Infrastructure-4col - ICISAicisa.cag.gov.in/resource_files/4ad63928a7679ad9c19dd533bdf2cea5.pdfEPF Employees Provident Fund ... JNPT Jawaharlal Nehru Port Trust ... MTNL Mahanagar

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IndiaFinancing Infrastructure :

Addressing Constraints and Challenges

June 2006

Finance and Private SectorDevelopment Unit South Asia Region

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EXECUTIVE SUMMARY 9

I. INTRODUCTION 21

II. CONSTRAINTS TO INFRASTRUCTURE FINANCING 25

2.1 Financial Sector Related Constraints 25

Constraints to equity and quasi-equity financing 25

Restrictions on ECBs 29

Limited use of takeout financing 30

An underdeveloped corporate bond market and the lack of longer term financing 30

Regulatory and institutional issues constraining higher participation ofFIs and commercial banks 36

2.2 Fiscal Barriers to Private Financing of Infrastructure 41

High customs duties on infrastructure equipment 42

Section 10(23G) of the Income Tax Act 42

Tax holidays under section 80IA 43

Poor state government finances 43

2.3 Approvals, Red tape and Inadequate Administrative Capacity in Government 43

Multiple clearances 43

Lack of coordination between government ministries / departments 44

Problems in contract negotiations and delays in the award of contracts 44

Limited capacity within government to execute PPPs in infrastructure 44

2.4 Constraints Related to Poor Infrastructure Regulation andRelated Risks and Uncertainties 45

Sector specific issues: roads 45

Sector-specific issues: power 46

Sector-specific issues: ports, airports and railways 48

The RBI and non-sector specific regulatory issues 48

III CONCLUSIONS AND THE WAY FORWARD 51

3.1 Addressing Financial Sector and Related Regulatory Issues 51

Contents

INDIA – Financing Infrastructure : Addressing Constraints and Challenges

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Facilitating equity financing 51

Encouraging the use of more innovative financing instruments likemezzanine and takeout financing 52

Developing a longer term corporate bond market 52

Encouraging participation by FIs in infrastructure financing 53

3.2 Fiscal measures that would support private financing ofinfrastructure and financial market innovation 55

3.3 Streamlining Approvals, Cutting Down on Red Tape andEnhancing Infrastructure Regulation 56

3.4 Stimulating Public Private Partnerships—Building Government Capacity 56

BIBLIOGRAPHY 61

ANNEXES:

ANNEX A: INVESTMENT NEEDS FOR INFRASTRUCTURE, 2001-02 TO 2010-11 63

ANNEX B: CASE STUDY: TAKEOUT FINANCING 84

ANNEX C : STATUS OF DEBT MARKET IN INDIA 86

ANNEX D: USE OF FINANCIAL INSTRUMENTS TO INCREASE LIQUIDITY 89

ANNEX E: PARTICIPATION BY FIs IN INFRASTRUCTURE PROJECTS 90

ANNEX F: SECTOR SPECIFIC RECOMMENDATIONS TO IMPROVETHE REGULATORY ENVIRONMENT 96

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ACKNOWLEDGEMENTS

This report was prepared by a joint World Bank-IFC team led byPriya Basu (Lead Economist, Finance and Private SectorDevelopment, South Asia Region, World Bank), and comprisingInderbir Dhingra and Varsha Marathe (Finance and Private SectorDevelopment, South Asia Region, World Bank), and ShalabhTandon and Mayank Choudhary (IFC). The report benefited froma background note on infrastructure financing gaps prepared byOmkar Goswami (CERG, India). The peer reviewers were CliveHarris (Energy and Infrastructure, South Asia Region, World Bank)and Stephan von Klaudy (Infrastructure Sector, World Bank). AllenTownsend (Energy and Infrastructure, South Asia Region), AlainLocussol (Water and Urban, South Asia Region) and Anita George(IFC) commented on an earlier draft. Heather Fernandes (Financeand Private Sector Development, South Asia Region, World Bank)designed the report and provided administrative support. Thisreport was discussed with the Ministry of Finance, Governmentof India; while the report benefited greatly from commentsprovided by the Government of India, it does not necessarily beartheir approval for all its contents, especially where the Bank hasstated its judgments/opinions/policy recommendations.


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AAI Airports Authority of India

ADB Asian Development Bank

AERA Airport Economic RegulatoryAuthority

AGR Adjusted Gross Revenue

ANDIMA Association of Open MarketInstitution

APDRP Accelerated Power Developmentand Reform Program

BIS Bank for International Settlements

BOT Build Operate Transfer

BRO Border Roads Organization

BSNL Bharat Sanchar Nigam Limited

CAGR Compounded Annual Growth Rate

CBDT Central Board of Direct Taxes

CDMA Code Division Multiple Access

CFS Container Freight Stations

COD Commercial Operations Date

CONCOR Container Corporation of IndiaLimited

CRF Central Road Fund

CRR Cash Reserve Ratio

DDBDEA Deep Discount Bonds Departmentof Economic Affairs

DFI Development Finance Institution

DoT Department of Telecom

DRT Debt Recovery Tribunal

ECB External Commercial Borrowings

EGOM Empowered Group of Ministers

EPC Engineering ProcurementConstruction

EPF Employees Provident Fund

EXIM Export Import Bank of India

FDI Foreign Direct Investment

FI Financial Institution

GAIL Gas Authority of India

GBS Gross Budgetary Support

GDP Gross Domestic Product

ABBREVIATIONS AND ACRONYMSGE General Electric

GIC General Insurance Corporation

GQ Golden Quadrilateral

GSM Global System for MobileCommunications

HSD High Speed Diesel

HUDCO Housing and Urban DevelopmentCorporation

IATA International Air TransportAssociation

ICD Inland Container Depot

IDBI Industrial Development Bank ofIndia

IDF India Development Fund

IDFC Infrastructure Development FinanceCorporation (IDFC)

IEBR Internal and Extra BudgetaryResources

IIBI Industrial Investment Bank of IndiaLimited

IIG Inter Institutional Group

IIM Indian Institute of Management

ILD International Long Distance

IL&FS Infrastructure Leasing and FinancialServices

IMC Inter-Ministerial Committee

IMG Inter-Ministerial Group

IPP Independent Power Producer

IR Indian Railways

IRDA Insurance Regulatory andDevelopment Authority

IRR Internal Rate of Return

ISP Internet Service Providers

JNPT Jawaharlal Nehru Port Trust

LIC Life Insurance Corporation of India

M&A Mergers & Acquisitions

MAT Minimum Alternate Tax

MCA Model Concession Agreement

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MDR Major District Roads

MEXDER Mexican Derivatives Exchange

MIBOR Mumbai Inter Bank Rate

MoF Ministry of Finance

MoU Memorandum of Understanding

MoU Minutes of Usage

MSEB Maharashtra State Electricity Board

MTNL Mahanagar Telephone NigamLimited

NABARD National Bank for Agriculture andRural Development

NDS Negotiated Dealing System

NDTL Net Demand and Time Liabilities

NEEPCO North Eastern Electric PowerCorporation

NHAI National Highways Authority ofIndia

NHDP National Highway DevelopmentProject

NHPC National Hydro Electric PowerCorporation

NIA New India Assurance Company

NIC National Insurance Company

NLC Neyveli Lignite Corporation

NLD National Long Distance

NPA Non-Performing Assets

NRVY National Rail Vikas Yojana

NSC National Savings Certificate

NSE National Stock Exchange

NSICT Nhava Sheva InternationalContainer Terminal

NTP 99 New Telecom Policy 99

NTPC National Thermal PowerCorporation

OECD Organization for EconomicCooperation and Development

OIC Oriental Insurance Company

OTC Over The Counter

PFC Power Finance Corporation

PFI Public Financial Institutions

PGCIL Power Grid Corporation of India

PLF Plant Load Factor

PMGSY Pradhan Mantri Gram SadakYojana

PMO Prime Minister’s OfficePPA Power Purchase AgreementPPF Public Provident FundPPP Public-Private PartnershipPRG Partial Risk GuaranteePSA Port of SingaporePWD Public Works DepartmentsQIB Qualified Institutional BuyersRARSY Remote Area Rail Sampark YojanaRBI Reserve Bank of IndiaROSC Report on the Observance of

Standards and CodesRTGS Real-time Gross SettlementSARFAESI Securitization and Reconstruction

of Financial Assets andEnforcement of Security Interest

SBI State Bank of IndiaSEBI Securities and Exchange Board of

IndiaSERC State Electricity Regulatory

Commission SIDBI Small Industries Development Bank

of IndiaSLR Statutory Liquidity RatioSND National Private Bond SystemSOE State Owned Enterprise SPV Special Purpose VehicleTAMP Tariff Authority for Major PortsTDR Term Deposit Receipt TDSAT Telecom Dispute Settlement

Appellate TribunalTEU Twenty-foot Equivalent UnitsTIFI The Infrastructure Fund of IndiaTRAI Telecom Regulatory Authority of

IndiaUII United India AssuranceUS GAAP US Generally Accepted Accounting

PrinciplesUTI Unit Trust of India


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CURRENCY EQUIVALENTSAs of April 27, 2005, US$1 = Rs. 43.43 Rupees (Rs).

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It is well recognized that, with its present stateof physical infrastructure, India will be hard-pressed to sustain 7 percent plus annual GDPgrowth over the medium term. Be it in power,roads, ports, airports, water, railways, urbanfacilities or even telecoms, the country’sinfrastructure needs are enormous. There is amassive and urgent need to increase investmentin these sectors.

In recent years, efforts have been made by theGovernment of India (GoI) to step-up investmentin infrastructure, and particularly to catalyzegreater private investment. In the Union Budget2005, the Finance Minister reiterated theimportance of infrastructure for rapid economicdevelopment and noted that, in theGovernment’s view, “the most glaring deficit inIndia is the infrastructure deficit”. In this context,he proposed to continue (and enhance)budgetary support for investment ininfrastructure, including through initiatives tocatalyze greater private financing ofinfrastructure through a proposed viability gapfund (VGF) and a special purpose vehicle (SPV).Efforts have also been made, over the years, tostrengthen the policy and regulatory frameworkunderpinning some of the key infrastructuresectors, with notable success achieved in thetelecommunications sector. The commitment toinfrastructure has been further reiterated in theUnion Budget 2006 recently, through increasedbudgetary allocations and reform initiatives forinfrastructure sectors.

But investment in infrastructure over the pastdecade has not lived up to expectations. The1996 India Infrastructure Report projected theneed for an increase in investment in

EXECUTIVE SUMMARY

infrastructure from levels of under 5 percent toabout 8 percent of GDP by 2005/06. The samereport targeted significant increases in bothpublic and private spending on infrastructure—including a doubling of private infrastructurespending to over 2 percent of GDP by the late1990s, and then further increases. At the end ofthe 1990s, however, actual investment (publicand private) in infrastructure1 remained at under4 percent of GDP per annum. In 1999, publicinvestment in infrastructure stood at 2.8 percentof GDP while private investment was just 0.9percent of GDP2. Indeed, throughout the pastdecade, private investment in infrastructure hasremained at well below the targeted 2 percentof GDP.

Cross-country data shows that, even in countrieswhich recorded impressive private investment ininfrastructure in the 1990s, the figure wastypically 4 percent to 6 percent of GDP. While itis true that even with good policies in place,private investment will not contribute the bulkof what is needed and public investment willretain its predominant role. However, there isroom for PPPs to play a much greater role thanbefore. Estimates suggest that over the lastdecade private investment has accounted foraround 20% of total investment in infrastructurein developing countries. India can, of course, do

1 In energy, transport, telecoms and water supply &sanitation.2 The estimate for private investment in telecom used byus, from the World Bank’s WDI database, is lower thanthat cited by the Planning Commission. Nonetheless,even if one considers the private investment figure in thetelecom sector as released by the Planning Commissionfor the Plan Period 1997-2002, total private investmentin infrastructure as a percent of GDP in 1999 onlyincreases marginally to 1 % of GDP from 0.9%.


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much better. Since 1996 private investment inChile has averaged 3-4% of GDP; in Brazil it hasaveraged 1.5% and in Colombia around 2-3%over the same time period. Over this period inChina private investment has accounted foraround 10% of total investment in the roadprogram, compared to around 4% in India.

International experience shows that there is nounique formula for facilitating PPPs ininfrastructure. However some of the keyingredients of a successful PPP program are:

clear and stable policy and legal frameworksfor PPPs that have broad support;

competent and enabled institutions that canidentify which projects are best done as PPPsand whether they are priorities, and thenprocure and properly monitor them;

efficient oversight and dispute resolutionprocedures; and

of course, well developed financial markets,including long-term corporate bond market.

This note, which was prepared in response to aspecific request from GoI’s Department ofEconomic Affairs (DEA), focuses primarily onfinancial sector related constraints to privateinvestment in key infrastructure sectors in India,where the potential for greater privateparticipation exists. It identifies key financialsector related constraints and suggests practicalsolutions for addressing them. However, sincefunding is inextricably linked to policyuncertainties, sector specific policy andregulatory issues, and procedural hassles facedby project developers, these constraints—whichare arguably the most binding at this stage inthe development of Indian infrastructure—arealso examined in the note.

It should be clarified at the outset that theanalysis presented in this note will become

particularly relevant as infrastructure policy andregulatory frameworks emerge and reformsadvance; a better developed financial systemcan accelerate access to finance byinfrastructure projects, while a less developedfinancial system is likely to slow down reform ininfrastructure since it cannot as quickly respondto the changing financial requirements, inparticular for long-term resources. Goodexamples in this context are South Africa andChile, both of which were able to mobilize long-term (i.e. up to and over 20 years) local currencydebt in form of bank loans and bonds, once theyhad designed toll road programs that generatedprojects with acceptable risk profiles. Otherexamples would be Malaysia and South Korea,or in Europe countries like Portugal, Spain andGreece that would not have been able tomobilize long-term resources for their privateinfrastructure programs as smoothly in the pre-Euro period.

That finance will become an ever moreimportant constraint for Indian infrastructure overthe medium term is evident from calculations onfinancing gaps. According to the estimates offunding in the GoI’s given for the Tenth and theEleventh Five Year Plans, government finance— consisting of gross budgetary support to thecentral plan, allocations to the states and internaland extra-budgetary resources of central StateOwned Enterprises (SOEs) — amounts to roughlyRs.13,601 billion for the main six infrastructuresectors3 over the period 2001-02 to 2010-11.This, of course, assumes that the governmentwill be able to undertake fiscal adjustment. Evenif one were to accept this assumption, Indiawould still face a staggering financing gap of overRs.5,500 billion for the decade ending 2010-11.By any canon, this is a huge difference betweenwhat the country needs and what thegovernment can pay. Success in attractingprivate funding to help meet this gap will dependon India’s success in having regimes, systems andpractices in place that consistently encourage

3 These comprise roads, power, telecommunications,railways, airports and ports.

Executive Summary

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private investment and public privatepartnerships (PPPs) in infrastructure.

The note is organized as follows. Section Iprovides a brief introduction to the topic.Section II analyses the reasons why moreprivate finance has not been forthcoming forthe different infrastructure sectors. In doingso, it examines barriers posed by the absenceof a sufficiently sophisticated financial sector,f iscal barriers, red tape and proceduralinefficiencies that have contributed to projectdelays and discouraged private investors, andconstraints arising from the absence ofadequate infrastructure regulation thatexacerbates r isks and uncertaint ies forinvestors. Section III suggests practical waysto mitigate these constraints and policyreforms to facilitate more sustained privateinvestment and PPPs in infrastructure.

KEY CONSTRAINTS TO PRIVATEFINANCING OF INFRASTRUCTURE

Financial sector constraints to privatefinancing of infrastructure

Infrastructure projects are complex, capitalintensive, long gestation projects that involvemultiple and often unique risks to projectfinanciers. Infrastructure projects arecharacterized by non-recourse or limitedrecourse financing, i.e., lenders can only berepaid from the revenues generated by theproject. This limited recourse characteristic, andthe scale and complexity of an infrastructureproject makes financing a tough challenge,which is further compounded by two factors.First, a combination of high capital costs and lowoperating costs implies that initial financing costsare a very large proportion of the total costs.Second, infrastructure project financing calls fora complex and varied mix of financial andcontractual arrangements amongst multipleparties including the project sponsors,commercial banks, domestic and international

financial institutions (FIs), and governmentagencies. Key constraints in the financial sectorrelate to the following:

Raising adequate equity finance tends to bethe most challenging aspect of infrastructureproject financing, as equity typically shouldersthe greatest level of operational, financial andmarket risk. However, at present, limited exitoptions for investors limits equity financing.Other constraints include a shallow capitalmarket (albeit continuously improving), andweaknesses in corporate governance(primarily minority shareholder protectionrights).

