Foreign funds wanted

Author: | Published: 1 Aug 2007
Email a friend

Please enter a maximum of 5 recipients. Use ; to separate more than one email address.

India's position as a global economic superpower has been cemented over the last few years. With a comfortable gross domestic product (GDP) growth of around 9.2%, it is today the fourth largest economy in the world.

The infrastructure sector has, however, not kept pace with the rapid economic growth witnessed in the country. Infrastructure maintenance and development has long been the exclusive responsibility of the state governments and public bodies, with their constraints of public funding and operation. An estimated $150 billion investment is required to match rising demand over the next few years.

The Committee on Infrastructure headed by the prime minister of India estimates that, by 2012, investment requirements in infrastructure sectors will include Rs2.2 trillion ($54 billion) for roads and highways, Rs400 billion for modernization of the civil aviation sector, Rs500 billion for ports and Rs3 trillion for railways. This is without considering the investment required in the traditional infrastructure sectors such as oil and gas, and power.

To address the widening gap, the Indian government has been working towards legal and policy level changes in the infrastructure sector, to facilitate private sector participation and foreign investment. Innovative financing structures, with state backing, are also being considered, including a scheme in which funds can be borrowed directly from the Reserve Bank of India (RBI), the country's central bank.

Considerable activity has also been seen in the financing of infrastructure projects as a result of greater private sector participation. However, these initiatives have had their fair share of roadblocks in the past and further impetus needs to be provided for the next stage of infrastructure development.


India continues to experience a severe power shortfall, with several states, including the industrial pioneer Maharashtra, whose capital is Mumbai, the commercial nerve centre of India, facing severe power shortage. In 2004, the Ministry of Power estimated that capacity addition of 100,000 MW or more will be required in the 10 years ending in 2012 to meet the projected electricity demand of the country.

Privatization efforts in this sector began in 1991 and the sector has since then witnessed groundbreaking legal changes. A new phase of regulatory and legal changes commenced with the enactment of the Electricity Regulatory Commissions Act 1998, which set up an independent regulator, and the Electricity Act 2003 (the 2003 Act), which consolidated and replaced old statutes and laid down the framework for restructuring the electricity industry in India. The establishment of the Central Electricity Regulatory Commission (CERC) and the State Electricity Regulatory Commissions (SERC) set the stage for transparent tariff setting. Over the last few years the CERC and the SERC have been involved in setting tariffs for power procurement by distribution licensees, setting consumer tariffs and settling disputes between generators and licensees. A specialist appellate body, the Appellate Tribunal for Electricity, has also been constituted to deal with electricity law disputes, reducing the burden of the ordinary courts of law considerably and giving the sector a fair and balanced appellate forum comprised of legal and technical experts.

Competitive bidding has emerged as the preferred route for awarding generation, transmission and distribution projects to ensure lower prices, and has been endorsed in the Tariff Policy 2006.

The recently concluded award for the two ultra-mega power projects (UMPPs) (4000 MW or more and requiring investment of more than $3 billion each) was accomplished through the competitive bidding process. Five more projects of similar size are at various stages of bidding. Several benefits are proposed to be extended to UMPPS, such as tax exemptions and enhanced foreign currency borrowings. The land and several approvals are acquired by the government and then handed to the successful bidder.

Despite this consolidation, the power sector is still dogged by regulatory uncertainty. More work is needed in this area. The establishment of the Appellate Tribunal for Electricity is a welcome step and is expected to provide greater stability and independence to the regulatory regime, a much-needed departure from the inconsistent approach of several state regulators. Over time, the long-lasting debate on the jurisdiction of the regulatory commissions to arbitrate and regulate contracts is expected to be resolved by the Indian judiciary.

Though a start has been made on trading in electricity as a distinct form of activity, in a country that is facing acute power shortage, the regulators and courts are increasingly faced with claims of profiteering by traders. The extent of trading margin and whether power utilities can trade are being considered by courts. In the last year, 22 licences have been awarded for inter-state trading.

