress of key projects. CCI has also initiated institutional, regulatory, and procedural reforms (14).

Constitution of Public–Private Partnership Appraisal Committee The Public–Private Partnership Appraisal Committee (PPPAC) was constituted in 2005 to thoroughly scrutinize and perform due diligence in the formulation, appraisal, and approval of PPP projects. Only those PPP project proposals costing Rs 1,000 million and above received from ministries and departments are considered for approval by PPPAC (17).

Introducing Viability Gap Funding The viability gap funding (VGF) scheme (announced in 2006) aimed at improving the financial viability of competitively bid infrastructure projects that were economically and otherwise justified but whose

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financial returns were below the standard threshold. Under VGF, the central government provides grant assistance of up to 20% of capital costs to PPP projects undertaken by a government authority. The sponsoring authority could provide an additional grant of up to 20% of project costs during the operation period. For national highway projects, the National Highways Authority of India provides the entire VGF from the excess revenues transferred to it by the central government. The VGF support for each project is determined through competitive bidding. The bidder with the lowest VGF quote would be eligible to be awarded the project, provided other requirements were satisfied.

Empowered Committee–Empowered Institution An interministerial empowered committee–empowered institution was established for appraising and approving projects for availing the VGF grant for PPP projects. To ensure that the process of granting VGF is not vitiated and the fund is not misused by the concessionaire, the VGF is released to the lead financial institution that funds the concessionaire (18).

Setting Up of India Infrastructure Finance Company Limited Private players executing infrastructure projects through the PPP mode had limited access to debt funds of longer maturity periods because of the high cost of such debt and because benchmark rates for raising long-term debt from the market were also absent (19). IIFCL was therefore set up in 2006 as a nonbanking company to provide long-term loans to finance infrastructure projects with long gestation periods. IIFCL provides financial assistance of up to 20% of the project costs by direct lending and also by refinance. Half of this lending can be as subordinated debt (serving as quasi equity).

India Infrastructure Project Development Fund Although the cost of a PPP project is borne by the concessionaire (except in the case of VGF), the preliminary work in the form of advisory services, such as preparation of project agreements, structuring of projects, development expenses, and cost of engaging consultants, requires funding. Ministry of Finance, Government of India created an India Infrastructure Project Development Fund to provide loans for such purposes (14).

and transparently and in a nonarbitrary manner. The model concession agreements published by the planning commission for various sectors provide this framework (14).

Emerging Trends in PPP for Infrastructure Development PPPs are increasingly becoming the preferred mode for construction and operation of commercially viable infrastructure projects. But there are many areas in which the PPP model has not been ventured so far in India, sectors such as schooling, health care, irrigation schemes, and upgrading and maintenance of water bodies. Countries and states within countries remain at different stages of understanding and deployment of the PPP. Despite having established a comprehensive framework for PPPs and 15 years of experience, India remains in the first stage of the PPP market maturity curve (12). Governments that have not gone for large-scale PPP projects for schools, hospitals, and defense facilities can learn from countries such as the United Kingdom. Some of the mistakes often made in the earlier stages of the maturity curve, such as the tendency to apply a standard model for all infrastructure projects, can be avoided. Through the development of a strong, broad-based framework in regard to establishments (such as CCI, PPPAC, and an empowered committee–empowered institution), clear-cut procedures and documents (such as model concession agreements), and financial institutions and funds (such as India Infrastructure Project Development Fund and IIFCL), India is about to enter the second stage of the PPP maturity curve. Countries in Stage 2 of the PPP market maturity curve establish dedicated PPP units in agencies and begin developing new hybrid delivery models. In this stage, the PPP market gains depth and expands to multiple projects and sectors. Countries also leverage new sources of funds from capital markets. Countries in Stage 3 of the PPP market maturity curve refine, innovate, and use more sophisticated risk models with increased focus on the life cycle of the projects. An advanced infrastructure market is developed with the participation of pension funds, provident funds, insurance funds, and private equity funds (12). India has yet to see those advances take place.