Mezzanine financing, which is critical infunding infrastructure projects in developedcountries, is also limited in India. The reasonsfor this are many, notably: (i) the lack of asufficiently large and varied pool ofinfrastructure projects, which leads to apreference among funding institutions to optfor more straightforward loans (rather thanhybrids); and (ii) interest rate caps on externalcommercial borrowing (ECBs), which preventthe pricing of different debt or quasi-equityinstruments (like mezzanine financing)commensurately with the risks associatedwith them.

Interest rate caps pose a constraint toattracting ECBs, but an even greaterconstraint in utilizing foreign currency loansis the lack of a sufficiently deep forwards-market in foreign exchange. Infrastructureprojects require long tenor loans, and iffinanced through foreign currencyborrowings these need to be adequatelyhedged against currency risks since fewinfrastructure projects have forex earningsto serve as a natural hedge. Inability to hedgelong term currency risk in a market which islimited to one year’s forward cover poses abig challenge to the use of foreign currencyloans in these projects.


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Underdeveloped debt markets are yetanother key constraint to infrastructurefinancing, given that most infrastructureprojects begin to generate profits in 10-15years and require longer term debt. The lackof size and depth in India’s corporate bondmarket is associated partly with the lack ofdepth in the government bond market andthe absence of a yield curve for governmentbonds which could serve as a benchmarkfor corporate bond. Beyond that, corporatedebt markets are constrained bycumbersome primary issuance guidelines;inadequate credit information; inefficientclearing and settlement mechanisms; poorand lengthy enforcement laws relating todefault proceedings; inefficiencies arisingfrom weaknesses in regulation, includingpoor coordination among the variousagencies involved in corporate debt marketregulation; and the absence of long terminvestors.

A host of regulatory and institutional problemsfacing financial institutions (FIs) constrain theirparticipation in infrastructure projects. Afundamental factor limiting the participationof all types of FIs in infrastructure financingrelates to regulatory uncertainty, which raisesthe risk-profile of infrastructure sectors, andmakes FIs reluctant to finance infrastructure,particularly in the early stages, where projectrisks are concentrated. Restrictivegovernment policies and regulatory guidelineshave further constrained the participation ofinsurance companies and pension funds ininfrastructure. For example, InsuranceRegulatory and Development Authority (IRDA)requires insurance companies to invest in debtpaper with a minimum credit rating of ‘AA’,which automatically excludes investment byinsurance companies in debt paper of mostprivate infrastructure sponsors. Insufficientknowledge and appraisal skills related toinfrastructure projects also pose a constraint.

Fiscal barriers

An enabling fiscal environment is a pre-requisite for attracting private sector playersto inherently high risk ventures. There aresome fiscal issues—particularly in relation toSections 10(23G) and Section 80IA of theIncome Tax Act—that need to be ironed outin order to give further fillip to infrastructuresectors. Also, the fact that nearly all statessuffer from serious fiscal imbalances and areridden with huge debt obligations does notmake them the most bankable businesspartners for the private sector.

Approvals, Red tape and GovernmentAdministrative Capacity

Infrastructure projects require multipleclearances at centre, state and local levels,resulting in serious delays. The time taken toobtain all the requisite approvals for aninfrastructure project can vary between alow of 18 months to as much as four to fiveyears. In spite of many states havingintroduced, on paper, ‘single windowclearance’, the fact remains that when mostprojects apply for approvals at the state-level,these have to go through multiple clearancesat various levels.

Most infrastructure projects involve dealingwith multiple ministries. One of the keyreasons for projects not taking off at the pre-financing stage is that the actions and policiesof different ministries are not coordinatedand are often at variance with each other.

Problems in contract negotiations and delaysin the award of contracts are pervasiveacross all infrastructure sectors.

Limited capacity within government toexecute PPPs in infrastructure

Both the central government and the statesare aiming to use PPPs more extensively tohelp meet gaps in the provision of basic

Executive Summary

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services in the country. But PPPs represent aclaim on public resources that needs to beunderstood and assessed. They are oftencomplex transactions, needing a clearspecification of the services to be providedand an understanding of the way risks areallocated between the public and privatesector. Their long-term nature means thatthe government has to develop and managea relationship with the private providers toovercome unexpected events that over timecan disrupt even well-designed contracts.Financiers of these projects critically evaluatea project in terms of all design featuresmentioned above and hence the ability toconceptualize and structure a PPP from thegovernment’s side is a key variable indetermining the viability of, and thewillingness of FIs and banks to finance theproject.

The capacity to effectively conceptualize,procure and manage these PPPs is limitedwithin the public sector – bothorganizationally (legal frameworks,procurement guidelines etc) and at theindividual level. Internationally, governmentsembarking on PPP programs have oftendeveloped new policy, legal and institutionalframeworks, individual training and technicalsupport to provide the requiredorganizational and individual capacities. Asimilar comprehensive effort at buildingcapacity to facilitate PPPs is needed by thecentral and state governments.

Deficiencies in Sector Policy andRegulatory Frameworks

There are also a number of sector specificpolicy and regulatory impediments, whichvary considerably across sectors. In some,such as telecom, the obstacles andcontradictions during the initial phase of the1990s are things of the past. Throughlearning-by-doing, the Telecom Regulatory

Authority of India (TRAI) has truly establisheditself as an efficient, fair, expeditious andindependent regulator which is respected asa body for creating a level playing field andfostering the rapid growth of telecom in India.In sharp contrast, the regulatory environmentin power leaves much to be desired; and asyet there is no independent regulatoryinstitution in place for ports or airports.

INCREASING PRIVATE FINANCINGOF INFRASTRUCTURE: THE WAYFORWARD

Addressing Financial Sector and RelatedRegulatory Issues

A deeper and more diversified financial sectorcould certainly help increase private participationin infrastructure. Developing local capital marketscan play a critical role in facilitating privateinvestment in infrastructure. Key priorities include:

Facilitating equity financing

Improving exit policies to make it easier forinvestors to exit. In this context, a key priorityis for Reserve Bank of India (RBI) to introduceenabling regulations for the use of put optionsas an exit mechanism for investors in unlisted(privately held) companies. At present, theregulations do not allow financial investorsto reach an upfront agreement with sponsorson the terms of a put option, if the sponsorcompany is unlisted. Greater comfort on exitwould encourage financial investors to takeequity in greenfield infrastructure projects byhaving some defined, low guaranteedreturns. This practice is standard in manyemerging markets, especially in LatinAmerica. An additional and desirableoutcome of this would be that with the entryof more financial investors in the equitymarket, it would broaden the investor baseand with successful closing of projects itwould increase investor confidence.


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Other factors that would help increase equityinvestment in infrastructure projects includebetter corporate governance, with aparticular focus on minority shareholderprotection rights.

Encouraging the use of more innovativefinancing instruments like mezzanine andtakeout financing

Removing interest rate caps on ECBs couldencourage foreign investors to useinstruments like mezzanine and take outfinancing for infrastructure investment: TheGovernment should consider either removingthe 350 basis point interest rate cap aboveLIBOR on infrastructure loans above 5 years,or, at the very least, double the cap to 700basis points above LIBOR. In addition, toolsfor mitigating the risks involved forinternational lenders should be developed —for example, Partial Risk Guarantees (PRGs)to hedge against political risk, and developingthe swap market to mitigate foreignexchange risk.

Developing a longer term corporate bondmarket

A well developed government bond market is acritical prerequisite to the development of thecorporate bond market. Hence, there is anurgent need to increase the depth and thebreadth of the government bond market,through the following measures:

To improve the breadth of the governmentbond market, the government shouldconsider recalling the existing illiquid,infrequently traded bonds and re-issue liquidbonds.

The existing regulation that requiresinstitutional funds such as pension funds andinsurance funds to hold till maturity allgovernment securities should be removedand they should be allowed to actively tradein the market.

To bring in more retail investors to thegovernment bond market there is a need tointroduce an element of marketability andprice discovery, which can only be broughtin by making securities trading screen basedand more transparent.

Furthermore, the development of India’scorporate bond market would benefit from thefollowing measures:

Issuance and listing: The procedures forpubl ic issuance of debt need to bestreamlined, drawing on lessons fromcountries like Korea, where regulatoryapproval takes just 5 days (against 21 daysin India). To facilitate timely market accessof corporate debt securities, a distinctionbetween regulatory requirements thatapply to the wholesale market (wherequal if ied inst itut ional investors areconcerned) from those that apply to theretail market could be made to enablelisting to be a straightforward exercise.Private debt placement guidelines alsoneed to be made less restrictive. Extendingshelf registration to all types of corporateissuers, would also facilitate quick, timelyand cost-effective access of issuers to themarkets. This is widely used in developeddebt markets, such as the US and UK,Korea and Singapore.

Better corporate credit information can playa critical role in corporate debt marketdevelopment. More effort needs to be putinto collecting and disseminating data onbond issues, size, coupon, latest credit rating,underlying corporate performance,information on secondary trading(particularly pre-trade information related toinvestors having access to best quotes) anddefault histories of companies. A centralizedagency for this purpose would be a welcomestep forward.

Executive Summary

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Better market infrastructure. Efficient tradingand settlement systems are critical forproviding an exit route for debt investmentsin infrastructure. India needs to upgrade itstrading and settlement systems. Mechanismsthat have been put in place in several Asianand Latin American markets, which haveadopted sophisticated settlement systemsand have also put in place mechanisms forrecourse (through guarantee funds/compensation funds) in settling transactions,could provide some useful lessons.

New products. Government shouldencourage financial intermediaries to offernew product structures (e.g., creditenhancement, bond insurance) that enablesub-investment grade corporates/municipalities to access financing. This couldbe achieved through initial guarantee orfunding support to the financialintermediaries. RBI and Securities andExchange Board Board of India (SEBI) shouldconsider regulatory reforms that would helpdevelop hedging tools for investors andtraders: e.g., credit derivatives, bond futuresand options.

Increasing the appetite of long-terminvestors. Given the current stage of marketdevelopment, where long term institutionalinvestors are yet to develop, the bankingsystem could play an important role in thedevelopment of the corporate debt market;regulatory caps on banks’ investments incorporate bonds could be relaxed (limited to10 percent of their total non-SLR investments)as could the minimum rating requirement(minimum investment grade, i.e. AA andabove). While not an immediate constraint,over the medium term, the debenture trusteesystem needs to be strengthened toencourage retail investment in infrastructureby providing protection from default by thecompany in payment of timely interest. Othermeasures also need to be taken to encourage

insurance companies and pension funds tostep-up their investment in infrastructureprojects. These are discussed below.

Encouraging participation by FIs ininfrastructure financing

Investment policies and regulatory guidelinesfor insurance companies, pension funds,mutual funds, banks and other FIs need tobe sufficiently flexible for these entities tochoose an appropriate risk-return profilewithin fiduciary constraints. This will also helpprofessionalize fund management. While itwould not be appropriate or practical tointroduce radical changes in investmentguidelines at this stage, primarily becauseissues such as high rate of assured return,deficiencies in the accounting methodology,lack of skills in fund management need tobe resolved first, there is certainly a need toderegulate these sources of long-termfinance and formulate prudential norms forinfrastructure related projects. Theauthorities should look at the existinginvestment norms prescribed for insurance,Employees Provident Fund (EPF) and PublicProvident Fund (PPF) with a view to relaxingthem so that these institutions can commitsignificantly larger amounts of long-termfunds for infrastructure. In particular,investment guidelines for:

insurance companies need to be modified toallow investment in instruments with a ratingof less than AA. At present theseinvestments are counted towards‘unapproved’ investments. This, inconjunction with development of creditenhancement products should enableinsurance companies to invest ininfrastructure projects;

pension funds should be modified to allowthem to invest in infrastructure projects,which have a guarantee from the centralgovernment or multilateral agencies. The cost


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of such funding will also be lower since thesewill not carry any currency risk.

Going forward, with appropriate changes inthe investment guidelines, three mechanismscould be used to channel pension funds in toinfrastructure projects without distorting theirrisk-return profile. First, to initialize entry into such projects at the lowest risk level,pension funds should be allowed to invest inprojects where a multilateral agency orcentral government extends a guarantee onthe minimum rate of return. The multilateralagency in turn could charge the projectsponsor (such as National Highways Authorityof India (NHAI)) a commercial fee to extendthis guarantee. Second, pension funds shouldbe permitted to deposit part of their fundswith banks for long periods and ensure thatthe banks use them exclusively forinfrastructure financing. Third, in the longerterm, pension funds should be allowed todeploy funds in projects appraised by the all-India FIs.

There exists an urgent need for specializedinfrastructure financing institutions such asInfrastructure Leasing and Financial Services(IL&FS) and Infrastructure DevelopmentFinance Corporation (IDFC) to participate atthe design stage of a project. The backingof such institutions at an early stage wouldcarry at least two advantages. First, it wouldmake it easier for project developers toobtain finance from other sources. Second,it would provide the developer with theopportunity to use the expertise of suchinstitutions in project designing and financialstructuring. It must be noted, of course, thatpotential conflicts of interest could arise ininstances where the specializedinfrastructure financing institution providesadvisory services for the project and also bidsfor the role of structuring the financingpackage. Such potential conflicts of interestwould need to be handled carefully.

Project evaluation and fund managementskills at banks and other FIs with long termfunds (insurance companies and pensionfunds) need to be strengthened. In particular,insurance companies need to be encouragedto develop specialized appraisal skills in theinfrastructure projects. Given the largecorpus of funds available with thesecompanies, going forward, they will need tobecome lead financiers in infrastructureprojects. However, at present, they do nothave the requisite appraisal skills toappropriately evaluate project viability.

There is a need to create a debt recoverymechanism for pension and provident fundson the lines of the Debt Recovery Tribunal(DRT). While the need for such a tribunal isnot felt at present due to the restrictedinvestment profile, it will be critical if pensionand provident funds are to have anysignificant exposure in the infrastructuresector.

In order to provide an active incentive forbanks to scale-up infrastructure financing,the RBI could consider classifyinginfrastructure as one of the priority sectors.Moreover, as far as banks are concerned,liabilities created by the sale of long terminfrastructure bonds may be kept outside thepurview of Statutory Liquidity Ratio (SLR) andCash Reserve Ratio (CRR).

Fiscal measures that would support privatefinancing of infrastructure and financialmarket innovation

While it should be noted that fiscal concessionsare not necessarily desirable, per se, they mighthelp increase returns and hence, investment. Inthis context:

The Ministry of Finance (MoF) could considerreducing the customs duty on capital goodsand machinery that are critical for roads,ports, airports, power, railways,

Executive Summary

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telecommunication, oil and gas pipelines andsupply and distribution of water. This fiscalincentive would significantly reduce the costof many infrastructure projects.

With respect to the fiscal concessions undersection 80IA and 80IB, the government couldconsider extending the time horizon from thepresent 10+5 years (0 percent tax on the first,and 50 percent tax liabilities in the secondperiod) to a 20 year time horizon where theproject would be tax free for the first 10years, pay a third of the tax liabilities in thenext five and 50 percent of it in the final five.In addition, the government could alsoconsider removing the provisions of MinimumAlternate Tax (MAT) for those infrastructurecompanies which are availing the benefitsunder sections 80IA and 80IB. Anotheralternative would be to remove sections 80IAand 80IB altogether and, instead, allow forunlimited carry-forward of losses. This wouldallow all infrastructure companies to set offthe large losses in the initial years ofoperations against the profits of the laterperiod — and, in effect, create a moretransparent fiscal incentive than 80IA or 80IB.

