Project finance in India

Author: | Published: 12 Jul 2001
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Infrastructure development was a sector that received enthusiastic attention from the early days of Indian liberalization. India was the promised land, with an abundance of large projects at various stages of conceptualisation – a hundred or so power projects, scores of telecom projects, many infrastructure deals. A decade later, the enthusiasm has ebbed considerably and several projects lie by the wayside, for want of debt or equity. Developers are tired, and seem to be willing to give the promised land a pass for the time being. Some part of this exhaustion may be well founded, but myth and exaggeration have contributed to some degree as well, in creating an investor-unfriendly image. This article attempts to provide an insider's perspective.

The truth is that India needs infrastructure and there are deals to be done. Foreign investment (whether debt or equity) is welcomed with open arms, and restrictions are reduced literally on a daily basis. More importantly, there are local resources available. The Indian institutions both source and provide long-term funds. Money for 10 or 12 years is available. The bond market for long-term infrastructure projects is developing, albeit slowly. Indian developers and financiers are developing sophistication in financing techniques. They understand risk. They understand limited resource finance. Some can even match expertise with the best in the world. A professional community of advisers – legal, financial and sector experts – has also emerged. The legal system, albeit slow in resolving disputes, is as sophisticated as any in the world. There is truly a rule of law. The basics exist. As in the early and mid-nineties, one would have expected the streets to be lined with eager financiers and advisors. Why then, is the pace of infrastructure development so agonisingly slow?

Before an analysis of the causes, a quick snapshot of the status of a few key sectors is appropriate.


'Fast track' projects (eight in number) they say is a misnomer. True. A few of them that had Government of India counter guarantees did achieve financial close and even generate power. Nearly half fell by the wayside and are all but dead. Amongst the closed projects is one that renounced the counter guarantee (a lesson there perhaps). Several medium-sized projects including Balaji, Samalpatti and PPN Power Projects in the State of Tamil Nadu, the power project established by Jindal Tractabel Power Corporation in the State of Karnataka, and the Kondapalli Power Project in the State of Andhra Pradesh, did close. There were no counter guarantees and substantially the funding was from long-term Indian lenders. A creditable achievement.

This article has been written at a time when the power industry is suffering the negative images of the Cogentrix and Enron controversies. Recently, AES has announced its dispute with another state government. There is no denying that this incessant bad news has shaken investor confidence. However, it should also be noted that many other projects are generating power and are being paid. A lesson to learn from this may be for developers, their advisers and the authorities, to be aware not just of project risk, but of the possibilities for the attainment of deals that are workable. This is where the emerging talent in India lies, in achieving workable projects.

That being said, projects ahead of their time and ahead of reforms in the distribution sector, in the absence of strong payment security mechanisms, may need to live with a sense of insecurity, at least until sector reform is credibly done.

Considerable progress has been made in several states in this area, albeit mostly on paper. Tariff reform began in 1998 with the enactment of the Electricity Regulatory Commissions Act 1998, and many states either established Electricity Regulatory Commissions (ERCs) under this legislation or under special legislation enacted for this purpose. The role of the Central Electricity Regulatory Commission primarily is to regulate the tariffs of generating companies in respect of inter-state generation and transmission, to promote competition, to frame guidelines in matters relating to electricity tariffs, and to arbitrate or adjudicate on tariff disputes. The ERCs in some states, including Maharashtra, Orissa, and Andhra Pradesh, have been active and passed tariff orders. The recent order by MERC mandating "merit order despatch" has invited criticism since it implicitly overlooks the take or pay regime, and has been used to excuse the utility from despatching power. It was a hot summer and probably the older plants must have run at peak load, if the utility did not despatch Dabhol power for long periods, based on this order. The airconditioners certainly worked!

States such as Andhra Pradesh, Haryana, Orissa, Uttar Pradesh etc have introduced special legislation to unbundle the sector, with the establishment of separate generation or transmission entities and one or more distribution vehicles. Orissa moved ahead more rapidly than others and established four Distribution Circles with a view to privatizing each of them. Though completed, the privatization of distribution in Orissa has not been the success originally envisaged. This area of power sector reform requires urgent attention and lies at the heart of the reform in the entire electricity sector.

