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Development of Infrastructure:

Provision of infrastructure typically requires substantial capital investment


with a very long gestation period. Infrastructure has been developed mainly in the
domain of the public sector historically. This has led to poor technical efficiency,
inadequate levying and collection of user charges leading in turn to low levels of re-
investment. Coupled with increasing fiscal stress in most governments, the levels of
service in most publicly provided infrastructure is rather poor. A Committee on
Infrastructure headed by the Prime Minister was set up in August, 2004 to, inter-alia,
initiate policies that ensure time bound creation of world class infrastructure and
delivery of services matching international standards and at the same time developing
structures that maximize the role of public private partnerships in the field of
infrastructure.

The need for private participation:

1. Huge Investment requirements

2. Low rates of investment in infrastructure in India(low GCFI)

3. Inefficiencies in the public provision of infrastructure characterized by poor


technical efficiency, inadequate levy and collection of user charges and
consequently low rates of reinvestment.

Investment Requirements

The Indian Infrastructure Report, 1996 projected an investment requirement of


Rs. 7,500 billion, (in 1995-96 prices) over the period 2001-02 to 2005-06. The total
investment required in infrastructure during the Tenth Five Year Plan was initially
projected at Rs.1,089,400 crore at 2001-02 prices which has been revised to Rs.
1,108,800 crore at 2001-02 prices in the Mid Term Review document.
The Committee on Infrastructure, headed by the Prime Minister, has estimated
the investment requirements in some of the key sectors as Rs. 2,20,000 crore in the
National Highways sector by 2012; Rs.40,000 crore for Airports by 2010 and
Rs.50,000 crore for the Ports sector by 2012. It has been estimated that India has the
potential to absorb US $ 150 billion of Foreign Direct Investment in the next few
years in the infrastructure sector alone. It is estimated that the overall investment
requirement in the infrastructure sectors in the next 5 years is to the tune of $320-350
bn. As per the Committee on Infrastructure Financing set up by Ministry of Finance,
the infrastructure spending target for the Eleventh Plan Period is estimated to be USD
384 Billion at 2005-06 prices which translates to USD 475 Billion at current prices.

In a recent discussion paper Planning Commission has estimated the total GCF in
Infrastructure during the Eleventh Plan to be Rs. 20,01,776 crore (at 2006-07 prices)
or US$ 488 billion (at an exchange rate of Rs.41/$). This amounts to an average of
7.44 per cent of GDP (at market prices) over the Plan period. To supplement the
estimated aggregate capital formation in infrastructure described above, an alternative
has been used taking into account actual sector-wise development patterns. Public and
private investment in each sector during the Eleventh Plan has been projected based
on a detailed review of sector trends, including historic evolution of Plan
expenditures. This ‘bottom-up’ exercise yields total investment in infrastructure

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during the Eleventh Plan of Rs. 23,84,905 crore or US$ 581.68 billion (at Rs.
41/US$).Assuming conservatively that 15 per cent of the investment projected on the
basis of detailed sectoral analysis will spill over to the Twelfth Plan, it is estimated
that total investment in infrastructure during the Eleventh Plan period would amount
to Rs. 20,27,169 crore (or US$ 494.43 billion). Subsequently this figure has been
revised to US$515 billion in the 11th plan document.

Gross Capital Formation in Infrastructure: The rates of investment in


infrastructure in India are low compared with China and some Asian countries. The
India Infrastructure Report (1996) had projected the need for an increase in
investment in infrastructure from levels of under 5 per cent to about 8 per cent of
GDP by 2005-06. However, gross capital formation in infrastructure (GCFI) as a
proportion of GDP has remained at around 4 per cent of the GDP during 1997-98 to
2003-04. GCFI is estimated to be 4.5% of GDP during the 10th Plan Period.

Enabling Policy Environment for private investment, domestic as well as foreign.

Measures by Government:

i) Improving the efficiency of parastatals in production and deliveries;

ii) Permitting the private sector to exert competitive pressure through


participation in all the infrastructure sectors;

iii) Progressive levy of appropriate user charges on infrastructure services;

iv) Setting up autonomous regulatory authorities, tariff authorities and quasi-


judicial bodies in the infrastructure sector and examining the requirements
of such institutional arrangements in others;

v) Providing fiscal incentives in terms of “tax holiday” to infrastructure


projects, tax incentive to investors providing long-term finance or
investing in equity capital of the enterprises engaged in infrastructure
facility etc; and

vi) Permitting FDI in various infrastructure sectors.