The fiscal benefits given under section10(23G) should be approved at one shot forthe stipulated 10-year period, instead of thepresent practice of the companies or SPVsgetting annual approval from the CentralBoard of Direct Taxes (CBDT). Moreover, thegovernment should seriously considereliminating the word “wholly” — whichprevents any infrastructure SPV fromredeploying its investible surplus in anothergroup infrastructure SPV — and substitutingit by “substantially”. The tax implications ofthis is minuscule compared to the operationalflexibility that it will give to companies whichhave more than one infrastructure SPV. Theconcept of escalating section 10(23G)benefits to umbrella infrastructure companiesshould be investigated — something that

could be possible if the word “wholly” isreplaced by “substantially”. This will allowsponsors to consolidate their infrastructureSPVs under a single holding company, whichwill have the critical threshold to carry out asuccessful public offering. Such a mechanismwill give sponsors and FIs an exit option fromequity participation, which could be recycledfor new projects. Also, the government oughtto consider making the benefits of 10(23G)available to retail investors, who could theninvest in dedicated infrastructure mutualfunds which would use the finances soobtained to offer longer term credit facilitiesto infrastructure projects.

Streamlining Approvals, Cutting Down onRed Tape and Enhancing InfrastructureRegulation

Governments need to assure potentialinvestors that there is an intention to lay outclear policy frameworks for each sector andreduce uncertainties arising out of policyimplementations and arbitrary actions incontractual commitments of thegovernments.

All infrastructure projects involve multipleclearances from different Ministries andDepartments — which contribute tosignificant delays. In order to mitigate thisproblem, the Government of India needs toset up sufficiently high-level Inter-Ministerialgroups for roads, power, telecom, ports andairports. Ministries which are represented ineach of these groups would vary accordingto the sector. It would be useful for thesegroups to be formed under the aegis of thePlanning Commission, and for them to meetonce every 45 or 60 days to discuss andresolve all outstanding Inter-Ministerial issues.

In addition, each Ministry substantivelydealing with infrastructure should adopt thepractice introduced by the Ministry of Powerby setting up Inter-Institutional Groups (IIG).


18

These would consist of the infrastructuredevelopers and senior representatives frombanks and FIs. Under the leadership of theSecretary of the concerned Ministry, the IIGswould meet once a month to discuss theprogress of specific infrastructure projectsand to resolve any outstanding issues ordisputes between the developers and variousfunding agencies. This experiment has beenvery successful in the case of Power andshould be replicated in other key Ministries.

Infrastructure is an urgent national priority. Togive it the importance it deserves, there has tobe a clear signal that the ownership lies at thehighest level of government. Therefore, itwould be advisable for the Prime Minister’soffice (PMO) to have a dedicatedinfrastructure secretariat which would not onlymonitor the status of projects in differentsectors but also convene quarterly meetingsbetween the Prime Minister and those of hiscabinet colleagues in charge of infrastructureministries. This secretariat could ensureconsistency in policy formulation andimplementation for various infrastructuresectors, and would liaise with variousgovernment agencies to present a singlewindow clearance to the private sector. Thisact alone would demonstrate the government’sfocused commitment to infrastructure. Thegovernment has constituted a Committee onInfrastructure chaired by the Prime Minister.This Committee has a secretariat in thePlanning Commission. This committee doesfocus on policy direction for improvinginfrastructure in the country and is aimed atensuring inter-ministerial coordination oninfrastructure issues. However, there is also aneed for a more operational role for asecretariat as suggested above.

Develop a policy and regulatory frameworkfor sectors where no framework has beenarticulated (airports, railways) and establishindependent regulators.

Stimulating Public Private Partnerships—Building Government Capacity

There is a need to encourage entry of the privatesector in infrastructure development throughviable PPP projects, and it is a fact that privateinvestors in infrastructure look for stable andfriendly sector-specific policies. Developingdomestic capabilities to manage, participate inand finance private infrastructure projects isimportant to broaden the constituency of PPPs,enlarge the pool of funding, and mitigate foreignexchange risk. In industrialized countries, andincreasingly in more mature reformeddeveloping countries, one of the largest sourcesof financing for investment is the utility’s owncash flow. But additional funding will have tocome from domestic capital markets and frompension funds/ insurance companies. This willrequire a strong macroeconomic framework anda solid financial infrastructure, as well asattractive investment opportunities as detailedin the earlier sections.

To encourage PPPs, the Government of India hasannounced that it will provide viability gapfinancing for selected infrastructure projectswhich are socially and economically necessarybut carry either high risk or inadequate InternalRate of Return (IRR) to be fully funded by theprivate sector. According to the policy, up to 40percent of the financing needs of such projectscould be met through VGFs. This is a step in theright direction and could help to hasten thefinancial closure of many infrastructure projects.For instance, the 22.5 km long Trans-HarborBridge that is proposed for Mumbai and costingover $1 billion is not feasible without at least 30percent viability gap funding. So too is the casefor almost all major bridges as well as largesections of India’s national and state highways.Assuming that the viability gap funding policy iscredible, its success will require, among otherthings, strengthening the institutional capacityof government to manage, participate in, andmonitor PPPs.

Executive Summary

19

Capacities for identifying, procuring andmanaging PPPs could be strengthened in Indiaso that they can make a larger contribution tomeeting basic infrastructure needs. The stepsthat the Centre could take to achieve this are:

Issuing a policy statement on the use of PPPs,including rationale and benefits expected;

The creation of a national level PPP unit forinformation dissemination and guidancefunctions, plus transactions advisory supportto central agencies and ministries in their PPPprograms;

Setting up a project preparation fund foridentifying and procuring PPPs; and

Setting up a fund to partly cover the cost ofgovernment participation under PPPs.

In addition, if there is to be an increase in theusage of PPPs, the Centre would have to workto strengthen oversight of their fiscal costs andassist state governments in doing the same.

The investment needs for infrastructure areenormous. India faces a very large financing gapwhich needs to be bridged by domestic as wellas foreign private sector investments. Successin attracting private funding to infrastructure willdepend partly on India’s ability to develop a moresophisticated financial sector, requiring reformsthat facilitate the use of diverse financialinstruments by investors, and address the currentbarriers to increased participation by bothsponsors and financial institutions. But securingincreased private funding for infrastructure willalso require reforms to address the more bindingconstraints, related to the policy and regulatoryenvironment. In the foreseeable future,Government will remain the key investor incritical infrastructure sectors, although PPPs could

help reduce some of the funding pressure onGovernment. The Government’s ability to financeinfrastructure will, of course, depend crucially onthe success with which it is able to progressivelyreduce the fiscal deficit to make available publicfunds for infrastructure investment.

Three caveats

First, while the focus of this note is on identifyingand addressing constraints to private financingof infrastructure, it is important to recognizeupfront that private investment can, at best,provide a partial solution to meeting India’simmediate infrastructure investment needs. Inareas such as rural roads, rural electrification,rural water supply and sanitation, thegovernment will likely have to play a significantfinancing role in the foreseeable future.

Second, while the primary concern of this noteis to examine financial sector related factors thatmay constrain private investment ininfrastructure, as noted, funding issues are closelylinked to sector policy and regulatoryframeworks. These latter issues are alsoexamined in the note.

Third, while this note focuses mainly on supplyside constraints, clearly, the demand side alsomatters. Indeed, many financiers argue that,while they do have the resources, appetite andinstruments to fund infrastructure, the problemlies in the absence of financially viable ‘bankable’projects with acceptable risk profiles. They arguethat, if bankable projects existed, the fundingcould be made available. This links back to issuesrelated to the policy and regulatory environmentin which infrastructure project developers andfinanciers in India have to operate.

�

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It is well recognized that, with its present stateof physical infrastructure, India will be hard-pressed to sustain 7 percent plus annual GDPgrowth over the medium term. Be it in power,roads, ports, airports, water, railways, urbanfacilities or even telecoms, the country’sinfrastructure needs are enormous. There is amassive and urgent need to increase investmentin these sectors.

In recent years, efforts have been made by theGovernment of India (GoI) to step-up investmentin infrastructure, and particularly to catalyzegreater private investment. In the Union Budget2005, the Finance Minister reiterated theimportance of infrastructure for rapid economicdevelopment and noted that, in theGovernment’s view, “the most glaring deficit inIndia is the infrastructure deficit”. In this context,he proposed to continue (and enhance)

I. INTRODUCTION

Figure 1: Investment in infrastructure in India Figure 2: Private Investment inInfrastructure in India

* In energy, transport, telecoms and water supply &sanitation.Source: World Bank WDI Database.

* In energy, transport, telecoms and water supply &sanitation. Source: World Bank WDI Database.

budgetary support for investment ininfrastructure, including through initiatives tocatalyze greater private financing ofinfrastructure through a proposed viability gapfund (VGF) and a special purpose vehicle (SPV),discussed later in this note. Efforts have also beenmade, over the years, to strengthen the policyand regulatory framework underpinning someof the key infrastructure sectors, with notablesuccess achieved in the telecommunicationssector.

But investment in infrastructure over the pastdecade has not lived up to expectations. The1996 India Infrastructure Report projected theneed for an increase in investment ininfrastructure from levels of under 5 percent toabout 8 percent of GDP by 2005/06. The samereport targeted significant increases in bothpublic and private spending on infrastructure—


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4 In energy, transport, telecoms and water supply & sanitation.5The estimate for private investment in telecom used by us, from the World Bank’s WDI database, is lower than that citedby the Planning Commission. Nonetheless, even if one considers the private investment figure in the telecom sector asreleased by the Planning Commission for the Plan Period 1997-2002, total private investment in infrastructure as apercent of GDP in 1999 only increases marginally to 1 % of GDP from 0.9%.6 In the Philippines, private investment in infrastructure reached over 12 percent of GDP in 1997, driven mainly by theprivatization of the water utility in Manila and a few large Independent Power Projects in the same year. Since the late1990s, however, private investment in infrastructure has tapered across countries. In East Asian countries, it declinedafter the financial crisis that took hold in 1997, and in Argentina, it declined in the aftermath of the crisis in 2001.

Figure 3: International trends in private investment in infrastructure

* In energy, transport, telecoms and water supply & sanitation.Source: World Bank WDI Database.

including a doubling of private infrastructurespending to over 2 percent of GDP by the late1990s, and then further increases. At the end ofthe 1990s, however, actual investment (publicand private) in infrastructure4 remained at under4 percent of GDP per annum (Figure 1). In 1999,public investment in infrastructure stood at 2.8percent of GDP while private investment wasjust 0.9 percent of GDP5. Indeed, throughout thepast decade, private investment in infrastructurehas remained at well below the targeted 2percent of GDP. (Figure 2).

Cross-country data shows that, even in countrieswhich recorded impressive private investment ininfrastructure in the 1990s, the figure wastypically between 4 percent to 6 percent of GDP.6

(Figure 3). Contrasting this against India’s

performance suggests that there is considerablescope for higher private investment ininfrastructure in India in the future, at least insectors such as telecom, ports, airports andurban power and urban water.

In response to a specific request from GoI’sDepartment of Economic Affairs (DEA), this notefocuses primarily on financial sector relatedconstraints to private investment in keyinfrastructure sectors in India, where thepotential for greater private participation exists.It identifies key financial sector relatedconstraints and suggests practical solutions foraddressing these constraints. However, sincefunding is inextricably linked to sector specificpolicy uncertainties, regulatory issues, andprocedural hassles faced by project developers,

Introduction

23

these set of constraints—which are arguably themost binding constraints at this stage in thedevelopment of Indian infrastructure—are alsoexamined in the note.

Three caveats

First, while the focus of this note is on identifyingand addressing constraints to private financingof infrastructure, it is important to recognizeupfront that private investment can, at best,provide a partial solution to meeting India’simmediate infrastructure investment needs. Inareas such as rural roads, rural electrification,rural water supply and sanitation, thegovernment will likely have to play a significantfinancing role in the foreseeable future.

Second, while the primary concern of this noteis to examine financial sector related factors thatmay constrain private investment ininfrastructure, as noted above, funding issuesare closely linked to sector policy and regulatoryframeworks. These latter issues are alsoexamined in the note. In the power sector, forexample, 70 percent of the corpus of the InterInstitutional Group (IIG) set-up for this sectorremained unutilized as of November 2004. In theroads sector, no significant projects have beenoffered by National Highways Authority of India(NHAI) for over one year7 leading to a situationof over-syndication by banks in the projects onoffer. In October 2004, State Bank of India (SBI)signed a Memorandum of Understanding (MoU)with Life Insurance Corporation of India (LIC)under which it was expected that SBI wouldevaluate projects and provide short term (up tofive years) funding, while LIC would take on thelong-term risk. However, to date, not a singleprivate or public-private project has beenfinanced under the MoU. Project developersargue that this has much to do with policy flip-flopping, ambiguities in sector policy and

regulatory frameworks, and proceduraldelays.

Third, while this note focuses mainly on supplyside constraints, clearly, the demand side alsomatters. Indeed, many financiers argue that,while they do have the resources, appetite andinstruments to fund infrastructure, the problemlies in the absence of financially viable ‘bankable’projects with acceptable risk profiles. They arguethat, if bankable projects existed, the fundingcould be made available. This links back to issuesrelated to the policy and regulatory environmentin which infrastructure project developers andfinanciers in India have to operate.

It should be noted, though, that while there maybe a theoretical surfeit of funds for infrastructureat present, this will most likely not be the caseover the medium to longer-term. According tothe estimates of funding given for the Tenth andthe Eleventh Five Year Plans, governmentfinance — consisting of gross budgetary supportto the central plan, allocations to the states andinternal and extra-budgetary resources of centralState Owned Enterprises (SOEs) — amounts toroughly Rs.13,601 billion for the main sixinfrastructure sectors8 over the period 2001-02to 2010-11. This, of course, assumes that thegovernment will be able to undertake fiscaladjustment. Even if one were to accept thisassumption, India would still face a staggeringfinancing gap of over Rs.5,500 billion for thedecade ending 2010-11. (See Annex A for detailsof this calculation). By any canon, this is a hugedifference between what the country needs andwhat the government can pay. And it will haveto be met by private sector financing. Success inattracting private funding to infrastructure willdepend on India’s success in having regimes,systems and practices in place that consistentlyencourage private investment and public privatepartnerships (PPPs) in infrastructure.

7 Very recently NHAI has offered 37 projects in the road sector.8 These comprise roads, power, telecommunications, railways, airports and ports.


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The rest of this note is organized as follows.Section II analyses the reasons why more privatefinance has not been forthcoming for thedifferent infrastructure sectors. In doing so, itexamines barriers posed by the absence of asufficiently sophisticated financial sector, fiscalbarriers, red tape and procedural inefficienciesthat have contributed to project delays and

discouraged private investors, and constraintsarising from the absence of adequateinfrastructure regulation that exacerbates risksand uncertainties for investors. Section IIIsuggests practical ways to mitigate theseconstraints and policy reforms to facilitate moresustained private investment and PPPs ininfrastructure.

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2.1 Financial Sector RelatedConstraints

Infrastructure projects are complex, capitalintensive, long gestation projects that involvemultiple and often unique risks to project financiers.(See Box 1). Infrastructure projects arecharacterized by non-recourse or limited recoursefinancing, i.e., lenders can only be repaid from therevenues generated by the project. This limitedrecourse characteristic, and the scale andcomplexity of an infrastructure project makesfinancing a tough challenge. This challenge isfurther compounded by two factors. First, acombination of high capital costs and low operatingcosts implies that initial financing costs are a verylarge proportion of the total costs. Second,infrastructure project financing calls for a complexand varied mix of financial and contractualarrangements amongst multiple parties includingthe project sponsors, commercial banks, domesticand international financial institutions (FIs), andgovernment agencies.

Constraints to equity andquasi-equity financing

Equity financing

Raising adequate equity finance tends to be themost challenging aspect of infrastructure projectfinancing, as equity typically shoulders thegreatest level of operational, financial andmarket risk. Equity can be provided by projectsponsors (those who have an operational interestin the contract) or financial investors (those whohave only an investment interest).

II. CONSTRAINTS TOINFRASTRUCTURE FINANCING

In India, as in many other countries, the earlyphase of private financing of infrastructure hasshown a predominance of sponsor equity. Butthe ability of sponsors to raise equity from theprimary market remains limited. First,infrastructure companies or project sponsorstypically have much higher gearing than othercorporates, which makes them unattractivecandidates in the securities market. Second, notonly are the projects operationally complex butalso, they involve complexities in terms ofcontracts, legal structures, right of first chargeon assets etc. Consequently, investors, especiallyretail investors, find it difficult to understand thetrue risks involved — and are wary of investingin such issues.