Issues in Financing for PPP Projects in India

Framework and Model Documents

Inadequate Funding from Infrastructure Finance Companies

In PPP projects, the government essentially transferred its authority of providing public goods to the concessionaire for a specific period called the concession period. This approach typically involved the transfer or lease of public assets, delegation of governmental authority for the recovery of user charges, operation or control or both of public utilities and services in a monopolistic environment, and the sharing of risk and contingent liability by the government. The project agreement terms and the bidding process for awarding concessions were usually complex because many stakeholders were involved. Standard documents streamline and expedite decision making and ensure that the entire process is conducted fairly

There are still many unresolved issues in financing private players in the PPP model. Nearly 70% of the resource requirements of the private sector are funded by borrowing. But the debt component of the total investment during the 11th FYP was about 48.1%. To bridge that gap, it is necessary to enhance the availability of bank credit (5). Although the IDFC and the IIFCL are meant to provide long-term debt for the infrastructure development, they are deemed insufficient to meet the growing debt needs of the sector. For instance, the lending from IIFCL is restricted to 30% of the total project debt, leaving the concessionaire to seek 70% of the total project debt from commercial banks (20).

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Asset–Liability Mismatch and Overdependence on Commercial Banking Credit to the infrastructure sector by the commercial banks increased from 13% of their total credit in 2000 to 33% in 2009 (5). The essential issue in debt finance for infrastructure is the asset–liability mismatch as infrastructure debt funds are given primarily for longgestation projects. This issue affects the private developer too. Faced with the short payback period and long gestation period of the project, the developer passes on the burden to the end user. Some regulatory issues in borrowing from banks and financial institutions also need to be looked at. Banks cannot provide longterm finance funding, given the fact that their funding is through short-term deposits. This mismatch poses in part liquidity risk, as well as interest rate risk. Lending on a floating rate basis can mitigate the interest rate risk for the bank, but the concessionaire would not be in a position to gauge the financial viability of the project in the long run. Further, the expertise of banks and financial institutions in the credit appraisal of such projects is limited. It is also not advisable to rely on commercial banks for the entire debt component. The solution lies in tapping diverse sources of debt funding. Also the banks’ debt schemes need to be attuned to the requirements of the infrastructure sector as much as the agriculture and manufacturing sector. Moreover, it is an accepted practice throughout the world that long-term liabilities are to be used to finance long-term assets, thereby eliminating the asset–liability mismatch. To hedge risks effectively, which is inherent in long-gestation infrastructure projects, derivative markets are essential. But derivative markets are yet to grow in India.

Issues in External Commercial Borrowing The existing guidelines do not permit domestic financial intermediaries to refinance existing rupee loans from external sources although the demand for the same exists. The refinancing of existing rupee loans through external commercial borrowing, if permitted for infrastructure projects, could benefit foreign investors who might invest during the postconstruction (less risky) period of the project. This approach would help lenders who would prefer to have their loans refinanced to enhance their assets portfolio, and it gives scope for the concessionaires to generate funding from a greater diversity of sources (5). But, there is a flip side. Exchange rate differentials are crucial to external commercial borrowing and are to be accounted for in the total interest rate (21). If exchange rate differentials are unhedged, refinancing through external commercial borrowing may even result in the interest rates being higher than the expected return on equity. For instance, the exchange rate of Indian rupee (INR) per 1US$ remained stable at about Rs 45 between 2004 and 2007 and between 2009 and 2011. But, the exchange rate increased to Rs 62 per 1US$ in 2013. Foreign exchange hedging is available only for a period of 8 years. Investments through external commercial borrowing cannot be hedged effectively for foreign exchange fluctuations beyond 8 years (22).