Other Measures being taken

In roads and ports sectors, Model Concession Agreements have been


developed to maximize public private partnerships. At the same time, public
investments are being stepped up, coupled with revamping of Airports Authority of
India (AAI), National Highways Authority of India (NHAI) and Port Trusts. Telecom,
where competition has delivered benefits, can serve as the role model for most
infrastructure sectors of the economy. In the roads sector, the Jaipur-Kishangarh
highway is a Build Operate Transfer (BOT) success story and it has been decided that
the four laning of 10,000 kms, under NHDP III will be done entirely on BOT basis.
The sub-group of the core group on NHDP Financing had finalized its Report on the
suggested financing pattern for NHDP, which has been approved by CoI. The report
of the IMG on restructuring of NHAI has been finalized and has been approved by the
Union Cabinet. An IMG on financing of ports has given its final Report which has

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been approved by CoI. An IMG looking at issues relating to reducing dwell time in
ports has finalized its Report.

In the railway sector, a number of projects are being funded by public private
partnership, State Government participation, funding of projects of national
importance through the general exchequer and multi-lateral funding. Ministry of
Railways has formed a PSU, the Rail Vikas Nigam Limited (RVNL). RVNL has been
entrusted with the task of promoting public private partnership for railway projects.
Railways have also decided to set up dedicated freight corridors on Delhi-Howrah and
Delhi-Mumbai routes. Decision has been taken to allow private parties to participate
in container services, hitherto the preserve of CONCOR. A model concession
agreement has been finalized by the IMG constituted for this purpose.

Greenfield airports at Devanahalli near Bangalore and Shamshabad near


Hyderabad are being built on Build Own Operate and Transfer (BOOT) basis with
public private partnership. The international airports in Delhi and Mumbai are being
restructured and modernized through private sector participation. In the joint venture,
AAI and other Government PSUs will be holding 26 per cent equity. The balance 74
per cent will be held by the strategic partner. The Task Force on financing of the
development and modernization of 35 non-metro airports has finalized its report
which has been approved by CoI. The Task Force has identified the need for
Greenfield airports in several cities, in addition to Hyderabad and Bangalore. The
Task Force has also recommended that the city side development in all airports should
be taken up through PPPs.

Regulation as an essential ingredient in PPPs

Private investment requires a policy framework which can enable an adequate


rate of return and also an independent regulatory system which is seen to be fair by
consumers and also by producers. In power (CERC and SERCs) and
telecommunication (TRAI) sectors, regulatory authorities have been set up with
extensive functions. In the highways sector, regulation has relied mainly on the
concession agreement, while in ports, the role of the Regulatory Authority (TAMP) is
confined to tariff setting. In the Airports sector, the Airports Economic Regulatory
Authority (AERA) Bill has been passed in the Parliament. The separation of
regulatory and adjudicatory functions has been recognized with the formation of
appellate tribunals in the telecom (TDSAT) and electricity (Electricity Appellate
Tribunal) sectors. There are various points of view on the need for a Railway
Regulator. However, with greater private sector participation, there would be a clear
need for a regulator.

Financing through VGF and SPV

To accelerate and increase public private partnerships in infrastructure, two


major initiatives have been taken by the Ministry of Finance. These are (a) provision
of viability gap funding; and (b) setting up a special purpose vehicle to meet long
term financing requirement of potential investors.

Viability-Gap support

The salient features of the scheme are:

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a) In order to be eligible for funding under this scheme, the PPP project must
be implemented, i.e. developed, financed, constructed, maintained and
operated for the project term, by an entity with at least 51 per cent private
equity.

The eligible sectors include:

i) Transportation: Roads and bridges, railways, seaports, airports,


inland waterways;

ii) Power;

iii) Urban Development: Urban transport, water supply, sewage, solid


waste management and other physical infrastructure in urban areas;

iv) Infrastructure projects in Special Economic Zones; and

v) International convention centers and other tourism projects.

vi) Any other sector can be added by the Empowered Committee with
the approval of the Finance Ministry.

b) The total Viability Gap Funding under this scheme shall not exceed twenty
per cent of the total project cost. The government or statutory entity that
owns the project may provide an additional 20% grants out of its budget.

c) The implementing agency must be selected through a transparent and open


competitive process.

d) The bidding criteria would be the amount of VGF sought.

e) Viability gap funding under this scheme will normally be in the form of a
capital grant at the stage of project construction. Proposals for any other
form of assistance may be considered by the Empowered Committee and
sanctioned with the approval of Finance Minister on a case-by-case basis.