In the longer-term, equity finance from financialinvestors – including private equity funds suchas venture capital funds and other institutionalinvestors, such as dedicated infrastructure fundssponsored by a consortium of insurancecompanies, pension funds, Governmentsponsored funds, commercial banks,development banks, private fund managers andother privately-held companies -- can prove tobe critical. This is particularly true in situationswhere the sponsor’s equity is consumed at theearly stages of projects, and not recycled quicklyenough due to lack of refinancing options.However, at present, equity financing by financialinvestors is constrained by the following factors:

Limited exit options constrain equityparticipation. Financial investors have a well-defined investment horizon and usually divest ina pre-determined span of time9. They usually

9 For example funds like AIG Asian Infrastructure Fund (Asia I, $1.08 billion); AIG Asian Infrastructure Fund II ($1.67billion); AIG-GE Capital Latin American Infrastructure Fund ($1.01 billion); AIG Emerging Europe Infrastructure Fund


26

prefer to determine the terms of the exit on anupfront basis. The best route for financialinvestors to exit from an infrastructure project isto sell their stake to the sponsors, through a ‘putoption’, which involves an upfront agreementbetween the financial investor and sponsor,including agreement on the minimum price atwhich the financial investor could sell the equitystake to the sponsor at a future date. However,in India, the regulations do not allow suchagreements to be reached upfront betweenfinancial investors and sponsors of an unlistedcompany. For one thing, the approval to exercisethe ‘put’ has to be obtained from the ReserveBank of India (RBI) at the time of the exercise,and cannot be obtained up-front. For another,put option agreements with sponsors of unlistedcompanies cannot guarantee a minimum priceon the sale of shares to the sponsors. The saleprice in such transactions is subject to pricingrequirements of the RBI, which requires anindependent valuation to determine a “fair” pricefor the shares at the time the option is exercised.This leaves a lot of uncertainty in the minds ofinvestors and prevents them from negotiating afloor to their return and ensuring a suitable exitprior to investing.

Additional constraints to equity investmentinclude a shallow capital market (albeitcontinuously improving), and corporategovernance issues (primarily minority shareholderprotection rights).

Some of the issues that impinge on the broaderissues on minority shareholder rights relate to(a) adequate recording of ownership rights:Mandatory disclosure on shareholder ownershipis limited to only the shareholder’s name whichusually is not sufficiently unique; (b) transparencyin disclosures related to capital structures andarrangements: Such transparency would enable

certain shareholders to obtain a degree ofcontrol disproportionate to their equityownership. While there is a trend towards moretransparent share ownership, the classificationdoes not give a fully transparent picture of controldue to the prevalence of complex cross-holdingsacross family or business groups; and (c) Misuseof corporate assets and abuse in related partytransactions remain problems. It is not alwayseasy to identify “related parties” or assess thefairness of a transfer price.

More specifically, there are atypical corporategovernance issues with respect to protection ofminority shareholder rights in infrastructureprojects. Often infrastructure project developersare construction companies, equipment suppliersor infrastructure services companies. Forexample:

Road projects are being developed byconstruction companies

Ports and airports are being developed byconstruction companies, equipment suppliers,user companies, port managementcompanies etc.

Power projects are developed by constructioncompanies and equipment suppliers

Return on equity for these companies on theirinvestment in infrastructure projects comes notonly from the returns generated by the project,but also from the additional business generatedfrom the project. For example:

Construction company undertaking theEngineering-Procurement-Construction(EPC) contract for the construction of a road,port, airport, power project.

Equipment supplier supplying equipment tothe port, airport, power project.

($550 million); AIG African Infrastructure Fund ($407.6 million) and IDB Infrastructure Fund (approx.$1 billion) have atypical time horizon of 5 to 10 years to divest all funds. The recently initiated ‘The Infrastructure Fund of India’ (TIFI)—anAsian Development Bank (ADB) and AMP Capital Investors venture—is expected to have a life of 7 years.

Constraints to Infrastructure Financing

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Management company managing the portor airport operations.

User companies using the facility.

For these companies, revenues from theseactivities exceed the returns provided by equity.Many times, this is their primary motivation forventuring into infrastructure projects, rather thanthe returns provided by the project itself. For afinancial investor, the only return on equity isprovided by the revenues generated by theproject. Therefore, there is a severe conflict ofinterest between the project developer and thefinancial investor. A project developer may actin a way which maximizes his return from thesecondary activities, at the cost of projectrevenues. The financial investor, who is in aminority position in such projects, loses out in suchsituations.

To improve corporate governance, and to protectminority shareholders rights infrastructureprojects must go for competitive bidding for theEPC contracts, equipment supply contract,management contract and user contracts. Theproject promoters may participate in such biddingprocesses, but must emerge a winner from sucha process to obtain the contract for providingsuch services.

Limited mezzanine financing

In the developed world, many infrastructureprojects are part-funded through ‘mezzaninefinance’, which is a hybrid of debt and equity.Mezzanine finance is debt capital with fixedpayment or repayment requirements, but withthe right to convert to an equity interest in acompany. An example of this type of financing isthe convertible unsecured loan which is a loanthat pays fixed interest but gives its holder theright to convert it into equity sometime in thefuture. Mezzanine is generally subordinateddebt. It carries two advantages: first, it attractsinvestors by offering a rate of return which ishigher than that of senior debt and second, on

the balance sheet of a company, it is treatedlike quasi-equity, which makes it easier toincrease the component of the usual bank orfinancial institution loans. Also, sincesubordinated debt is not a loan, FIs do not insiston escrow backing for such funding. Mezzaninefinance is typically found with venture capitalcompanies and/or alternative lending institutionsseeking a higher rate of return. Unfortunately,there is no infrastructure funding entity that hasactively explored mezzanine financing in India inany sizeable amounts. The reasons for thisinclude the following:

First, an impediment to the use of mezzaninefinancing is the lack of a sufficiently large andvaried pool of infrastructure projects. Whenprojects and financiers are few and far between,and when modern infrastructure financing is inits nascent stages, there is a preference forfunding institutions to opt for morestraightforward loans than hybrids.

Second, interest rate caps on externalcommercial borrowing (ECBs) constrain the useof mezzanine financing by foreign investors. Theinterest rate caps make no provision for pricingdifferent debt or quasi-equity instrumentscommensurately with the risks associated withthem.

Third, regulatory norms and premium pricing arealso factors that weigh against mezzaninefinancing. The norms for provisioning againstNon-Performing Assets (NPA) do not make adistinction between senior debt and subordinateddebt; the latter deserves more liberal treatmentgiven its quasi-equity nature. Also, sponsors withprojects that are at the margin in terms ofprofitability find the ‘premium’ demanded forsubordinated debt over senior debt by a host ofrisk-averse lenders far too excessive—enoughto turn a potentially profitable venture into anunviable one. As the situation stands today, mostdomestic lenders (banks and FIs) prefer to providesenior debt to ‘bankable’ projects with a lower


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10 For example, having a parallel un-tolled road with a toll road as in the case of Mumbai-Pune Highway.

Box 1: Risks Presenting Unique Challenges to Infrastructure Project Financiers

Key risks relate to recovery in infrastructure projects which arise out of wrong revenue forecasts, inability of governmententities to levy appropriate user charges, and the arbitrary actions of state governments as consumers. Recent experiencessuggest that there are at least seven different types of risks which characterize most infrastructure projects: (i) Publicrisks, involving political, administrative, legal, regulatory, and dispute resolution and enforcement mechanisms; (ii)Economic and financial risks, i.e. those dealing with interest rates, currency risks, and other macroeconomic factors; (iii)Market risks, which concern traffic, revenue and business model forecasts; (iv) Construction risks, or the problemsassociated with timely completion and force majeure; (v) Operating and maintenance risks; (vi) Environment risks; and(vii) The risk of public unacceptability of project features, such as levels of tariffs, the inability of government entities tolevy appropriate user charges and the arbitrary actions of state governments as consumers.

India has been fortunate in the last half decade to be relatively immune to interest rate, currency and other macroeconomicrisks. But it has faced all other risks listed above in some measure. Attracting private financing in infrastructure willrequire a facilitating environment that addresses these various unique risks.

Three types of market risks that pose a unique challenge to infrastructure project financiers are particularly worthnoting: *

Wrong traffic projectionsWrong traffic projectionsWrong traffic projectionsWrong traffic projectionsWrong traffic projections. For the PPP projects in roads, most traffic projections made by the best of independentconsultants have been way off the mark, and all they need are small revenue fluctuations to bring about sharp declinesto their Internal Rate of Returns (IRRs) For instance, in case of the Delhi-Noida Flyover, traffic was initially overestimatedto the tune of 50 percent. To be fair, over estimating traffic and revenue is a global phenomenon. For instance, the trafficon the toll highway between Mexico City and Acapulco via Cuernavaca was so grossly over estimated — and actualtraffic flow was so much less — that the Build-Operate-Transfer (BOT) project ran on severe losses for almost a decade,and needed to be renegotiated twice over. The risk of over-estimated traffic projections becomes extremely relevant inthe case of the BOT contracts, where the private developer has to bear the traffic risk, and even more so in greenfield tollroads that compete with existing ‘free’ routes. In case of expansion and upgradation projects obviously the trafficprojections are relatively easier to forecast, but then it is not obvious that in these cases the private contractor needs tobear the traffic risk (as in the annuity projects in India where the private party does not bear any traffic risk). If trafficprojections for roads are difficult, those for ports, especially green-fields, are virtually impossible to estimate. While initialover estimation tends to get dampened with experience, it still leads to an unintended harmful consequence. Lendersget over-cautious about all traffic projections and almost instinctively evaluate all projects by cutting down the revenuefigures. This immediately increases project risk, reduces IRR and often makes the cost of funding so high as to scuttle theproject.

Collection risks. Collection risks. Collection risks. Collection risks. Collection risks. The flow of funds for infrastructure projects is critically dependent on the credibility and certainty offuture revenue streams which, given the existing uncertainties in collection, remains suspect. In roads, power and water,the inability of the government to apply and recover appropriate user charges from users seriously hampers the viabilityof projects.10 In roads, such problems occur even in instances where the traffic is more or less correctly projected. Theyrelate to cases where, because of political clout, consumers simply refuse to pay the appropriate charges. Such caseshave been known to have occurred in toll roads, for example the Coimbatore Bypass project in Tamilnadu. They alsooccur quite frequently in the power sector with both State Electricity Boards (SEBs) and some sections of final consumersconsistently refusing to pay their dues.

Arbitrary reneging of contracts. Arbitrary reneging of contracts. Arbitrary reneging of contracts. Arbitrary reneging of contracts. Arbitrary reneging of contracts. The power sector in India has been plagued by this problem — the Maharashtra StateElectricity Board (MSEB) terminating its Power Purchase Agreement (PPA) with Dabhol, followed by similar terminationsin Andhra Pradesh and Karnataka. In Tamil Nadu, although no PPA has been terminated so far, the authorities frequentlythreaten to do so whenever independent power producers try to press for payments. This arbitrary termination risk isextremely severe in India, especially given the precarious financial situation of most SEBs. The problem gets accentuatedbecause most state governments’ guarantees are not financially credible.

* Regulatory and other risks are discussed later in the note.


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return rather than risk large quantities of fundsto earn a couple of hundred basis points higher.

Restrictions on ECBs

Given the risk aversion and/or relativeinexperience of many financial intermediaries inIndia in the area of infrastructure financing,external financial resources (ECBs, mezzanine,equity, etc.) can potentially play an importantrole in meeting funding gaps. Recentamendments to government policy on ECBsprovide for greater flexibility regardinginfrastructure related projects. Revised ECBguidelines now allow (i) companies to access ECBfor undertaking infrastructure investment activityin India, (ii) borrowings under the approval routeby FIs dealing exclusively with infrastructure. Themaximum amount of ECB that can be raised byIndian companies under the automatic route inany financial year was increased to $500 million,with minimum average maturity of three yearsfor loans up to $20 million, and of five years forloans above $20 million. Of late, there has beena growth of ECB (through the approvals route)for infrastructure, from $270 million in 2001-02to nearly $1.9 billion in 2003-4. (Table 1).

Despite the welcome increase in ECB forinfrastructure, the fact still remains that externalfunds are significantly inadequate compared tothe needs. This may be attributed to thefollowing:

One concern raised by investors is the interestrate cap on ECBs. According to the ECBguidelines, interest rates are capped atLibor+200 basis points for loans with an averagematurity of 3-5 years, and at Libor+350 basispoints for loans with an average maturity of morethan five years. It has been argued that, whilethese caps may be adequate for ‘normal’industrial projects, they are too low to attractfunds for riskier infrastructure projects. They limitthe compensation which lenders can receive forlonger tenors or higher credit risk and, in effect,reduce the availability of long term loan fundsfor infrastructure — where the credit needs aretypically for longer durations and where the riskprofiles often require pricing at spreads higherthan those allowed by the ECB caps. This hasimplications for mezzanine financing (discussedabove).

An even greater constraint in utilizing foreigncurrency loans is the lack of a sufficiently deepforwards-market in foreign exchange.Infrastructure projects require long tenor loans,and if financed through foreign currencyborrowings these need to be adequately hedgedagainst currency risks since few infrastructureprojects have forex earnings to serve as a naturalhedge. Inability to hedge long term currency riskin a market which is limited to one year’s forwardcover poses a big challenge to the use of foreigncurrency loans in these projects.

Table 1: ECB approvals for infrastructure, 2001-02 to 2003-04

In USD million In Rs. Billion

2001-022001-022001-022001-022001-02 2002-032002-032002-032002-032002-03 2003-042003-042003-042003-042003-04 2001-022001-022001-022001-022001-02 2002-032002-032002-032002-032002-03 2003-042003-042003-042003-042003-04

Power 270 375 700 13 18 32

Telecom 0 341 1,166 0 17 54

Roads 0 829 0 0 40 0

Total 270270270270270 1,5451,5451,5451,5451,545 1,8661,8661,8661,8661,866 1313131313 7575757575 8686868686

Note: Exchange rates are Rs.46.7, Rs.48.4 and Rs.46.0 per USD for 2001-02, 2002-03 and 2003-04 respectively.

Source: Economic Survey 2003-04


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Limited use of takeout financing

Commercial bank funding of infrastructureprojects runs the risk of asset-liability mismatch.An innovative method is to encourage the useof ‘take-out’ finance. Here, a bank which isfunding an infrastructure project gets into anarrangement with a financial institution, wherethe institution commits to buying the bank’s loansafter a certain period. There are two versions tothis arrangement: unconditional and conditionaltake-out finance. The unconditional versioninvolves full or partial credit risk with theinstitution agreeing to take over the finance fromthe original lender.11 Under conditional take-outfinance, the institution commits to taking overthe finance from the lending institution only if itis satisfied with certain stipulated conditions.Hence, it is only unconditional takeout financingthat helps bank resolve the asset-liabilitymismatch since under the conditional takeoutfinancing model, the long-term risk still remainson the books of the banks until the take outactually happens12. Take-out financing is ideallysuited for annuity and BOT type road and housingprojects. While there are some recent examplesof institutions like IDFC and Housing and UrbanDevelopment Corporation (HUDCO) tryingtakeout financing as a method, this has notfound much favor in India. (See Annex B for acase study on takeout financing). Whileunconditional takeout financing is not verycommon, it can give a fillip to infrastructurefinancing by addressing both the unwillingnessand the lack of experience of institutionalinvestors to participate in infrastructurefinancing. The main factors limiting the use oftakeout financing include the following:

First, the presence of excess liquidity in thesystem reduces the need for banks to quickly

circulate their funds, and hence, the appetitefor instruments like takeout financing. Withlimited number of ‘bankable’ projects in thefray and no liquidity crunch, banks have noinclination to sell out these good assets fromtheir portfolio.

Second, high stamp duties reduce theattractiveness of takeout financing andsecuritization. Being a state government subject,stamp duties vary considerably across thecountry. Excessive rates of stamp duties in somestates have stymied the growth in innovativefinancial instruments such as take-out financingand also securitization. In the light of thedifferential duties across states in India, theinfrastructure SPV for securitization could beregistered in the state with the lowest stampduty. However, the fact remains that it results inhigher transaction costs and inconvenience indomiciling the entity based on this criteria,despite having all business interests elsewhere.Furthermore, since these duties are charged advalorem they inflict a high cost for projects thatinvolve high value securities or large assettransactions.