Lack of Mezzanine Financing for Infrastructure Projects Mezzanine financing (quasi-equity funding) is still in the nascent stage in India. Mezzanine financing allows the financing company

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to convert the loan into equity in the case of delays in loan repayment. The interest rate of a mezzanine loan is somewhat higher than the loans of a senior lender. Given the debt–equity ratio of 70:30 across PPP projects, the concessionaire may be accused of implementing the project by leveraging loans. Mezzanine financing may check this trend and make the concessionaire more accountable. Some private equity firms in India have forayed into mezzanine financing. Long-term lending financial institutions such as IDFC and IIFCL may provide mezzanine financing.

Use of Insurance Funds and Pension and Provident Funds for Infrastructure Projects It is mandatory for life insurance companies to invest at least 15% of their life fund in infrastructure and housing. Only 10% of assets under management were invested to fund infrastructure development in 2011–2012 (22). This percentage shows that insurance companies have not contributed as much as they should in the infrastructure financing domain. At present because of the conservative outlook on pension fund usage, it has not been used in infrastructure financing. But efforts are on to bring pension and provident funds into infrastructure financing.

Other Issues Affecting Infrastructure Financing A project’s failure to be completed as scheduled poses serious problems to all other stakeholders, the concessionaire, financial institutions, the project authority, and the government. The delay in land acquisitions and environment clearance, aberrations and delay in policy making resulting in policy paralysis, and the lack of quick redress mechanisms make the financial calculations go awry as a result of the delayed project planning and execution. It does not benefit the stakeholders and results in high cost of services for end users. Construction cost increases with delay, jeopardizing the return on investment. Delay in the commercial operations date (COD) would delay revenues from the user for the concessionaire, thereby affecting the cash flow and the ability of the concessionaire to repay the loan, thereby rendering the originally financially viable project unviable.

Recent Improvements in Infrastructure Financing in India Some measures introduced by the government in the recent past for better infrastructure financing are discussed in the following.

Takeout Financing and Infrastructure Debt Fund Commercial banks are not in a position to finance PPP infrastructure projects whose repayment period extends between 15 and 20 years because of the asset–liability mismatch. If commercial banks are allowed to transfer the loan after a period of 5 to 6 years, which normally coincides with the construction period of the project, to another financial institution, the asset–liability mismatch could be overcome. This approach is called takeout financing. The loan is transferred from the books of the financing bank within the predetermined period (say, 1 year from the COD) to another financial

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institution (second lender), ensuring that the project receives longterm financing by more than one lender. The first lender receives the payment from the second lender. To make takeout financing possible, the Deepak Parekh Committee proposed the Infrastructure Debt Fund (IDF) to raise funds amounting to Rs 500 billion (US$11 billion), and subsequently in 2011 the government of India announced the IDF (20). The framework allowed the IDF to be set up by one or more sponsors; they could be commercial banks, nonbanking financial companies, investment banks, or multilateral agencies. The sponsors have to invest at least 10% of the total fund. To facilitate offshore investors, the withholding tax was reduced to 5% from 20% on interest payments on IDF borrowing. For domestic investors, an investment of up to Rs 20,000 in these bonds was eligible for an income tax deduction, for which they would obtain about a 7.5% to 8.25% interest rate, either annually or cumulatively. The tenure of IDF bonds was 10 years with a minimum lock-in period of 5 years (23). In general, IDF earns about 10% more than the interest rate paid by IDF to its investors. After operating costs are deducted, the balance is kept as a corpus to meet any liabilities arising out of nonperforming assets. IDF bonds are not project specific, and IDF pools all the bonds while lending to project companies. IDF was restricted to PPP projects that have completed 1 year of commercial operations. Given the fact that it takes about 4 to 6 years for a PPP project (such as a road) to begin its commercial operation, the funding by IDF 1 year after the COD would save commercial banks from the asset–liability mismatch problem as the debt can be moved to IDF from commercial banks 1 year after the COD (20). Many financial institutions have introduced IDF bonds from 2011. In 2011–2012, the first year of rollout, Rs 30,000 was raised; in 2012–2013 it was about Rs 25,000 and is targeted at Rs 500 billion for 2013–2014 (24). But, Rs 500 billion is too little for India when compared with the total infrastructure investment of US$1 trillion that is the goal for the 12th FYP.