Special Purpose Vehicle (SPV)

12. Government have approved the setting up of a SPV for the purpose of
providing long-term debt to infrastructure projects. The SPV will borrow money
against Government Guarantee and on-lend these funds to the infrastructure projects.
This is expected to ease the asset liability mismatch of the financial institutions and
lower the cost of long-term debt:

13. Pursuant to this, a scheme has been drawn up to set up and a Non-Banking
Finance Company (NBFC) called India Infrastructure Finance Company Ltd. (IIFCL)
is being set up. The IIFCL office opened for business on March 13, 2006. It is
presently trying to build a network within the financial community. It started working
with a capital of Rs.10 crores. The equity contribution of Rs.90 crore, as provided in
the Union Budget 2006-07 has been received. With this, the paid up capital of the
company has gone up from Rs.10 crore to Rs.100 crore as against the authorized
Capital of Rs.1000 crore.Approval of the Government guaranteeing the first part of

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the company’s borrowing programme for the year 2006-07, amounting to Rs.5,000
crore, has been received. The guarantee is subject to payment of guarantee fee payable
at the rate of 0.25 percent per annum , in advance. IIFCL proposes an ECB of $1
billion and is seeking Government approval for a domestic bond issuance of Rs.12000
crore in 4 tranches of Rs.3000 crores each. A number of proposals for financing have
been received by IIFCL. The salient features of this scheme are:

a) The IIFCL will borrow money from the markets on the strength of
Government guaranteed bonds. These will be long duration bonds (more
than 10 year maturity). The IIFCL can also raise money from
organizations such as the World Bank, Asian Development Bank etc. and
international debt markets, i.e., External Commercial Borrowing etc.

b) It will then lend this money to viable infrastructure projects. The projects
may be sponsored by any entity, whether in the public or private sector or
by a joint venture. Preference will be given to Public projects and Public
Private Partnership Projects.

c) The IIFCL will fund projects on the strength of appraisal done by the lead
Financial Institution. Disbursements and recoveries will be ‘pari-passu’
with senior debt and will be done through the lead financial institution.

d) Lending may be in the form of direct loans or through Financial


Institutions (Refinancing). The extent of loans will be 20 per cent of the
cost of projects or less. Cost of land provided by Government will not be
funded.

Infrastructure Finance Initiative: Infrastructure Development Finance


Company Limited (“IDFC”), Citigroup Inc. (“Citi”), India Infrastructure Finance
Company Limited (“IIFCL”) and Blackstone Group Holdings L.P. (together with its
affiliates, “Blackstone”) announced the launch of “The India Infrastructure Financing
Initiative”, a collaborative effort to deploy approximately US $ 5 billion in capital for
infrastructure projects in India. This initiative is an important milestone in the search
for innovative solutions to meet the vast challenge of financing the development of
India’s burgeoning infrastructure sector. This initiative was facilitated by the Ministry
of Finance. The Fund is to be structured as a Venture Capital Fund.
The plan is to deploy about US$ 2 billion in equity capital and US$ 3 billion
in long term debt financing with maturities exceeding ten years. The equity fund of
USD 2 billion would be raised in 2 tranches of USD 1 billion each, one after the other.
IDFC, Citi and Blackstone will together invest US$ 250 million. The IIFCL will
invest a small portion. The balance is expected to come from reputable international
investors as well as selected domestic institutional investors. This would be raised
within a period of 4-6 months from the date the agreement is finalized. The second
equity fund of USD 1 billion would be raised in the subsequent twelve months. The
equity financing program will be managed by IDFC and will invest in greenfield,
brownfield and operating projects primarily in roads, power, airports, ports, and
industrial and commercial infrastructure.
The USD 3 billion would be raised in foreign currency debt financing as ECB
funding on account of IIFCL on a pre-approved basis. This amount would be raised in
several tranches over the next three years for projects appraised by IDFC and also

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certain banks / financial intermediaries as a concrete pipeline of projects becomes
visible.
The agreement to establish the fund was signed on February 15, 2007 by Dr.
Rajiv B. Lall from IDFC, Mr. Sanjay Nayar from Citi, Mr. S.S. Kohli from IIFCL,
and Mr. Robert L. Friedman from Blackstone in the presence of the Finance Minister,
Shri P. Chidambaram in North Block, New Delhi.

IDFC has received commitments of US$ 1.225 bn in two funds that are part of
the above initiative and on final closing of both funds would have raised close to $1.7
bn. IDFC has announced a first close of $525 mn for India Infrastructure Fund, an
equity fund which is a part of the initiative. The fund raising is still ongoing and
IDFC expects to raise $ 1 bn in this fund. IDFC has received commitments of $700
mn for another equity fund which is a part of the above initiative but is awaiting FVCI
(Foreign Venture Capital Investment) approval from RBI to announce its closing. The
debt part of the fund is yet to be created.

Utilization of a part of the Forex Reserves: It has been decided that one wholly
owned subsidiary of IIFCL would be set up in London for borrowing of funds from
the RBI and lending to Indian companies implementing infrastructure projects in
India. RBI would provide funds to this subsidiary in the form of 10 year maturity US
dollar denominated bonds with a face value of USD one million, with the maximum
aggregate issuance of USD 5 Billion. The bonds will be fully guaranteed by the
Government of India for both principal and interest. The off-shore subsidiary of
IIFCL was registered in London on February 7, 2008.