An underdeveloped corporatebond market and the lack oflonger term financing

Most infrastructure projects fructify into profitmaking entities 10 to 15 years after the initialinvestment and hence require longer tenorfinancing (with long drawn out repayments) toensure financial viability of the project. Theavailability of a developed bond market is animportant backbone to project financing forinfrastructure as it increases the prospects forproject finance banks to eventually off-load theirassets, and for project companies to lock in fixed

11 In such a case the credit facility extended to the borrower is reflected on the books of the original lender till it is takenover. The institution agreeing to take over shows this obligation as a contingent liability till it actually takes over withfull or partial credit risk as agreed upon.12 Here, the assets on the books of the original lender carry 100 percent risk weight as the take over is not automatic.


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interest rates at lower margin when the projecthas stabilized after a few years of operation13.Moreover, functional bond markets areimportant for funding existing infrastructureutilities/companies, as well as certain types ofprojects with no or low construction risk and anestablished revenue pattern. Unfortunately,India still does not have a wide or deep enoughcorporate bond market for such paper.According to the estimates of the Bank forInternational Settlement (BIS), the size of India’scorporate bond market was 0.3 percent ofnominal GDP in December 2003—much lowerthan that of Malaysia (43.3 percent) or SouthKorea (27.7 percent). Trading on the Indiancorporate bond market is limited. For instance,in the long-term debenture market (10 years ormore), of the 70 or so issues available for trading,including those of banks and FIs, 41 issues havenot been traded even once since their issuance.The rest are sporadically traded—from once amonth to once a year. Listed SOE bonds — amajor part of corporate debt paper — are tradedon the Wholesale Debt Market (WDM) of theNational Stock Exchange (NSE). However,trading in the private corporate sector bondmarket is insignificant, and most of the issuanceis currently on a private placement basis.

What explains the underdevelopednature of India’s corporate bondmarket?

The lack of size and depth in India’s corporatebond market may be attributed to three broadsets of issues viz., development of governmentsecurities market, lack of market infrastructure

and innovations in the corporate debt marketand regulatory issues:

I. Outstanding issues in the developmentof the government securities market

Absence of a benchmark yield curve forgovernment bonds. While the government hasissued long term securities, the relatively smallaverage size of each benchmark securitiesissuance14 coupled with limited trading activityhas meant that there is really no risk-freebenchmark reference rate to peg the longertenor section of the yield curve.15 To create areliable government bond benchmark yield curve,the size of each benchmark security needs tobe sufficiently large, usually a significant multipleof the average transaction size. Starting in 2003,the RBI has made efforts to consolidate issuanceswith the aim of concentrating liquidity in a smallnumber of benchmark issues. However, moreactive steps need to be taken for consolidation.(See Annex C). The government debt market iswholesale in nature; the limited trading that does

13 Internationally, the contributions of bonds to total project debt financing has been growing at a slow pace and atpresent bonds represent around 20 % of international project financing with the rest coming from syndicated loansmainly from banks.14 While the size of the gross borrowing requirement is large, the market’s absorptive capacity is small and this putsconstraints on the size of individual issues leading to a number of small issuances of benchmark securities. This in turnaffects liquidity of the benchmark securities.15 Recently, the NSE in its WDM segment has come up with an innovative formula to devise a 20-year yield curve. While itfunctions as the only “quasi-reference” rate for long term corporate paper, it has not sufficed to trigger a more activebond market for long tenor debt securities.

Table 2: Interest rates on various savingsinstruments

Saving InstrumentSaving InstrumentSaving InstrumentSaving InstrumentSaving Instrument Rates (%)Rates (%)Rates (%)Rates (%)Rates (%)

Postal Savings 6.25-7.5

National Saving Scheme 8.5

EPF 9.5

PPF 8.0

G-Sec 4.69-5.73

T-bill 4.36-4.37

Note: Rates for 1 to 5 years duration except EPF; as ofDec 2004Source : Reserve Bank of India, State Bank of India,National Stock Exchange and Department of Posts


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take place is done bilaterally over the telephonethrough brokers,16 or on the Negotiated DealingSystem (NDS). This results in a non-transparentmarket with poor-price discovery where only theparties to trade have information about the trade.The lack of trading in the government debtmarket may be attributed to two other factors.First, institutional investors such as pension fundsand insurance companies are mandated to holdGovernment securities until maturity, thushindering active trading. Second, retail investorsprefer to invest in instruments such as postalsavings and provident funds where returns areartificially pegged at much higher rates (seeTable 2), than to invest in the debt market,especially given the lack of awareness on therisk-return profile of the Government securitiesand the relatively higher cost of trading in theretail segment of Government securities.

II. Market infrastructure issues and lackof innovative instruments in thecorporate debt market

Cumbersome primary issuance guidelines forcorporate issuers have further constrained thedevelopment of the corporate bond market.Raising debt through a public issuance in Indiaentails high costs, associated with regulatorycompliance, advertising, and intermediation coststo brokers and underwriters, and is a lengthyprocess - the minimum timeframe for clearanceof offer documents by the regulator is 21 days.By comparison, approval by the regulator takesjust 5 days in Korea (for secured and guaranteedbonds).

Each country has particular features which causethe costs of issuing securities to differ. The costof raising US $ 100 million through a plain vanilladomestic bond issuance expressed as apercentage of issue size is 2.40, 2.74 and 1.18per cent for Brazil, Chile, and Mexicorespectively17. Anecdotal evidence suggests thatpublic issuance costs in India for a similar issuancesize could vary between 4-6 percent whichtypically covers costs related to fees for rating,listing, trusteeship, R&T Agent, arranger fees andstamp duty. On the other hand, the privateplacement market in India offers competitiverates and quick access to the market as there isrelatively less regulatory compliance. Hence, thissegment which is less transparent accounts forover 90 percent of debt placement in India18.Recent guidelines that require compulsory listingof all privately placed debt on the stock exchangeand detailed listing agreements with theexchange have greatly increased the disclosurerequirements and costs for private placement,thereby affecting first-time issuers who wish totap the market. Also, shelf registration19, whichfacilitates frequent and quick issuance of debtsecurities, is available in India only to speciallydesignated Public Financial Institutions (PFIs) andnot to all corporate issuers.

Inadequate corporate credit information.Investors lack sufficient, timely and reliableinformation on bonds. Data on bond issues, size,coupon, latest credit rating, underlying corporateperformance, information on secondary trading(particularly pre-trade information related toinvestors having access to best quotes) and

16 NSE does provide a platform for trading, but it is mainly used for reporting deals which have been executed and thusit remains a negotiated market.17 Source: Zervos, 2004; The Transactions Costs of Primary Market Issuance: The Case of Brazil, Chile, and Mexico, TheWorld Bank.18 In most jurisdictions, while extensive disclosure guidelines tend to apply to public issuances, private placements areusually exempt from such stringent rules. In the US, many issuers prefer to use Rule 144A for placing securities privatelyto ‘qualified institutional buyers’ which exempts them from registration, detailed disclosures and costs related topreparing financial statements according to US General Accepted Accounting Principle (GAAP).19 Shelf-registration in India is allowed through an umbrella prospectus, whereby a company files one consolidated offerdocument with the securities market regulator for the entire amount it proposes to raise over the next 12 monthsallowing the company to make more than one offering within the stipulated period.


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default histories of companies are sparselyavailable, and are not available from one source.No one knows exactly how much debt isoutstanding on any given date. This has muddiedthe corporate debt market and created barriersto active trading and pricing.

Lack of market infrastructure. Inefficient clearingand settlement mechanisms (currently mosttrades in the secondary debt market are settledbilaterally by the trading parties outside theclearing and settlement system run by the stockexchanges) and poor and lengthy enforcementlaws relating to default proceedings make thecorporate debt markets even more illiquid. Thereforms undertaken by several East Asian andLatin American countries to improve marketinfrastructure related to clearing and settlementsystems could provide some useful lessons (SeeBox 2).

Skewed interest rates. Many companies with

‘AAA’ (i.e., investment grade) ratings offer lowercoupons than the sovereign rate on instrumentssuch as Public Provident Fund (PPF) or NationalSaving Certificates (NSCs). (Table 2). Individualinvestors, therefore, have almost no interest inthe primary as well as secondary corporatecoupon debts, unless these are accompanied bysome significant fiscal concessions resulting innet higher return compared to sovereign orquasi-sovereign instruments.

Lack of innovative instruments such as third-partycredit enhancement and hedging tools forinvestors and traders to mitigate credit risk andinterest rate risk. Third party credit enhancementor the provision of credit guarantee (also knownas bond insurance) by a third party for issuerswith non–investment grade rating provides animportant avenue for these lower rated issuersto tap the market20. From the point of view ofthe issuer, credit guarantee would help lower

Box 2: Reforms in clearing and settlement systems in East Asia and Latin America regions

Robust clearing and settlement systems are a crucial element to bond market development because theyhelp enhance the efficiency of bond trading and reduce their associated risks. In addition, bond marketliquidity is closely linked to the reliability of bond clearing and settlement systems. Investors will only tradebonds if they are confident of the settlement of their trades. A key measure to improve market infrastructurewould be to establish a clearing system for corporate debt, wherein settlement is guaranteed.

To date, many countries in East Asia have adopted electronic trading and real-time gross settlement (RTGS)and delivery versus payment (DvP) clearing and settlement systems on a transaction by transaction basis. InLatin America, Mexican authorities have also paid attention to the market infrastructure, improving custodyand clearing and settlement arrangements and adopting a RTGS. These improvements to the basic infrastructure,together with the development of a peso yield curve, help to explain the rapid growth of the local interest ratederivatives market on the Mexican Derivatives Exchange (MEXDER), which allows local participants to hedgeinterest rate risk (see Glaessner 2003). In terms of volume of derivatives contracts, MEXDER has become oneof the most active exchanges worldwide in short-term interest rates futures trading. In Brazil the Associationof Open Market Institution (ANDIMA) became the prime mover behind the establishment and running of thenational clearing, settlement and registration systems for corporate bonds in Brazil. The importance of theNational Private Bond System (SND) in Brazil is such that it has been reported that most corporate bond issuesare registered with the SND even when there is no legal obligation to do so. Registration with the SND is saidto lend more credibility and transparency to the bond issue. The SND is responsible for the registration andsettlement of most corporate bonds in Brazil.

Source: IOSCO, 2002 and World Bank

20 Having said that, while credit insurance is important for the overall bond market, it is acknowledged that creditinsurance for infrastructure financing has been more difficult and has been used in a few developing countries (such asin Chile for the toll road program) and often times in conjunction with official insurers such as MIGA or Inter-AmericanDevelopment Bank.


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funding costs as well as broaden market accessand the investor base21. From the investors’perspective, credit guarantee provides additionalcomfort or protection against default risk andcan also contribute towards enhancing liquidityin the secondary market. Further, with a creditenhanced rating, many issuances are able toqualify under the guidelines of pension andinsurance funds and of other conservativeinvestors Credit guarantees play an importantrole in enhancing financial intermediation bybridging the gap between the borrowers–especially those with inadequate credit ratings– and certain investors who would only beallowed or interested in investing in bonds withhigher credit rating. Currently, there are noinstitutions that provide such credit guaranteeproducts in India. In more developed markets,credit guarantee services tend to be providedby specialized credit guarantee companies. Forexample in the US, credit guarantee facilities aremainly provided by four major credit guaranteecompanies called the ‘monolines’ and the creditguarantee market has been recording asubstantial growth in the US and to a smallerextent in Europe in the last two decades. In Indiathird party credit enhancement has notdeveloped due to lower maturity of the market,lack of market intermediaries such as themonoline insurers which have deep financialability and risk capital to provide such servicesand lack of reliable credit default histories (whichis at a very nascent stage of development in Indiatoday) needed to appropriately price creditguarantee products. Even if a lower-ratedborrower uses this product, it would not beeconomical for it to do so unless the savingsresulting from reduced interest cost exceed the

cost of guarantee. There have been very limitedinstances of credit-enhancement for bondissuances in India, mainly in municipal financingwith multilateral (USAID, World Bank) funding.

Development of financial instruments such ascredit derivatives and interest rate hedging toolsto increase liquidity in the secondary markets isconstrained either by the absence of enablingguidelines from RBI in the case of creditderivatives or by an absence of a suitable moneymarket index for the interest rate swap marketto develop (although indications are that this isnow beginning to develop). A comparison withother developing countries with regard to theavailability of such instruments is provided inAnnex D.

III. Regulatory issues

Overlap in regulation of the debt markets. Theexistence of regulatory barriers arising fromcapital/financial markets could be explained inpart due to regulatory overlaps in the debtmarkets and in part due to the fact that bondmarkets are difficult to develop and creating theright regulatory and market conditions for anefficient bond market is a gradual process22. Inthe debt markets, Ministry of Finance (MoF), RBIand Securities and Exchange Board of India (SEBI)all have regulatory and supervisory roles that arenot sufficiently delineated. As investment bankerto GoI, the RBI oversees the Government debtmarket, and conducts primary issuance for theGovernment’s debt requirements in the domesticbond markets. RBI is also responsible forregulation and policy for over-the-counter (OTC)financial derivatives and spot markets forgovernment bonds. In addition, RBI regulates the

21 The issuer enhances its creditworthiness by purchasing credit guarantee and receives the credit rating, usually AAA, ofthe credit guarantee company. Unless the savings resulting from the reduced interest costs exceed the cost of theguarantee, this form of credit enhancement is not useful for the issuer.22 There are certain pre-conditions that need to be in place in order to have a well functioning debt market such asmacroeconomic stability and credibility, benchmark issues, taxation issues, regulatory guidelines and legalinfrastructure, efficient money markets, bankruptcy laws, proper accounting, auditing and disclosure rules which arebeing introduced gradually in the Indian debt market.


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largest of investors and issuers in the bondmarkets viz. the banks and financial institutions.On the corporate debt market, SEBI isresponsible for regulating and supervisingprimary offerings of securities (equity and debtinstruments) by companies that are listed, or tobe listed on an exchange as well as secondarytrading, clearing and settlement of allinstruments (including financial derivatives)traded on stock exchanges. The overlap inregulation and different focus of each authoritytends to inhibit coordination between theregulators leading to impediments indevelopment of new products and innovation inthe design of debt markets which could lead tomore efficient and safer issuance, trading,clearing and settlement mechanisms.

As markets develop and mutual funds evolve,bond funds are likely to hold a variety ofinstruments as is the case with ‘income’ funds inmature markets, SEBI will clearly have jurisdictionover such bond funds. To the extent thatcorporate bond issuers interface with entitiessuch as banks for arrangements such astrusteeship and guarantees of payments, therecording of such arrangements on banks’ bookswould require RBI oversight. In this context, theestablishment of good mechanisms for regulatoryinformation sharing and coordination areimportant. Such overlaps and jurisdiction issueswill increase as financial markets become morecomplex and open, thereby increasing thechallenge of regulating and supervising them. Afew examples of this overlap which result in

Box 3: Examples of regulatory overlap in the debt market

The exchange-traded secondary debt market in India is one such area of overlap, particularly for ‘on-exchange’government securities. The National Stock Exchange offers a trade reporting system for government securities(permission to offer this facility is granted by both RBI and SEBI) which allows a network of brokers to interfacebetween banks and other institutional investors trading in government securities. Setting up of a parallelelectronic negotiated dealing system (NDS) in 2002, owned and maintained by the RBI (which is the marketregulator of the dealing system as well, a situation which could result in conflict of interest) has resulted induplication of infrastructure and fragmentation of the market for government securities as the NDS is restrictedto those entities which hold current accounts and securities with RBI (banks, primary dealers, Financial Institutionsetc). Currently, market participants like brokers, provident funds, etc., who play an active role on NSE’sWholesale Debt Segment are not part of this system. This results in fragmentation and inefficient pricediscovery.