Funding from Multilateral Agencies and Foreign Banks Among the 322 projects that were executed in the first phase (Golden Quadrilateral) of the National Highway Development Programme, 82 were executed under the Engineering, Procurement and Construction mode with the aid of the World Bank, the Asian Development Bank, and the Japan Bank for International Cooperation, which contributed about 60% of the total project cost in the first two phases of the Delhi Metro Rail Corporation project. Many other metro rail projects such as Bangalore, Chennai, and Jaipur are also modeled after the Delhi Metro Rail Corporation project with financial aid from the Japan Bank for International Cooperation.

Relaxation of Norms for External Commercial Borrowing The Reserve Bank of India relaxed external commercial borrowing norms for infrastructure finance firms in January 2013. Infrastructure finance companies can now avail themselves of overseas borrowing up to 75% of their net worth without approval from the Reserve Bank of India, as against 50% earlier. The hedging requirement for currency risk was also reduced from 100% of their exposure to 75% (23). But, the exchange rate increase in INR versus US$

between March 2013 and October 2013 would have nullified the benefit arising out of the hedging requirement relaxation.

Secured Loan for Infrastructure Development The Reserve Bank of India in March 2013 announced that in certain conditions, the debt due to lenders in PPP projects may be treated as secured, with some riders (25). The conditions are that the user charges, toll payments, are to be kept in an escrow account in which senior lenders have priority over withdrawals by the concessionaire, predetermined increase in user charges or an increase in the concession period if project revenues are lower than anticipated, and the right of substitution by the senior lender in the case of concessionaire default (26).

Reasonable Exit Options In 2009 the B K Chaturvedi Committee recommended reasonable exit options for the concessionaire in PPP road projects. It was on the expectation that if developer companies are allowed to divest their equity holding without any lower limit at the end of the construction phase to operation and maintenance companies, faster rotation of capital for construction companies would result, which would invite more investment for infrastructure projects under the PPP. The B K Chaturvedi Committee redefined the change of ownership as the bidders’ share in equity dropping below 51% anytime until 2 years after COD. Further, it said each member of the consortium evaluated for the purposes of prequalification and short listing in response to the request for qualification should hold at least 26% of such equity until 2 years after COD. While requiring the bidder to hold 51% until 2 years after COD, the B K Chaturvedi Committee relaxed the need to hold any equity after that. It was finally accepted that the bidder was to hold at least 26% from 2 years after COD for the rest of the concession period (27). In June 2013 the Indian government announced that the bidder could relinquish its equity completely for completed and ongoing projects (28).

Financial Reforms Needed for PPP Financing in India Using Domestic Savings Gross domestic savings are about 30% of the GDP in India. Low-risk, low-return savings of India are targeted primarily toward bank deposits. Medium-risk, medium-return savings are moved toward mutual funds. High-risk, high-return savings are moved toward the stock markets. By providing inflation indexed government bonds (which have an inherent sovereign guarantee), the government may move sizable low-risk, low-return savings and medium-risk, medium-return savings of India toward infrastructure funding. The household savings account for 7.7% of GDP in 2012–2013 was about Rs 10.9 trillion. At present, the retail investor receives an income tax exemption up to Rs 20,000 for investing in IDF bonds. To tap domestic savings for infrastructure financing, the Working Sub-Group on Infrastructure Funding Requirements and Its Sources for the implementation of the 12th FYP (2012 to 2017) recommended that the income tax exemption for IDF bonds may be raised to Rs 100,000 (29). When mutual funds, which are moderate in risk and

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return, are expected to generate a return of 15% per annum and when investment in real estate is expected to give a substantial return, it is difficult to attract voluntary investments for the IDF bonds. When equity investors in infrastructure projects expect a return of 20% to 25% on their equity, it is to be accepted that household investors expect a return of 8% plus inflation. To make IDF bonds more attractive, the interest rates for IDF bonds may be indexed to inflation with a maturity period of 15 years or so. Doing so would give an option for domestic savings to become invested in long-tenure infrastructure financing.