A key area of reform relates to the new proposals on payment security. The mega power project policy was announced a few years ago. The Hirma, Pipavav and Ennore power projects were listed for this purpose. The mega project status conferred special benefits including tax benefits and preferred payment security through escrow or other arrangements. Like the 'D' Project, these are also monster-sized projects and are moving in a stop-start fashion. In the absence of credible payment structures, these mega projects are not bankable. True that with the intervention of the Power Trading Corporation (PTC), the ability to sell the power to more than one state should, in theory, spread the risk. But neither the credit standing of PTC nor the states in question have inspired the requisite confidence. The crux will be the innovation of a payment security structure. Amongst the options explored include the creation of a charge on the Consolidated Fund of India, or of the state government, direct payment instructions to the Reserve Bank (to debit state revenues), creating an overriding legislative charge on state revenues from particular sources of tax. The constitutional efficiency of these is a matter of debate and there is little precedent. Clearly these are long-haul projects and will undergo several fits of activity before they reach their final outcome.


Quite like the power sector, major initiatives have been taken to develop telecom infrastructure. However, unlike the situation with power, as any India watcher will tell you, there has been a telecom revolution of sorts – with fast-moving technology, the provision of world-class telephony has been a reality in many parts of India. The process, which began in the early nineties, had its share of hiccups.

The liberalization of telecommunications started with the invitation for bids for the introduction of private CMTS operators in 1992 and the issue of the New Telecom Policy of 1994. A bidding war ensued, and so did litigation over the manner of the award of the tenders. Eventually the process was straightened out and licences were awarded, with the government earning unprecedented revenue therefrom. The provision of CMTS services began in 1996 and quickly thereafter the operators realized that they had made their bids on the basis of overly optimistic business projections. The high cost of network roll-out, coupled with abysmally low penetration levels, rendered the operators unable to meet their licence fee obligations. Faced with a sinking industry, the government announced its revised telecom policy statement, the National Telecom Policy 1999, better known as the NTP 99.

The NTP 99 introduced the bedrock of today's industry, with the 'revenue-sharing' formula substituting the fixed tariff licence fee regime of the previous policy. This policy, in addition to restating the basic tenets of the old regime, also resulted in (a) recognition of technological advancements, (b) introduction of new categories of licences, (c) state-run operators obtaining licences on the same terms and conditions as private players, thus creating a more level playing field, and (d) rationalization of the rules regarding foreign direct investment. The NTP 99 also envisaged the end of state-run monopolies in international and national long-distance telephony, and the corporatization of the DOT. This last item has already occurred, and the DOT's operating division was hived off into a distinct corporate entity, the BSNL.

In the meantime, the TRAI – the telecom watch dog – was created under its parent statute of 1997. For the first time, private players had a forum that was inexpensive and made relatively quick decisions to air their grievances. At inception, the euphoria of its existence cloaked its lack of powers over the combined policy maker, regulator, and dominant player in the market, ie the DOT. Time and litigation delineated the scope of the functions and powers of TRAI. The reenactment of the TRAI Act in 2000 brought a fresh lease of life, albeit with greater restrictions on its essential powers, to the TRAI. The main amendments related to the process of dispute resolution between stakeholders in the industry.

More recently, the industry has seen the introduction of new licence categories, including in relation to the provision of optic fibre backbone and national long-distance services. Essentially, the backbone providers have been licensed in two categories, one to provide ducts and dark fibre, and the other to provide capacity. The former permits 100% FDI and requires only registration, and the government expects to see a main chunk of the investments enter this sector. The government has also liberalized the rules regarding the establishment of private international gateways, vide submarine cable and satellite uplinking. Restrictions on the use of the Ku band are expected to be lifted shortly.

The huge initial outlays that were required have resulted in a phase of consolidation, both of markets and of players. The major players have acquired interests in circles so as to create larger base footprints along the vital north-south corridors, and especially to link the two cities of Delhi and Mumbai. Hutchison and BPL – two of the largest operators – have begun to consolidate their holdings in each of their respective circles, whilst the merger of Birla AT&T and Tata Cellular has created a telecom behemoth. In the non-voice areas also, investments by players such as Satyam and Dishnet, have tended to concentrate on the creation of retail and connectivity infrastructure, a move surely influenced by the entry of PCC into the ISP and gateway markets.