Legality of OTC Derivatives – Following amendments to Securities Contracts (Regulation) Act, 1956, interestrate derivatives were introduced in 1999. Banks could undertake plain vanilla Forward Rate Agreements andInterest Rate Swap contracts for their own balance sheet management and also for market making purposes,provided they ensure adequate infrastructure, risk management systems and internal control systems. Overthe last three years the volume in the OTC market has grown noticeably with the outstanding notionalamount at around Rs. 6.4 trillion23. There is a proposal to amend the Securities Contracts (Regulation) Act,1956 to make only those derivatives contracts that are executed on exchanges legal and valid. This marketwould then come under the purview of SEBI as SEBI’s oversight extends over the exchange traded market.RBI’s stand on this issue is that while exchange traded derivatives have their own role to play in the debtmarket – by their very nature exchange traded derivatives have to be standardized products. On the otherhand, OTC derivatives can be customized to the requirements of trading entities. Thus, both OTC and exchangetraded derivatives are essential for market development. Therefore, RBI is proposing amendments to this lawto make contracts, of the class and nature as notified by RBI, legally valid, even if they are not traded on anyrecognized stock exchange. Market participants believe that this is an extension of the earlier regulatory turfissue that emerged during the introduction of exchange traded interest rate derivatives which have not takenoff since introduction.

23 Participation in the markets continues to remain limited mainly to select foreign and private sector banks and PrimaryDealers


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diffusing regulatory authority and uncertainty formarket participants are provided in Box 3.

Absence of long term investors has constrainedthe development of the long-term bond markets.With the exception of LIC, insurance companies,pension and provident funds, which should beactive investors in long-term corporate debtpaper, rarely invest in paper with a maturitylonger than 5-7 years.24 This has much to do withthe investment guidelines for these funds, whichtend to be restrictive. Equally, it has much to dowith their incentive structure. Most (if not all) ofthem do not have the incentive to earn above-market returns. The lack of incentives to earnhigh returns results in conservative investmentbehavior and stringent internal investmentpolicies. Most funds (especially in the publicsector) are managed by ‘administrators’ ratherthan fund managers and have a ‘buy-and-hold’philosophy, which discourages secondary markettrading. This could change in the future, oncethese funds start offering market-linked schemesand compete with each other for subscriptions.(These issues are discussed in more detail inBox 3).

Regulatory treatment of bonds vis-à-vis loans.Another important class of investors, banks, arealso constrained from participating actively in thecorporate bond markets due to regulatoryrequirements that discriminate between thetreatment accorded to investment by banks incorporate bonds, which require a higher risk

weight, than loans to corporates. Further, RBI’srecent guidelines restrict banks’ investment inunlisted non-SLR securities25 to 10 percent andrequire minimum investment grade rating,thereby keeping out banks from investing inbonds of lower rated corporates (this wouldaffect infrastructure companies as these wouldtypically be lower rated corporates given theinherent riskiness of the sector).

Regulatory and institutionalissues constraining higherparticipation of FIs andcommercial banks

It is widely accepted that insurance companiesand pension funds are ideal candidates forsupplying long tenor financing given the long-tenor nature (15 years or more) of their liabilities.But with a few notable exceptions, in recenttimes, most insurance companies and pensionfunds have not focused on funding infrastructure.Commercial banks have also had little appetitefor infrastructure financing26, although recentyears have witnessed an increase in their lendingto infrastructure. (See Annex E for a detailedanalysis of participation by FIs in infrastructureprojects).

The Industrial Development Bank of India (IDBI)’s27

report on the sanctions and disbursements of FIsreveals that the total loans sanctioned by theseinstitutions towards infrastructure in the firstthree years of the period 2001-02 to 2010-11

24Retail participation in the secondary corporate debt market is insignificant and has fallen from 1.74 per cent in 1995-96 to 0.03 per cent in 2000-01.25 Non-SLR securities typically comprise of securities issued by corporates, banks, FIs and State and Central Governmentsponsored institutions, SPVs etc. These securities are not considered as eligible securities for the purpose of SLRrequirements of banks and financial institutions.26 In part, this stems from asset liability mismatches on account of the difference in tenor between the bank’s liabilitiesand the tenor of advances needed for infrastructure financing. For instance, while infrastructure lending has an averagetenor of 7-10 years, the average maturity period of 58 percent of deposits of scheduled commercial banks in India wasunder two years as of March 2003. In absence of ‘take-out’ or mezzanine finance mechanisms, it is difficult beyond apoint for banks to manage longer tenor assets with shorter-tenor liabilities.27 The Industrial Development Bank of India (IDBI)’s annually prepares a report of the sanctions and disbursements of FIs,including towards the infrastructure sectors. The list of institutions included in this report are IDBI, IFCI, ICICI Bank, IIBI,IDFC and SIDBI (which are classified as all-India development banks), specialized FIs such as the Exim Bank and NABARD,and investment institutions i.e. LIC, GIC, NIC, NIA, OIC, UII and UTI.


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has been Rs.460.6 billion, or a mere 8.3 percentof our estimated aggregate financing gap ofRs.5,542 billion. At this rate, the total sanctions

for infrastructure projected forward for thedecade 2001-02 to 2010-11 turns out to be alittle more than Rs.1,500 billion, or 28 percent of

Box 4: International Experience of Channeling Local Financing throughDeveloping Local Capital Markets

There are four channels through which local financing capabilities are being developed internationally:·

First, through issuance of equity on the local stock market by companies already engaged in providinginfrastructure services. Telecom companies have been active issuers of equity in several countries (includingThailand and Argentina) and have played an important role in raising the capitalization of their emergingmarkets.·

Second, through private equity placements with individual project companies by institutional investorssuch as insurance companies and pension funds. This type of equity participation is more common withGreenfield projects that are financed on a limited recourse basis. The capital markets payoff emergesfrom the experience that institutional investors acquire through becoming more active investors in thereal sector (in many countries, insurance and pension funds have mainly bought government securities).Pension and insurance firms in Chile, Malaysia and Philippines are now becoming active investors throughtheir involvement in infrastructure projects.·

Third, through debt financing provided by local commercial banks and development FIs. These institutionscan be privately, publicly (government) or jointly owned. Most projects have a local currency financingrequirement and where possible local banks can contribute to development of the overall debt package.In many countries, local banks have limited experience with providing structured project financing debt,and participating in a large deal can enhance their risk appraisal capabilities.

Fourth, debt finance obtained through locally-issued bonds by infrastructure companies. Bond issues aremore common from established companies (such as those operating in telecoms) because bond purchaserstend to be risk averse. However, examples of pre-completion bond financing are starting to emerge inChile and Malaysia.

Each of these four channels provide a capital market impact that can be beneficial for a country’s mobilizationcapability, but the strongest impact occurs when project financing occurs through equity listing or a domesticbond issue. In addition, the state of a country’s capital markets may affect financing strategies.

For instance, bond issuances can sometimes be made pre-construction, but not on the local market, if thelegal and regulatory framework which governs capital market transactions is weak or if the domestic securitiesmarket is small. In India, a key legal weakness of the corporate bond market is the payoffs obtained bybondholders in the event of default. In industrial countries, an extensive ‘bankruptcy code’ exists, with wellfunctioning institutions. When a firm fails to pay out cashflows on time, the management team of the firm isdisplaced, the firm is sold off, and the residual value is given to the bondholders. Such processes do not existin India. Bondholders have to plan for near-zero recovery, in the event of default.

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI)Act, 2002 has made some progress on rapid repossession of collateral for secured credit. However, this is anarrow concept which does not address the deeper issues of the bankruptcy code. In a modern setting, bondissuance should be a senior claim on the cashflows of the firm, and not associated with specific assets. Oneof the key weaknesses of SARFAESI is that it is focused on the interests of institutional bondholders. It doesnot adequately address the claims of individual bondholders.

Differences in the capabilities of local bond market explain why Malaysia was able to finance a power projectthrough a bond issuance whereas a Philippines power project required an international bond offering. Countriesthat promote the growth of their capital markets will find it easier to finance infrastructure investments.

Source: IFC: Lessons of Experience in Financing Private Infrastructure, September 1996


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the aggregate finance gap. Clearly, these FIs havea long way to go. Moreover, while sanctions havebeen low compared to the financing gaps ininfrastructure, disbursements have been lowerstill. For the three years ending 2003-04, totaldisbursement of the FIs has be Rs.287.6 billion,which translates to 5.2 percent of the financegap for 2001-02 to 2010-11.

Among the various term-lending institutions, LIC(the largest insurance company in India that isalso state-owned) has emerged as the biggestplayer, with its disbursements for infrastructureprojects exceeding the combined disbursementsof IDBI, IFCI, IDFC, IIBI and SIDBI. However, mostof the involvement of the state-owned insurancecompanies, including LIC, is in infrastructureprojects of the central and state governments’SOEs backed by government guarantees. Theseare often not based on credibility or the detailedeconomics of the project. In fact, in the past,state governments have raised funds from theinsurance SOEs ostensibly for financinginfrastructure, which have then been divertedto the state’s consolidated finances. Commercialbanks have only been marginal players in termsof their share of infrastructure financing in therecent past, though this segment has registeredstrong growth in the last two years.

Within the sectors, FIs have a much higherappetite to lend for power projects than others.Power generation accounts for 62 percent of thevalue of infrastructure loans sanctioned and 55percent of disbursals. Telecommunication comessecond, accounting for 20 percent of totalinfrastructure sanctions, and 24 percent ofdisbursals.

The role of regulatory uncertainty andrisk in limiting FI participation

A fundamental factor limiting the participationof all types of FIs in infrastructure financingrelates to regulatory uncertainty, which raisesthe risk-profile of infrastructure sectors, and

increases the risk-aversion of FIs towardsinfrastructure financing. Even in cases whereprojects are being ‘regulated through contracts’,the inability to enforce the contract conditionsand threat (and actual experience) of reopeningof these contracts by government, greatlyincreases the risk profile of the projects (adiscussion on regulatory constraints in differentsectors is presented later in this note – Section2.4).

The risk-aversion of FIs in financing infrastructureprojects further manifests itself in their reluctanceto enter projects at the early stages, whereproject risks are concentrated. One of the mainreasons cited for viable projects not reachingfinancial closure quickly enough has been thelack of financial support at the initial stage of aproject’s life cycle. Commercial banks, of course,rarely take equity positions in infrastructureprojects. Unfortunately, even the specializedinfrastructure financing companies, such asInfrastructure Leasing and Financial Services Ltd.(IL&FS) and Infrastructure Development FinanceCompany (IDFC), have preferred to enter projectsonly after the Commercial Operations Date(COD) phase. Critics point out that the rationalefor setting up these specialized institutions wasprecisely to take initial equity positions in theseventures, and provide the confidence necessaryto attract further capital into the project.

Restrictive government policies andregulatory guidelines

Restrictive government policies and regulatoryguidelines have further constrained the abilityof insurance companies and pension funds toparticipate in infrastructure financing. (See Box5).

For commercial banks, while RBI regulations donot pose serious constraints for banks to increasetheir exposure to infrastructure sectors, theflexibility of banks to become more active in thissegment is constrained by RBI’s regulations that


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Box 5: Restrictive Investment Policies and Guidelines for Insurance and PensionsBox 5: Restrictive Investment Policies and Guidelines for Insurance and PensionsBox 5: Restrictive Investment Policies and Guidelines for Insurance and PensionsBox 5: Restrictive Investment Policies and Guidelines for Insurance and PensionsBox 5: Restrictive Investment Policies and Guidelines for Insurance and Pensions

The investment guidelines of insurance companies specified by IRDA require them to invest not less than 15percent of their investments in infrastructure and social sectors. It is understood that most of the investmentsby insurance companies in infrastructure are made to State-owned specialized FIs such as National ThermalPower Corporation (NTPC), Power Finance Corporation (PFC) (which have a AAA rating) as also to housingsector which qualifies under infrastructure investments. This clearly indicates the low risk-taking outlook ofthe insurance companies. The guidelines also lay down a minimum credit rating of ‘AA’ for investments indebt paper which would automatically exclude investment by insurance companies in debt paper of privateinfrastructure sponsors.

Investment guidelines for life insurance companiesInvestment guidelines for life insurance companiesInvestment guidelines for life insurance companiesInvestment guidelines for life insurance companiesInvestment guidelines for life insurance companies

S.NoS.NoS.NoS.NoS.No Type of InvestmentType of InvestmentType of InvestmentType of InvestmentType of Investment PercentagePercentagePercentagePercentagePercentage

i) Government Securities 25%,

ii) Government Securities or other approved securities (including (I) above) Not less than 50%,

iii) Approved Investments as specified

a) Infrastructure and Social SectorNot less than 15%

b) Others to be governed by specified Exposure/ Prudential Norms Not exceeding 20%

iv) Other than in Approved Investments to be governed by specifiedExposure/ Prudential Norms Not exceeding 15%

Source : Insurance Regulatory and Development Authority (IRDA)

Investment guideline for non-life insurance companiesS.NoType of InvestmentPercentageInvestment guideline for non-life insurance companiesS.NoType of InvestmentPercentageInvestment guideline for non-life insurance companiesS.NoType of InvestmentPercentageInvestment guideline for non-life insurance companiesS.NoType of InvestmentPercentageInvestment guideline for non-life insurance companiesS.NoType of InvestmentPercentage

i) Central Government Securities being not less than 20%

ii) State Government securities and other Guaranteed securities including (i)above being not less than 30%

iii) Housing and Loans to State Government for Housing andFire Fighting equipment, being not less than 5%

iv) Investments in Approved Investments as specified in Schedule II

a) Infrastructure and Social SectorNot less than 10%

b) Others to be governed by specified Exposure/ Prudential Norms Not exceeding 30%

v) Other than in Approved Investments to be governed by specifiedExposure/ Prudential Norms Not exceeding 25%

Source: Insurance Regulatory and Development Authority (IRDA)

Pension and provident funds, both Employees Provident Fund (EPF) and PPF, are also repositories of largeamount of long-term finance. However, as a legacy of government regulations, pension funds remain anotionally funded scheme. For one, almost 72 percent of the fund exists in the form of special deposits withthe central government. Under the existing stipulations, these funds cannot be drawn out for deployment inother avenues and, thus, remain a ‘black-hole’. For another, a significant portion of the remaining funds aredeployed in government securities, which, too, remain locked in for two reasons. First, once a governmentsecurity is subscribed, regulations mandate that they be held till maturity. Second, investment guidelines alsomandate that interest received from government securities be re-invested in those securities itself. Theinvestment profile of pension funds are highly regulated with a massive bias towards government securities.This precludes the largest source of long-term funds from bridging the financing gap in infrastructure. A surveyof pension fund investment guidelines of some of the Latin American countries suggest that while significant


40

exposure to government debt is stipulated there is considerable freedom for these funds to invest in a mix offinancial instruments with varying risk-return profiles. Since the early eighties, pension funds have becomeimportant players in capital markets of many Latin American countries due to radical reforms to the socialsecurity systems. However, Pension funds are subject to quantitative restrictions including list of authorizedassets, diversification rules, conflicts of interest regulation, valuation rules etc.

Investment guidelines for pension fundsInvestment guidelines for pension fundsInvestment guidelines for pension fundsInvestment guidelines for pension fundsInvestment guidelines for pension funds

Investment PatternInvestment PatternInvestment PatternInvestment PatternInvestment Pattern Percentage amountPercentage amountPercentage amountPercentage amountPercentage amountto be investmentto be investmentto be investmentto be investmentto be investment

i) Central Govt. Securities; and/or units of Mutual Funds which have beenset up as dedicated funds for investment in Government securities andwhich have been approved by SEBI 25%

ii) a) Govt. Securities; created and issued by any State Government; and/orunits of such Mutual Funds which have been set up as dedicated funds forinvestment in Govt. Securities and which have been approved by Securitiesand Exchange Board of India (SEBI) 15%

b) Any other negotiable securities the principal whereof and interest thereonis fully and unconditionally guaranteed by the Central Govt. orany State Government 15%

iii) a) Bonds/Securities of ‘PFIs’, Public sector companies’ including public sector banks 30%

b) Short duration Term Deposit Receipt(TDR) issued by public sector banks

iv) to be invested in any of the above three categories decided by their trustees 30%

v) The trust, subject to their assessment of risk-return prospects, may invest up to1/3rd of (iv) above, in private sector bonds/securities, which have an investmentgrade rating from at least two credit rating agencies.