Allowing Foreign Direct Investment Foreign direct investment (FDI) is permitted up to 100% in greenfield projects under the automatic route. In the case of existing projects, however, FDI under the automatic route is permitted up to 74%. Further, 100% FDI is allowed under the automatic route for coal and lignite mining; construction development projects; mining of diamonds, precious stones, gold, silver, and minerals; the petroleum and natural gas sector; power generation; transmission; distribution; power trading; and manufacture of telecom equipment. In telecommunication services FDI up to 74% subject to certain conditions is permitted. In the case of air transport services, FDI up to 49% is permitted (5). With 100% FDI for infrastructure projects, especially for those with long maturity periods, the ambitious targets of infrastructure development as envisaged in the 12th FYP may be achieved.

Increasing the VGF Cap The current policy allows VGF of up to 40% of the total project cost. In the case of road projects, the first two phases of the National Highways Development Project involving high-density corridors are almost complete. The remaining phases of the National Highways Development Project are not as financially remunerative as the projects of the first two phases. Out of about 35,000 km of road network, only 20,000 km were awarded (30). In 2012–2013, only 787 km were awarded, and not a single kilometer was awarded between April 2013 and October 2013 (31, 32). In the case of rail and power projects, the construction periods are much longer, the investments are gargantuan, and the return on investment is to be obtained over a long period of time (say, 30 to 40 years). For instance, the Hyderabad Metro Rail PPP costs Rs 118 billion, with a concession period of 35 years and an entitlement of a further 25 years, which includes the 5-year construction period. With that backdrop, it is better for the project authority to increase the VGF limit to 49% of the total project cost from the extant 40% with increased equity on the part of the concessionaire. In fact the VGF should be linked to the equity of the concessionaire. When the equity component is less, there is little skin in the game. For projects accessing VGF that are expected to yield windfall profits, provisions should be made in the concession agreement so that such windfall profits are appropriately shared between the authority and the concessionaire.

Allowing Balloon Payment and Delayed Payment Since the tenure of commercial bank loans is about 7 years, the concessionaire has to pay the principal and interest within 7 years of

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the beginning of the project. Rather than going for takeout financing at the end of the tenure of commercial bank loans, project financing institutions may make a loan at the beginning of the project but may allow a moratorium of payback for the concessionaire until the repayment of commercial loans is exhausted. Moreover, the payback may also be delayed by the adoption of a balloon payment.

Impetus for Corporation Bonds According to the 2011 census, 30% of the Indian population lives in urban areas, and by 2030 that figure is expected to increase to 40%. But, the existing infrastructure facilities in regard to roads, drinking water, power, sanitation, and so forth remain a far cry from the growing demand. With the current revenues, the urban local bodies are able to meet less than a third of the total fund requirements of infrastructure development (33). The impetus to corporation bonds would provide the necessary source for VGF while awarding PPP projects on urban infrastructure.

Building Government Capacity with Funds— Need for a Transport Infrastructure Corpus In India, the tax component, which is almost equally shared by the union government and the state governments, makes up about 50% of the retail price of petroleum (gasoline) and diesel. The union government collected Rs 748 billion during 2012–2013 from the central excise tax on petroleum products (34). Ideally, the heavy taxation on petroleum products needs to be channeled toward the development of a fuel-efficient, environment friendly, and sustainable transport infrastructure; environment mitigation programs; transport safety; and so on. There is a need to create a transport corpus at the union and states level sourced primarily from tax revenues of petroleum products that would provide the needed resources for VGF of megatransport projects.