Interest has grown in spot trading and merchanting in electricity, with open access to the transmission and distribution system being implemented. A few projects with a share of merchant sales are expected to achieve financial close shortly. A power exchange, a common platform for electricity trading, is being contemplated and the CERC has initiated a policy discussion on this topic.

One of the issues that will accelerate the growth of the sector is reduction of the cross-subsidy surcharge. The cross-subsidy surcharge, payable when a consumer purchases electricity from a person other than the distribution licensee in that area, is so high in most states that it does not make economic sense for a customer to purchase power directly from a private generator or a trader. The Tariff Policy requires that the cross-subsidy surcharge be brought down to a maximum of 20% of its opening level by 2011. Reduction in cross-subsidy surcharge will increase competition and provide freedom of choice to customers.

Oil and gas

The oil and gas sector has seen considerable activity over the past few years. In the upstream sector in 2006, pursuant to the National Exploration Licensing Policy, six rounds of successful bidding of oil exploration blocks were completed and the next round is being planned. Cross-country pipelines have been implemented to transport gas from the south-east coast to the industrial markets of the west. The government recently accorded cross-country pipelines infrastructure status under the income tax laws. In the downstream sector, new legislation has created the Petroleum and Natural Gas Regulatory Board, the regulator for all downstream activity, including refining, processing, storage, transportation, distribution, marketing and sale of petroleum and petroleum products. The Board was constituted recently and is expected to be fully functional shortly.

Limited recourse project financing of gas exploration is yet to be seen in India. The rights of the developer to freely dispose gas (without tender) and pricing are the subjects of a policy and legal debate. The Production Sharing Contract for grant of exploration rights, entered into under the Oilfields (Regulation and Development) Act 1948, permits security over participating interest for the purpose of raising financing but the security is subservient to the interests of the government, and financiers cannot carry out operations without government approval. An assignment of the rights of exploration granted under the Agreement is also not permitted without the government's consent.

In respect of pipeline financing, the chief asset of the developer, the right of use granted under the Petroleum Pipeline (Acquisition of Right of Use in Land) Act 1962, cannot be assigned or charged to the lenders. The only recourse available for the lenders is to act as the nominee of the rightholder to exercise all the rights that the rightholder has.

There have also been large refining capacity additions, financed by Indian and international lenders, in the last year.


Indian port traffic has increased from 165 MTPA (million tonnes per annum) in 1991 to over 500 MTPA in 2004-2005. There has also been a 10.4% growth in containerized cargo and a 6% growth in bulk cargo. Under the National Maritime Development Programme, projects worth $13.33 billion are proposed to be undertaken in India over the next few years.

Port sector reforms were initiated through amendments to both the Indian Ports Act 1908 and the Major Port Trusts Act 1963, and formation of the TAMP, an independent regulatory body to fix tariffs at the main ports. Modifications were made to permit joint ventures and foreign collaborations in the port sector and to enable port authorities to enter into private and joint ventures, creating additional port capacity.

Private participation in the port sector has increased, with several global players investing in the sector.

To facilitate public-private partnerships in the sector, the government of India has drafted and finalized a model concession agreement and standard bid documents for the sector. A draft Maritime Policy is also expected to provide an integrated vision for the development of the port sector.

The sector is, however, dogged by problems such as land acquisition, environmental clearances, lack of road and rail connectivity to sites, and competition between large and small ports, resulting in diminished enthusiasm.


The unprecedented growth in the aviation sector has shown the gross inadequacy of the existing airport infrastructure. Private players are permitted to take part in constructing, modernizing and developing airport infrastructure in the country under an amendment in the Airports Authority of India Act 1994. Services such as air traffic services, safety and security have been retained by the Airports Authority of India (AAI).

Recently, the Mumbai and Delhi Airports were handed over to the private parties under a competitive bidding process. Development of greenfield projects in Bangalore and Hyderabad has also been awarded to the private players.

As with the oil and gas sector, owing the strategic importance of airports, the government has restricted the rights of the developer to create security over the assets in an airport. The only right available to the lender is the right to substitute the developer subject to the approval of AAI.