Source:EPFO guidelines

Maximum exposure to an asset for pension funds in Latin American countriesMaximum exposure to an asset for pension funds in Latin American countriesMaximum exposure to an asset for pension funds in Latin American countriesMaximum exposure to an asset for pension funds in Latin American countriesMaximum exposure to an asset for pension funds in Latin American countries

ArgentinaArgentinaArgentinaArgentinaArgentina ChileChileChileChileChile ColombiaColombiaColombiaColombiaColombia PeruPeruPeruPeruPeru UruguayUruguayUruguayUruguayUruguay IndiaIndiaIndiaIndiaIndia

Government Debt 50% 50% 50%40% 60% 55%*

Time Deposit 28% 50% 50% 30% 30% 30%**

Bonds 28% 45% 20% 49% 15%

Stocks 35% 37% 30% 35% 25%’ Nil

Mortgage Bonds 28% 50% 30% 40% 20% Nil

Foreign Investment 10% 12% — 10% — Nil

Close-End Investment Funds 14% 5% 10% 15% — 15%

Futures and Exchange Risk Coverage 2% 9% — 10% — Nil

Source: Organization for Economic Cooperation and Development (OECD)

*which could go to a maximum of 85 percent due to a discretionary component of 30 percent with thetrustees

**Bonds/Securities of ‘PFIs’, Public sector companies’ including public sector banks and short term depositswith banks


41

prevent banks from participating in the creditderivatives markets. This precludes banks fromtaking on higher credit risk with the option ofhedging these risks to the extent needed throughthese products.

Furthermore, the skewed incentive systems ofthe larger (publicly owned) FIs, that havetraditionally operated in an uncompetitiveenvironment, have led to conservative internalinvestment guidelines of FIs, giving little spacefor investment in areas like infrastructure, thatare perceived as risky. Until recently, in theabsence of competition, the investmentdepartments of these institutions merelyfunctioned as administrators of funds, withoutany significant performance pressures on returns.Any shortfall on guaranteed returns to pensionand insurance plans were expected to be metthrough government support. But this is changingas competition increases.

Insufficient knowledge and appraisalskills

Insufficient knowledge and appraisal skillsrelated to infrastructure projects is anotherconstraint, increasing the risk perception ofinsurance and pension funds towardsinfrastructure projects. The banking sector, too,lacks the specialization and experience toappraise the risks and returns associated withlarge and complex infrastructure projects.Commercial banks have generally focused onworking capital finance, trade funding and billdiscounting and, therefore, have not developedsufficient expertise to appraise complex and riskyinfrastructure projects with long gestationperiods.28 Though, in recent times the State Bankof India (SBI) has developed relatively strong skillsin project evaluation and infrastructure projectadvisory, most banks know little about the

sectors. Consequently, entities that have accessto large amounts of relatively cheap depositors’funds shy away from infrastructure investment,unless proposals are appraised by specialized FIslike IDFC. Banks lack the incentive and thewherewithal to shore-up their appraisal skills.Additionally, the existing employees’ incentivestructure in the public sector, including promotionand rotation policies, of public sector banks,makes it difficult for these banks to develop and/or leverage on such a skill-set.

Lack of a reliable interest-ratebenchmark

One of the standard practices in internationalproject finance is to use a reliable and generallyaccepted interest rate benchmark (e.g. LIBOR)as a backbone for longer-term floating ratecommitments which are periodically rolled over.In India, the Mumbai Inter Bank Rate (MIBOR)has been in existence for sometime now but hasnot yet attained the reliability and acceptanceto serve as a benchmark for such project financesyndications. The absence of such a benchmarkwould limit flexibility and would reduce theincentive for FIs and banks to participate andthus the probability of success of syndicationsfor infrastructure finance.

2.2 Fiscal Barriers to PrivateFinancing of Infrastructure

An enabling fiscal environment is a pre-requisitefor attracting private sector players to inherentlyhigh risk ventures. The GoI has introduced taxconcessions, and these have helped. GoI has alsointroduced VGF for infrastructure projects thatare being operationalised currently. While taxconcessions are not necessarily desirable per se,they help increase returns and hence in certainsituations can help stimulate private investment.

28 This has been a handicap in project risk management, which covers the entire gamut of exposure i.e. engineering,construction, start-up and operations. To evaluate and mitigate such risks requires comprehensive due diligence,including a rigorous analysis of the assumptions underpinning the financial model — which majority of the banks areill-equipped to handle.


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In this context, there are some fiscal issues thatneed to be ironed out in order to give furtherfillip to infrastructure sectors. Some of these areidentified below.

High customs duties oninfrastructure equipment

While there are import duty concessionsavailable to imports used for infrastructuredevelopment, such as in the case of megapower projects, certain telecom equipment etc.,these are largely selective in nature. Forinstance, while equipment for mega-powerprojects can be imported against zero or lowduties, the same facility is not available forcapital goods used in roads. It has beensuggested that the government create a masterlist of all key capital goods and machinery usedfor roads, power, ports, airports, telecom andwater supply and distribution, and make theseavailable at zero duty. In large measure, this iswhat China has done in the recent past, whichhas significantly reduced its cost of setting upinfrastructure.

Section 10(23G) of the IncomeTax Act

This clause exempts tax on income fromdividends, interest and long term capital gainsfrom any investment made in an enterpriseengaged in the business of developing,maintaining and operating an infrastructurefacility — and has been of great help in facilitatinginfrastructure investments. However, threeissues still cause problems.

First, the borrowing infrastructure companyneeds to get annual approval andcertification of its “infrastructure status” fromthe Central Board of Direct Taxes (CBDT)before the lender can claim the fiscal benefitsunder this section. The process is notautomatic and often takes considerable time

— which has on several occasions led todelays in getting the concessions.

Second, there is an issue of escalation. Inessence, if the surplus of an infrastructureSPV that falls under section 10(23G)is re-invested in another infrastructure SPV —both of which belong to the same umbrellacompany — could the latter also obtain thefiscal benefits under this provision? As ofnow, the opinion runs counter to this.According to this view, an enterprisequalifies for the benefits under section10(23G) if it is wholly engaged in the businessof developing, maintaining and operatingany infrastructure facilities. The catch lies inthe word “wholly”. This apparently precludesany infrastructure enterprise to invest or lendits investible surplus in another infrastructureentity — for that would be an act offinancing, and not amount to developing,maintaining or operating of infrastructure.So, if an infrastructure enterprise lends a partof its surplus, it ceases to be a companywholly engaged in infrastructure and,instead, becomes also a lending or investingentity. Thus, according to this interpretation,it will not get the benefits of section 10(23G).This is a very linguistic and extremelylegalistic interpretation of the provision.Suppose a bank or financial institution lendsto an infrastructure company X, which in turnreinvests a part of the surplus in anothergroup infrastructure company Y only for thepurpose of financing an infrastructureproject. Clearly, in terms of transactions, thisis more efficacious than Y again needing toapproach a bank or FI for the additionalamount of funding. In principle, therefore,the benefits of section 10(23G) should flowto company Y, provided that it is also a pureinfrastructure company as defined under thesection. This problem can be resolved byeither eliminating the word “wholly” orsubstituting it with “substantially”.


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Third, the benefits of section 10(23G) donot flow down to retail investors. Had thatbeen possible, the tax benefits of thisprovision could have been leveraged tocreate more dedicated infrastructuremutual funds where the retail investorswould have been additionally attracted bythe tax incentive.

Tax holidays under section 80IASection 80IA of the Income Tax Act relates toinfrastructure projects and provides for 100percent tax deduction on profits for 10 years and50 percent for the next five. There are two issueswith this seemingly beneficial provision.

First, most infrastructure projects, especiallythose in roads, power and ports, take up to7-8 years before starting to show profits.Therefore, providing for a 100 percent taxholiday over the first 10 years does notactually amount to a serious fiscal incentive.

Second, even this limited fiscal incentive isoverridden by the Minimum Alternate Tax(MAT), which is levied at 7.5 percent on bookprofits. Consequently, the fiscal benefits fromsection 80IA get significantly diluted at theground level.

Poor state government finances

Nearly all states suffer from serious fiscalimbalances and are ridden with huge debtobligations. The debt to GDP ratio of stateshas increased by over 7 percent in the last fiveyears to 29.1 percent (31 March 2004). In2003-04 interest payments on debt accountedfor over 25 percent of revenue receipts. Apartfrom the increasing level of debt, theoutstanding guarantees of state governmentshave also recorded a sharp increase from 4.4percent of GDP in March 1996 to 7.5 percentof GDP, or Rs.1,842 billion. Clearly, in such asituation, states are not the most bankable

business partners for pr ivate sectorparticipation in infrastructure.

2.3 Approvals, Red tape andInadequate AdministrativeCapacity in Government

Almost all infrastructure projects in India sufferfrom unacceptable delays. Some of these relateto inadequate regulatory frameworks. However,much of it has to do with cascading level ofinefficiencies across virtually all approvingagencies. Given below are some of thesebarriers.

Multiple clearances

Infrastructure projects require multipleclearances at centre, state and local levels. Thisis a time consuming process not only due to thesheer number of approvals but also becauseclearances are sequential, and not concurrent.29

According to most developers and financiers, thetime taken to obtain all the requisite approvalsfor an infrastructure project can vary betweena low of 18 months to as much as four to fiveyears. For example, it took more than two yearsfor the Gujarat Pipavav port project to receivethe necessary clearances after achievingfinancial closure on the project. Delays like thesein getting government approvals, places Indiavery unfavorably compared to China and South-East Asia.

In spite of the theoretical concept of a singlewindow clearance in many states, when mostprojects apply for approvals at the state-level,these have to go through multiple clearancesfrom local panchayats, municipalities, forest,environment board etc which cause huge delaysin completion. In many cases, the concessionagreement entered into by individualdepartments do not have pre-approvedclearances from the Finance Department,leading to further delays.

29 For example, when Sify was setting up internet cafes in different states, it involved over 50 different clearances!


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Lack of coordination betweengovernment ministries /departments

Most infrastructure projects involve dealing withmultiple ministries. One of the key reasons forprojects not taking off at the pre-financing stageis that the actions and policies of differentministries are not coordinated and are often atvariance with each other. This is particularly truefor the power sector, where even if thedeveloper obtains the requisite permission forsetting-up of a generation facility, he finds itdifficult to start operations because of lack ofclearance for fuel supply, which involves sometwo other ministries. Similar problems existregarding the Ministry of Environment. There areno IIGs except in power. The recently set up IIGfor power has proved to be an effective way toexpedite PPP investments in the sector. Suchgroups have not been formed for other sectors,and their absence has impeded the developers’ability to achieve financial closure and completethe necessary formalities on time.

Problems in contract negotiationsand delays in the award ofcontracts

This is pervasive across all infrastructure sectors.For instance, it took Kakinada port four years toachieve financial closure. In the power sector,four gas-based power projects30, which hadachieved financial closure in early 2004 with aninvestment of over Rs.50 billion, are today onthe verge of closing down due to flawed fuelsupply contracts. While the gas supplier GasAuthority of India Limited (GAIL) has said that ithas no gas to offer to these plants, projectsponsors find it impossible to penalize GAIL dueto one-sided fuel supply contract31 that theywere forced into. Even a well run, relatively

efficient organization like the NHAI is nowcausing delays. To give an example, the bids forthe first lot of NHDP III projects were received inMarch 2004; not one of these has been awardedtill date.

Limited capacity withingovernment to execute PPPs ininfrastructure

Both the central government and the states areaiming to use PPPs more intensively to help meetgaps in the provision of basic services in thecountry. These PPPs can help meet theinfrastructure gap in India, but are not apanacea. They represent a claim on publicresources that needs to be understood andassessed. They are often complex transactions,needing a clear specification of the services tobe provided and an understanding of the wayrisks are allocated between the public andprivate sector. Their long-term nature meansthat the government has to develop and managea relationship with the private providers toovercome unexpected events that over time candisrupt even well-designed contracts. Financiersof these projects critically evaluate a project interms of all design features mentioned aboveand hence the ability to conceptualize andstructure a PPP from the government’s side is akey variable in determining the viability of, andthe willingness of FIs and banks to finance theproject.

The capacity to effectively conceptualize,procure and manage these PPPs is very limitedwithin the public sector – both organizationally(legal frameworks, procures, guidelines etc) andat the individual level. Internationally,governments embarking on PPP programs haveoften developed new policy, legal andinstitutional frameworks, individual training and

30 The projects were sponsored by Ispat group, GVK industries, GMR group and EPS Oakwell Power.31 Interestingly, the supply agreement had a clause which stated that the power company had to pay for the gas on offereven if it did not need it but did not have a clause to penalize GAIL in case of supply default.


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technical support to provide the requiredorganizational and individual capacities. A similarcomprehensive effort at building capacity tofacilitate PPPs is needed by the central and stategovernments.32.

2.4 Constraints Related to PoorInfrastructure Regulation andRelated Risks and Uncertainties

Regulatory impediments vary considerably acrosssectors. In some, such as telecom, the obstaclesand contradictions during the initial phase of the1990s are things of the past. Through learning-by-doing, the Telecom Regulatory Authority ofIndia (TRAI) has truly established itself as anefficient, fair, expeditious and independentregulator which is respected as a body forcreating a level playing field and fostering therapid growth of telecom in India. In sharpcontrast, the regulatory environment in powerleaves much to be desired; and as yet there isno independent regulatory institution in place forports or airports. To understand the extent ofregulatory barriers, therefore, one needs toanalyze the different sectors. Below is a briefdiscussion of some of the relevant regulatoryissues across the different sectors.

Sector specific issues: roads

By and large, the National HighwaysDevelopment Program under NHDP has been asuccess. There has been significant learning byboth government and the private sector. Throughwide-spread consultation and its own

experiences, the NHAI has stabilized a robustModel Concession Agreement (MCA) for its BOTas well as annuity projects. Standard biddingdocuments have also been prepared for thePradhan Mantri Gram Sadak Yojana (PMGSY)contracts. Till now, there have been no majorcases of the government reneging on BOT orannuity agreements, which has served tomaintain and enhance the credibility of thesecontracts — something that is lacking in thepower sector.

Moreover, there has been a clear financialcommitment on the part of the Government ofIndia in the form of setting-up a long-term ring-fenced source of finance, namely the CentralRoad Fund (CRF)33. Not only does it securesignificant long-term funds but it also helpsproject executing agencies such as NHAI to useit as quasi-equity to leverage market borrowings.

Despite its successes, there are some regulatoryissues that need to be addressed.

The major one relates to the small size ofNHAI projects. The average size of PPPprojects (BOT, annuity and through purecontracting SPVs) is 44.6 km; that of BOTprojects is 50.4 km; and of annuity-basedprojects is 59.4 km. This piece-meal approachadopted by NHAI towards awardingcontracts has three negative consequences.

First, it encourages the entry of smallerplayers with limited technical and financialabilities in the bidding process — oftenleading to as many as 30 bids in response to

32For a detailed discussion on this issue please see ‘India: Building capacity for Public Private Partnerships’, World Bank,May 2005.33 Under the Central Road Fund Act, 2001, a Rs.1 per litre cess is charged on petrol and high speed diesel (HSD), which isestimated to yield Rs.15 billion from petrol Rs.45 billion from HSD. The cess on HSD has been increased to Rs.1.50 from1 March 2003. Proceeds of the cess levied is first credited to the Consolidated Fund of India and thereafter credited tothe Central Road Fund from time to time after deducting the expenses of collection. The cess is apportioned as follows:(i) 50 percent of the cess on HSD is for the development of rural roads; and (ii) the balance 50 percent cess on HSD andthe entire cess on petrol in the following manner: 57.5 percent for the development and maintenance of nationalhighways; 12.5 percent for the construction of roads either under or over the railways and erection of safety works atunmanned rail-road crossings; and 30 percent on development and maintenance of roads other than nationalhighways, i.e. state highways.


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a single tender floated by NHAI. Though thiscould be construed as healthy competition,it has sometimes resulted in the selection offirms with unrealistically low bids, who laterhave not been able to deliver.34

Second, smaller projects inflict higher per unitcapital costs to the contractors. As the sizeof the project increases the per unit cost ofmobilizing requisite physical and financialcapital goes down more than proportionally.Scaling-up project sizes will incentivize biggerdomestic and foreign players to makecompetitive bids and also make it economicfor them to source the requisite capital in atimely manner.