The financing of the industry was, until recently, achieved by working capital and intercorporate loans, in addition to the regular equity and vendor funding routes. However, with the anticipated closing of the Shyam and Hughes fixed telephony projects, project financing appears to have finally come into play. This should once again contribute to the further development of vital infrastructure facilities, playing to the governments NLDO and backbone imperatives. Already some of the early effects of this policy are being felt in the spurt in the establishment of data and call centres, making India, literally, the land of the back office.

The key issues in relation to telecom projects and investments in India continue to be the high costs of network roll-out, especially the acquisition of rights of way, allocation of spectrum and the continuously changing policy, as typified most recently by the controversy over permitting the use of WiLL technology by fixed line operators and the allocation of vital spectrum to such use. A final decision is expected in this regard towards the end of this month. Other issues that would affect players include the lack of a definitive interconnection regime, by law or by contract, caused largely by the existence of a captive monopoly in the hands of the BSNL and MTNL.

The continuing disinvestment process, the announced early dismantling of VSNL's monopoly over international voice telephony and the introduction of internet telephony, coupled with the decision to pass both the Communications Convergence Bill and the proposals to lift restrictions on the use of the Ku band during the next parliamentary session, should see a continued inflow of investment to this industry.

Other sectors

There has not been much activity in the other infrastructure sectors, such as roads, ports, water and urban infrastructure. A few ports have been successfully privatised, mostly in the state of Gujarat, such as Pipavav and Mundra. All of these have been completely funded by domestic lenders.

In the roads sector, there has only been one project that closed on a project finance basis – the Delhi-Noida highway. In the short run, it has been easier to develop these projects departmentally rather than through private finance. The Bombay Pune Highway is a case in point.

Although a number of states have been attempting to privatize the water supply, only one project has neared closure to date, and no projects have closed in urban infrastructure. However, an increasing number of state governments have conducted feasibility studies and announced key initiatives into developing independent projects in areas as widespread as water and sanitation services, and health and roadways, and recently there has been a call to allow private participation even in education. The not too distant future does appear to be filled with opportunities for developers in these areas.

Sectoral reform in these areas has already begun, and the highlights of such reform with respect to ports and the aviation sectors are mentioned below.

Ports: the Major Port Trusts Act 1963 has been amended to permit private participation in the provision of a number of services, such as landing, shipping or transhipping passengers and piloting, hauling or any other services in relation to vessels. Reform has been initiated with the establishment of a Tariff Authority. Minor ports, which are governed by the Indian Ports Act 1908, have not seen much policy change. A few states, such as Gujarat, have state legislation permitting private participation in the minor ports. Although the government is attempting reforms, there are still many steps to be taken, including permitting the corporatization of ports and the establishment of an independent regulator.

Aviation: aviation is another focus area. A draft Civil Aviation Policy has been prepared but is yet to be finalized. The draft policy permits private investment in both the air transport services sector and in the airport infrastructure sector. There has been a recent amendment to the foreign investment regulations permitting 100% foreign direct investment in airports. However, if there is foreign direct investment of more than 74%, approval of the Government of India would be required.

Debt finance and new financial institutions

Projects with mismatched currencies for their revenues and borrowings will always be risky. Local currency sources of funds for a substantial part of the capital cost seem to be a prerequisite for a successful project. Fortunately, institutions such as ICICI, IDBI and SBI have made these funds available. Moreover, insurance companies and other institutions looking for long-term returns are increasingly participating in such financing, albeit cautiously.

In limited recourse projects, with several uncovered risks, credit enhancement becomes the much-needed recipe for facilitating the flow of funds to infrastructure projects. Recently, a telecom project obtained local currency financing through a bond issue, with credit enhancement provided by a partial credit guarantee from the International Finance Corporation (the IFC). This appears to be the forerunner of many such financings.