The creation of an independent regulator is on the horizon and bidding for privatization/modernization of airports in Chennai and Kolkata and about 35 airports in non-metro cities is expected later this year. Steps for augmenting non-aeronautical revenues at many airports are being explored by offering landside commercial development, with the expectation that this will subsidize the aeronautical charges.


Since 1997, the government of India has sought to encourage private sector participation in the development of roads. This included a policy decision that all future phases of National Highways Development Programme (NHDP) would be carried out mainly on a public-private basis. (The NHDP involves projects such as the Golden Quadrilateral, the North-South and East-West Corridor and port connectivity.) The National Highways Act 1956 was amended to permit private entrepreneurs to undertake development of national highways on a build-operate-transfer basis and to recover their investments through tolls.

It is anticipated that the sector would require an investment of $50 billion over the next decade, of which only 10% will be public funding. So substantial private participation is needed, backed by lending, essentially by domestic banks.

One of the main issues encountered in road financing regards the creation of security in favour of lenders. Under the standard concession agreement, the concessionaire is not permitted to create any encumbrance over the project road, which cumulatively encompasses all the assets relating to the project, including the rights of the concessionaire over the project site, tangible assets such as civil works, the project agreements such as the EPC, O&M and tolling contracts, and financial assets such as security deposits and insurance proceeds. So the concessionaire's ability to create satisfactory security in favour of the lenders is restricted and the only recourse available to the lenders is to substitute the developer with the approval of NHAI.

Several new projects are planned this year that require large capital, already attracting the attention of international banks and investors.

Urban infrastructure

With an increasing amount of population moving to the cities (so much so that India has 10 of the 30 fastest-growing urban centres in the world), there is a great pressure on existing urban infrastructure.

Problems with respect to effective development of urban infrastructure include the lack of revenues, high taxes and unsatisfactory performance by municipal corporations. There has also been a substantial reduction in the budgetary allocation for infrastructure over the years. State governments have not been in a position to fund urban infrastructure, due to their poor fiscal position.

Private sector involvement is expected to increase in urban infrastructure, with several projects in Mumbai proposed with private participation. The first phase of the Mumbai Metro has already been awarded to a leading private player. The bidding for the second phase of the Mumbai Metro, the trans-harbour sea link, is underway. Similar projects are also being contemplated in the cities of Bangalore and Hyderabad. International financiers have shown interest in financing municipal bodies.

Special Economic Zones

The enactment of the Special Economic Zones Act 2005 (the SEZ Act) consolidated the myriad state-level policies into a single legislation and gave an impetus to the uniform development of Special Economic Zones (SEZs) in India.

The SEZ Act provides for a single window clearance for all state and central government consents for the project. The units in an SEZ enjoy several fiscal benefits, including exemption from customs duty, central excise and income tax. Almost 400 SEZs are believed to be in the pipeline.

Land acquisition has emerged as a big problem for SEZs. After violent protests over acquisition of agricultural land and related displacement, the compulsory acquisition of land has been abandoned. There have been restrictions on the size of SEZs. More proposals are now being cleared with these changes in policies.


International non-recourse debt financing in projects is yet to be seen, despite the resolution of all investment claims in the Dabhol power project. However, an increasing role is foreseen for export credit agencies and multilaterals in some of the large projects that are coming up for financing in the power sector. A case in point is the bidding for the two ultra-mega power projects in Mundra and Sasan. Although initially several multinational developers had expressed an intention to bid for the project, most of them withdrew because they did not consider the risk profile acceptable. However, the debt financing is expected to see a combination of Indian and international funding.

Private equity investors will be a main source of funding for Indian infrastructure. Though greenfield projects are usually developed by Indian developers, private equity might provide an opportunity to take out Indian developers' capital, allowing them to use the capital to develop other projects.

So far, the financing of Indian infrastructure has not been affected by a lack of foreign capital. Leading Indian conglomerates have made large strides in the infrastructure sector. However, to meet the ever-growing capital requirements for infrastructure, international financing would be a welcome addition to India's growing market.