Holistic Outlook Toward PPP and Its Financing The policy changes to promote PPPs for bridging the gap in the infrastructure deficit undertaken at the union government level until now have not percolated uniformly across all union government ministries. For instance, the total costs of PPP projects completed and under implementation by 2010 in the Ministry of Road Transport and Highways and Ministry of Civil Aviation were Rs 556.09 billion and Rs 246.6 billion, respectively. For the same period, it was Rs 47.17 billion for the Ministry of Railways (14). Most of the infrastructure ministries and departments are on the concurrent list of union and state governments; the union government and the state governments could pitch in simultaneously. But even now, only some state governments have implemented infrastructure development through PPPs, although the framework for PPP projects is readily available for emulation by all state governments in scaling up investments in various physical and social infrastructure sectors. The total cost of PPP projects completed and under implementation by the union government and state governments was Rs 1012.57 billion and Rs 2064.81 billion, respectively, by 2010. Of the total value of state government PPP projects, five states, Uttar Pradesh, Gujarat, Maharashtra, Karnataka, and Andhra Pradesh, alone accounted for 58.3% (14).

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The issues pertaining to PPP financing have subtle linkages with a host of other issues afflicting PPPs and the general administrative system. Investment in long-tenured PPP projects poses a great risk for developers unless there is consistency in policy and fairness toward developers by successive elected governments. When the government falters from the mutually accepted concession agreements with no rationale, the developers must obtain a quick redress through arbitration or litigation. Conclusion PPPs have definitely been accelerated in India. The PPP Data Update Note 68A from the World Bank highlighted that India was a top recipient of private participation in infrastructure since 2006. India’s 43 new projects with private participation in infrastructure in the first semester of 2011 were almost half of the investment for new private participation in infrastructure projects for developing countries (35). But the acceleration is not enough to meet India’s goals set forth by the planning commission for the 12th FYP spanning 2012 to 2017. It has been estimated that the total fund requirement for the 12th FYP is about Rs 65 trillion (US$1 trillion), and the funding gap is about Rs 14.6 trillion (US$231 billion) (29). The framework for the PPP model is reasonably well developed but requires fine-tuning on various aspects. Apart from the general slowdown of the economy, the vital issue has been infrastructure financing. The trend in the recent past is to award larger projects under a PPP. For instance, the conversion of existing four-lane roads of the Golden Quadrilateral stretches to six-lane roads done with PPP amounts to a few hundred kilometers, unlike the road stretches awarded previously. The PPP reforms have to encompass railways, which hitherto missed out on huge developmental plans. When railways adopt PPPs, invariably the total project cost of railway projects will be much higher than for road projects. Therefore, it is necessary to have better infrastructure financing mechanisms in place. Moreover, as India is about to enter the second stage of the PPP maturity curve, PPPs have to encompass hitherto unattended sectors such as irrigation, development and maintenance of water bodies, rainwater harvesting, education (especially primary and secondary education), power, linking of rivers, creation of new channels and inland waterways, primary and preventive health care, and specialty hospitals. It is necessary to have a wide range of financial instruments to provide the mammoth financing requirements, and the suggestions in this paper would help in achieving that goal. References   1. Shrinivasan, R. India’s Population Will Peak at 1.7bn in 2060: UN Study. The Times of India, May 5, 2011. http://articles.timesofindia. indiatimes.com/2011-05-05/india/29512357_1_population-projectionsbillionth-person-peak. Accessed March 25, 2011.   2. Wilson, D., and R. Purushothaman. Dreaming with BRICs: The Path to 2050. Global Economics Paper No. 99. Goldman Sachs, Oct. 1, 2003. http://www.goldmansachs.com/our-thinking/brics/brics-reports-pdfs/ brics-dream.pdf. Accessed Feb. 15, 2012.   3. Swati, S. The 10% Growth Story and India’s GDP. http://www.chilli breeze.com/articles_various/India-growth.asp. Accessed Aug. 15, 2010.   4. Research and Markets. Brochure on India Infrastructure Report Q3 2010. http://www.researchandmarkets.com/reports/1246314/. Accessed Mar. 25, 2011.

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