The Guidelines on Policies and Procedures for External Commercial Borrowings (the ECB Guidelines) have also been liberalized. The ECB Guidelines now provide that Indian corporates may incur debt of up to $50 million and developers of infrastructure projects may access foreign exchange funds of up to $200 million for the purpose of equity investments in downstream infrastructure projects, without any approvals being required for the same. Procedurally, it has never been easier for Indian corporates to borrow foreign funds.

Independent regulators and dispute resolution

Each sector needs special regulation. Independent regulators have been and continue to be established for each sector, to provide the industry and technical expertise. Teething troubles have obviously arisen, and turf wars are not uncommon. However, as with some of the earlier experiments with tribunalization, the system should mature with time and familiarity.

Different litigation forums for foreign and Indian lenders, coupled with the lack of clarity of the Debt Recovery Tribunal's powers, and the delays associated with the civil judiciary, appear to have been overcome through inter-creditor arrangements, which now form the cornerstone of multi-lender financing.

Key causes for slow development and outlook for the future

The past decade has taught India many lessons in improving its ability to attract and retain serious investment in the infrastructure sector.

The lack of a policy framework and the sometimes poorly conceived policy initiatives seem to lie at the heart of the difficulties of the infrastructure sector. These added not merely legal risk, but also significant commercial risk. Obviously the lack of regulatory clarity on certainty of revenue streams, as well as competitive forces, did undermine the viability of projects. Some of the above problems have been exacerbated by the lack of an independent regulator, though in certain sectors, one is not sure if this has been a blessing in disguise.

Other factors for the perceived failure include the lack of well-laid bidding and procurement procedures, which earlier did lead to time consuming litigation. The initial phases of opening up a sector had necessarily to be a negotiated process, and experiments with international competitive bidding procedures were not always warranted. A few experiments in the auctioning of licences, such as in the telecom sector, had the advantage of induced competition, but the lack of clarity in the policy framework, the licensing conditions and a perceived lack of transparency were the causes of excessive initial delays.

The fear of the uncontrollable judicial process and its expansive view of locus standi, resulting in multifarious public interest litigation and the consequent inevitable delay to the project, also contributed to increased levels of anxiety for both developer and lender.

The list does not end there. The lack of coordination between the central and state governments, coupled with the lack of quality governmental agencies/advisers that were acquainted with the complexities of financing models, and the inevitable fears of a large and uneducated labour force caused a lot of hesitation towards and unnecessary suspicion of foreign investors. In fact, many utilities and agencies did believe that private financing, particularly with foreign investment, were essentially western conspiracies to exercise economic hegemony. Experienced advice and confidence building have made the difference in recent years.

The government and the players have realized that it takes a lot more than desperation and public need to achieve the financial closure and successful operation of infrastructure projects. A number of policy measures have been announced to overcome the earlier shortcomings, and further such announcements are in the offing. A major development in this regard is the consolidation of the many earlier, sometimes conflicting, notifications on foreign investment.

The government has also realized the need for, and obtained expert advice on the method and manner of developing the various sectors. An offshoot of this is the disinvestment process, whereby the government has started to off-load its stake in key industries to private participants. The silver lining of this process is not just that the units are already entrenched, but are also largely profit making and suitable for expansion.

The judiciary has now clarified many issues relating to the procurement process, and had strengthened the hands of the government in determining the scope and manner of private participation in public utilities. Certain basic concepts relating to locus standi have been clarified and vexatious litigants have been curtailed, by measures including the imposition of penalties.

Industry associations and other non-governmental bodies have also started many initiatives to educate both the public and the regulatory authorities on public-private partnerships in key sectors. Seminars, conferences and other discussion fora, on topics and issues related to infrastructure development and financing, are now a commonplace feature on literally any Indian's calendar. Editorials and opinions are also more focused on the need for an elimination of political posturing from infrastructure development.

Increased industrialization, the growth of GDP and control over inflation should, in conjunction with the above, contribute to make India a more investor-friendly location that ever before.

In conclusion, there is no gain saying that developers and financiers will continue to require a great deal of understanding, patience and perhaps an enduring belief in karma. However, there is a large viable infrastructure market waiting to be developed on a project finance basis in India, probably one of the largest in the world and real gold at the end of the rainbow for those willing to go the distance.

Project Finance

Amarchand & Mangaldas & Suresh A Shroff & Co.
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