Issues

To enable all these initiatives to succeed and put in place quality infrastructure,
many issues need to be addressed. To list a few:

i) Generate more funds for public investment in infrastructure.

ii) Develop a market for long-term debt which is essential for long-gestation
and high cost infrastructure projects.

iii) Provide flexibility to insurance companies and pension funds to invest in


long-term infrastructure financing products.

iv) Provide policy stability to boost private investor confidence.

v) Ensure a seamless regulatory framework which balances the interests of


the investors as also those of the users.

vi) Deliver a level playing field for new infrastructure providers to enable
them to effectively compete with the existing ones.

vii) Streamline clearances and have better Centre-State and inter-state co-
ordination.

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Role of PPP:

It has been observed worldwide that it is difficult for the private sector to meet the
financial requirements of infrastructure in isolation at the same time tackling the risks
inherent to building infrastructure. Therefore, the PPP model has come to represent a
logical, viable and necessary option for the Government and the private sector to work
together.

Public Private Partnership project as per Government of India means a project


based on a long term 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. The concession
agreement is specifically targeted towards financing, designing, implementing and
operating infrastructure facilities and the collaborative ventures are built around
mutually agreed allocation of resources, risks and returns.

PPP-Characteristics

i) PPPs do not mean reduced responsibility and accountability of the


Government.

ii) The Government remains accountable for service quality, price


certainty and cost-effectiveness (value for money) of the partnership.

iii) Government's role is one of facilitator and enabler by assuming social,


environmental and political risks; private partner's role is one of financier,
builder and operator of the service or facility and it typically assumes
construction and commercial risk.

iv) Resources required by the project in totality along with the


accompanying risks and rewards/returns are shared on the basis of a pre-
determined, agreed formula, which is formalized through a contract. Since
the private sector assumes the risk of non-performance of assets and
realizes its returns if the assets perform, the PPP process involves a full
scale risk appraisal. This results in better cost estimation and better
investment decisions.

v) PPPs deliver efficiency gains and enhanced impact of the investments.


PPP projects also lead to faster implementation, reduced lifecycle costs
and optimal risk allocation. Private management also increases
accountability and incentivizes performance and maintenance of required
service standards. Finally, PPPs result in improved delivery of public
services and also promote public sector reforms.

vi) PPP does not involve outright sale of a public service or facility to the
private sector.

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vii) Private Sector Company in a PPP means a company in which 51% or
more of the subscribed and paid up equity is owned and controlled by a
private entity.

viii) Worldwide most common partnership options are:

a. Service Contract

b. Management Contract/Lease

c. Build Operate Transfer

d. Concession

e. Joint Ventures

f. Community based provision

Most contracts take the form of 'concession' and 'Design, Build, Finance and
Operate' contracts. These contracts are usually financed by user fees or tariffs or by
government subsidies.

The PPP Experience so far:

In India most PPPs have been restricted to the roads sector. The US $ 100
million Delhi-Noida bridge project,implemented on a BOOT framework on the basis
of a 30 year concession, is India's first major PPP initiative. The Jaipur-Kishangarh
highway is a Build Operate Transfer (BOT) success story and it has been decided that
the four laning of 10,000 kms, under NHDP III will be done entirely on BOT basis.
Then there are successful PPPs in water supply. The Tirupur project in Tamil Nadu is
a shining example. It is a BOOT project and an SPV was set up for the purpose. The
project however took more than ten years from concept to financial closure. Many
other PPPs in water supply have been financed through municipal bonds in cities such
as Ahmedabad, Ludhiana and Nagpur. The housing projects coming up on the
outskirts of Kolkata City are a good example of what a PPP model can deliver in
terms of quality housing and living conditions to middle and lower middle class.
Gujarat and Maharashtra have had success especially in ports, roads and urban
infrastructure. Karnataka also has done well in the airport, power and road sector.
Punjab has had PPPs in the road sector. As per a World Bank financed and DEA
commissioned study by Pricewaterhouse Coopers, in the last 10 years a total of 227
PPP infrastructure projects were found to have achieved financial close. Furthermore,
PPP projects in India clearly show a sharp increasing trend in the past 10 years. Out of
the 227 PPP projects, more than 117 projects have achieved financial close in the last
three years. Road sector which forms more than 81% of the total projects by number
accounts for only 54% of the total projects by value. Port and Airport projects which
form 8.4% and 1.8% respectively by number constitute 21% and 17.2% respectively
of the pie by value.Western region followed by Southern region dominates both in
terms of number and value of projects. Though states dominate in terms of the
number of PPP projects awarded (55%), they trail the centre in terms of the total value
of the projects (centre accounting for 72%). This is because most state project sizes

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are less than $50 million but central project sizes; in particular Airport projects are
large being more than $100 million.