Third, small project sizes have discouragedlarge players, who can access both capital andexpertise and deploy these more effectivelythan fragmented operators. Diseconomies ofscale have also prevented more widespreaduse of annuity and BOT. Although the thrust ofthe NHAI’s NHDP program is to encourageprivate sector involvement in road creation,operation and maintenance, in reality morethan 80 percent of the Golden Quadrilateral(GQ) has been completed through EPCcontracts, i.e. civil works implemented throughcontracts on a cash payment basis. Till date,only 9 BOT and 8 Annuity based schemes havematerialized under GQ program, and none inthe NS-EW project.

The other regulatory issue relates to the CRF.Although the CRF is ring-fenced in thetechnical sense of the word, the timing andquantum of allocations to the CRF from theConsolidated Fund of India are stilldependent upon the central government. Fora program as important as improvement andmodernization of roads, it is more advisableto have a statutorily independent bodyadministering the CRF.

Sector-specific issues: power

More than any other, the power sector suffersfrom a wholly inadequate and non-credibleregulatory regime at both the central and stategovernment levels. Given below are some keydeficiencies:

State Electricity Regulatory Commissions(SERCs) do not act in a predictable andconsistent manner in most states. TheSEBs have been unbundled into three distinctentities (generation, transmission anddistribution). Also in theory, with theenactment of the Electricity Act, 2003, theseentities are supposed to be monitored andregulated by independent SERCs. However,in practice, no investor can be sure if theregulator will adjust prices, or when, or theextent to which non-action (or injuriousaction) will be defended on the grounds thatsocial factors (especially, “affordability”)need to be taken into account. Unpredictablebehavior of the SERCs relates in large partto their lack of autonomy and the fact thatthey are under pressure from many directions.Most, if not all, SERC members in any stateare former employees of the SEBs that theyare now expected to regulate. Moreover, thefunding of SERCs comes from the stategovernment. Consequently, the stage getsset for serious regulatory capture by both thestate government and its SEB. In most cases,SERCs are weakened from inception, whichallows large state utilities to remainunresponsive to their regulations.

It should be pointed out however, that theabove-mentioned issues stem predominantlyfrom a fundamental structural flaw in thecurrent operational and regulatory structureof the power sector. Since the reforms in thesector have progressed only to the extent of

34 Till date, at least 8 foreign firms and 9 Indian firms have been declared as non- performing and blacklisted. Twocontracts, one on NH-2 (Delhi-Kolkata) and one on NH-5 (Chennai-Kolkata) have also been terminated.


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unbundling and establishing regulatory bodieswithout actually changing ownership, theeffectiveness of the regulator to regulate theutility (which is another arm of the government)is obviously limited. The policy maker, theregulator and the utility are all different partsof the government. In this scenario, at the veryleast, there needs to be operational autonomyfor the utilities and functional and financialautonomy for the SERCs.

Access charges. The Electricity Act, 2003,which is supposed to be adopted by all states,provides for non-discriminatory open accessto transmission and distribution lines. Thereare serious regulatory concerns about state-owned transmission companies stiflingcompetition by levying prohibitively highaccess charges between private sectorgenerating companies and end-consumers.This has often been cited as one of the majorregulatory risks that could prevent an activeprivate sector market for the wheeling ofpower.

Credibility of fuel supply agreements.Every power generation project is basedupon fuel supply agreements — be it for coalor gas. Unfortunately, neither source of fuelfalls within the domain of the Ministry ofPower, and there have been serious delaysin power projects because the promised fuelsupply agreement has not materialized.Moreover, fuel that is promised to besupplied often does not arrive on time. InSeptember 2004, one of the bigger units ofNTPC had to be shut down for five and ahalf days because of coal shortages. Theshortage of gas has also been quite severein the past, which has adversely affected thePlant Load Factor (PLF) of many plants. Forexample, it is estimated that around 1,600MW of gas-based power capacity in theprivate sector is not being made operationalon account of fuel shortage. The Ministry ofPower estimates that but for the fuel

shortages, the growth in actual generationfor the first nine months of FY06 would havebeen five percentage points higher. Fuelsupply poses serious concern with newplants, which even after achieving financialclosure are not able to move on to theconstruction phase because of their inabilityto garner requisite fuel supply.

State government guarantees. Someobservers believe that guarantees could playan important role in catalyzing privateinvestment in the power sector.Unfortunately, the financial credibility of moststate government guarantees is clearlysuspect in light of the weak fiscal position ofstates. By March 2004, outstandingguarantees of all state governments wereas high as Rs.1,842 billion or 7.5 percent ofGDP. In addition to this, the estimatedcommercial losses of the SEBs in 2005-06were approximately Rs.226 billion (excludingsubsidies). Such financial penury does notaugur well for PPPs in power. Otherobservers, however, argue that in stateswhere the fiscal situation is relatively better,state government guarantees in fact createthe wrong incentives. In Rajasthan, forexample, the state’s transmission companycan borrow (essentially, to cover losses in thedistribution sector) from commercial banksand issue bonds at surprisingly good interestrates, despite annual financial losses of overRs.2000 crore, as long as it has a stateguarantee. Its ability to borrow at tenors ofup to 15 years may be a factor in delayingmore fundamental reform of pricing andcreates an uneven playing field againstprivate operators who do not enjoy similargovernment guarantees.

States reneging on escrows as well asPPAs. Initially, private power generating entitiesrequired SEBs to create escrow accounts soas to ring fence the revenues payable to them.However, in many cases, such escrows have


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not worked out because these did not addressthe basic problem of inadequate revenuestreams for the SEBs. An even more seriousissue is the prevalence of cases where SEBshave unilaterally reneged on contractuallyobligated PPAs. The most widely reported caseis the MSEB vis-à-vis the Dabhol project. Inaddition, there have been PPA reneging andtermination in Karnataka and Andhra Pradeshand Tamil Nadu.

Slow operationalization of the ElectricityAct, 2003. Without doubt, the Electricity Act,2003, is good in theory. The key features ofthe Act are:

Easing of requirements for private entryinto generation.

De-licensing of generation (thermal) andfreeing captive power plants from controlof SEBs.

Opening of transmission and distributionto private participation.

Allowing for multiple distribution licences.

Non-discriminatory open access totransmission lines.

A new power tariff framework based oncompetitive bidding

Mandating universal metering andpunishments for electricity theft.

Mandating setting-up of SERCs in allstates.

However, progress by states to frame the rulesto operationalize the Act has been slow andpatchy35. Consequently, it does not serve as aguidepost for structuring projects and makinginvestment decisions.

Sector-specific issues: ports,airports36 and railways

None of these sectors have independentregulators in place. While there is a TariffAuthority for Major Ports (TAMP) which regulatesand supervises tariffs of private sector serviceproviders, it is not a regulator in the wider senseof the term. Airports have yet to have anindependent regulator, although this was animportant recommendation of the NareshChandra Committee. Indian Railways has refusedto have one despite the recommendation of theRakesh Mohan Expert Group. In railways, thelack of a regulator has allowed the ContainerCorporation of India (CONCOR), a subsidiary ofIndian Railways, to exercise complete monopolyrights of managing and linking up inland containerdepots (ICDs) with container freight stations(CFSs) at ports, to the detriment of port-sidecontainer terminals although this monopoly isnow being ended by allowing private sector tooffer linkages to ICDs. The lack of independentregulators in these critical sectors createsproblems for future deregulation, and fails toprovide comfort to potential investors in termsof predictability and stability.

The RBI and non-sector specificregulatory issues

There are three regulatory barriers that havebeen mentioned by infrastructure players across-the-board, all of which have to do with RBIregulations.

Should infrastructure finance be treatedas priority sector lending? At present, theRBI rules state that 40 percent of a domesticscheduled commercial bank’s loans andadvances (and 32 percent of a foreign bank’s)should be directed to the so-called ‘priority

35 Of the reforms mentioned under the Electricity Act, SERCs have been set up in almost all states (though theiroperational success varies vastly) and the Tariff Policy has been announced and expected to be implemented shortly.36 The GoI is at present discussing the AERA (Airport Economic Regulatory Authority) Bill.


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sectors’, which comprise agriculture, smallscale industries, khadi and village industriesand a classified list of other small scalebusinesses. Infrastructure sectors such asthose examined in this note fall outside thedefinition of priority sector. It has beenargued by several banks that, given thecritical importance of infrastructure, it tooshould be considered as a priority sector.

Should there be Statutory Liquidity Ratio(SLR) and Cash Reserve Ratio (CRR)requirements on infrastructure bonds?At present, scheduled commercial banks arerequired to maintain with RBI on a fortnightlybasis an average cash balance or CRRamounting to 3.5 percent of the total of theNet Demand and Time Liabilities (NDTL) inIndia. SLR is peculiar to India, whichmandates that scheduled commercial banksmust keep 25 percent of their total demandand time liabilities in India in cash, gold orapproved government securities. The reason

for both is to maintain a safe liquidity inbanking system, although the SLRrequirement makes it easier for the centralgovernment to pre-empt depositors’ funds.It has been suggested by many banks thatsince 15-20 year AAA rated infrastructurebonds are of long maturity and carry no shortterm liquidity risks, liabilities on account ofthe sale of such instruments should beconsidered outside the purview of SLR andCRR.

Should there be interest caps on ECBs forinfrastructure loans? As mentioned earlier,long gestation infrastructure ECBs may notbe readily forthcoming in a regulatory regimethat imposes a cap of LIBOR plus 350 basispoints. It has been suggested by severalinfrastructure players that for infrastructureloans above five years maturity, there shouldeither be no cap on interest rate or, at thevery least, the cap should be doubled to 700basis points above LIBOR.

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The analysis in the preceding section clearlysuggests that while a number of financial sectorrelated constraints need to be addressed tofacilitate greater private financing ofinfrastructure, it will not suffice to reform thefinancial sector alone without paying adequateheed to other aspects of infrastructure. Indeed,it would be fair to say that, without reformingthe regulatory regime, central and state finances,the fiscal situation and without altering a politicaleconomy that looks askance at economicallyviable user charges, mere reforms in the financialsector will not lead to an upsurge in infrastructureactivities. Therefore, while the recommendationsoutlined below address the financial sector andfinancing instruments, they also focus on otherkey issues which have a direct bearing oninfrastructure investments.37

3.1 Addressing Financial Sectorand Related Regulatory IssuesA deeper and more diversified financial sectorcould certainly help increase private participationin infrastructure. Developing local capital marketscan play a critical role in facilitating privateinvestment in infrastructure. (See Box 4). Keypriorities include:

Facilitating equity financing

In the longer-term, equity finance from financialinvestors – including private equity funds such asventure capital funds and other institutional

investors, which include dedicated infrastructurefunds sponsored by a consortium of insurancecompanies, pension funds, Government sponsoredfunds, commercial banks, development banks,private fund managers and other privately-heldcompanies – is essential for increasing privateinvestment in infrastructure. The priorities are to:

Improve exit policies to make it easier forinvestors to exit. In this context, a key priorityis for RBI to introduce enabling regulations forthe use of put options as an exit mechanismfor investors in unlisted (privately held)companies. At present, the regulations do notallow financial investors to reach an upfrontagreement with sponsors on the terms of aput option, if the sponsor company is unlisted.Greater comfort on exit would encouragefinancial investors to take equity in greenfieldinfrastructure projects by having some defined,low guaranteed returns. This practice isstandard in many emerging markets, especiallyin Latin America. An additional, and desirable,outcome of this would be that with the entryof more financial investors in the equitymarket, it would broaden the investor baseand with successful closing of projects it wouldincrease investor confidence.

Other factors that would help increase equityinvestment in infrastructure projects include bettercorporate governance, with a particular focus onminority shareholder protection rights.38

III CONCLUSIONS AND THE WAY FORWARD

37 Telecom is a success story in all aspects and there are no recommendations for this sector.38 The legal framework and stock exchange rules should provide for full disclosure of shareholder agreements that couldhave an impact on how the company is governed or how other shareholders may be treated. For example, agreementsinclude understandings with respect to the exercise of voting rights, puts and calls, rights of first refusal, and powers ofcertain shareholders to nominate corporate officers. Detailed policy recommendations are available in the CorporateGovernance ROSC for India (Report on the Observance of Standards and Codes). The ROSC report can be accessed athttp://www.worldbank.org/ifa/rosc_cg-ind.pdf. The Bank is working in close cooperation with the Ministry of CompanyAffairs to address several of the issues raised in the ROSC assessment.


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Encouraging the use of moreinnovative financing instrumentslike mezzanine and takeoutfinancing

Removing interest rate caps on ECBs couldencourage foreign investors to use instrumentslike mezzanine and take out financing forinfrastructure investment: The Governmentshould consider either removing the 350 basispoint interest rate cap above LIBOR oninfrastructure loans above 5 years, or, at thevery least, double the cap to 700 basis pointsabove LIBOR. In addition, tools for mitigatingthe risks involved for international lendersshould be developed — for example, PartialRisk Guarantees (PRGs) to hedge againstpolitical risk, and developing the swap marketto mitigate foreign exchange risk.

Extending fiscal concessions, such as thoseunder section 10(23G) to venture capital andprivate equity funds that invest ininfrastructure, could also help encouragemezzanine financing.

Rationalization of stamp duties wouldfacilitate the use of takeout financing andsecuritization in states where these dutiesremain high. High stamp duties levied atad valorem rates are barr iers tosecurit izat ion as wel l as take-outfinancing. Given that stamp duties arestate subjects, the Central Governmentcan, at best, play a persuasive anddemonstrative role. While it is desirable towaive stamp duties for transactionsrelating to infrastructure projects, this maynot be possible because these duties oftenform a sizable part of a state’s revenues.An alternative is to: (i) reduce the dutiesto a uniform low rate across all states, and(ii) charge a lump-sum specific duty fortransactions beyond a certain threshold.Inadequate takeout financing can affect

annuity and BOT projects in roads, inpower as well as in ports.

Developing a longer termcorporate bond market

A well developed government bond market is acritical prerequisite to the development of thecorporate bond market. Hence, there is anurgent need to increase the depth and thebreadth of the government bond market,through the following measures:

To improve the breadth of the governmentbond market, the government shouldconsider recalling the existing illiquid,infrequently traded bonds and re-issue liquidbonds.

The existing regulation that requiresinstitutional funds such as pension funds andinsurance funds to hold till maturity allgovernment securities should be removedand they should be allowed to actively tradein the market.

To bring in more retail investors to thegovernment bond market there is a need tointroduce an element of marketability andprice discovery, which can only be broughtin by making securities trading screen basedand more transparent.

Furthermore, the development of India’scorporate bond market would benefit from thefollowing measures:

Issuance and listing: The procedures forpublic issuance of debt need to bestreamlined, drawing on lessons fromcountries like Korea, where regulatoryapproval takes just 5 days (against 21 daysin India). To facilitate timely market accessof corporate debt securities, a distinctionbetween regulatory requirements that applyto the wholesale market (where qualifiedinstitutional investors are concerned) fromthose that apply to the retail market could

Conclusions and the Way Forward

53

be made39 to enable listing to be astraightforward exercise. Private debtplacement guidelines also need to be madeless restrictive. Extending shelf registrationto all types of corporate issuers, would alsofacilitate quick, timely and cost-effectiveaccess of issuers to the markets. This iswidely used in developed debt markets, suchas the US and UK, Korea and Singapore.

Better corporate credit information can playa critical role in corporate debt marketdevelopment. More effort needs to be putinto collecting and disseminating data onbond issues, size, coupon, latest credit rating,underlying corporate performance,information on secondary trading(particularly pre-trade information related toinvestors having access to best quotes) anddefault histories of companies. A centralizedagency for this purpose would be a welcomestep forward.

Better market infrastructure. Efficient tradingand settlement systems are critical forproviding an exit route for debt investmentsin infrastructure. India needs to upgrade itstrading and settlement systems. Mechanismsthat have been put in place in several Asianand Latin American markets, which haveadopted sophisticated settlement systemsand have also put in place mechanisms forrecourse (through guarantee funds/compensation funds) in settling transactions,as discussed in Box 2 could offer some usefullessons.

New products. Government shouldencourage financial intermediaries to offernew product structures (e.g., creditenhancement, bond insurance) that enable

sub-investment grade corporates/municipalities to access financing. This couldbe achieved through initial guarantee orfunding support to the financialintermediaries. RBI and SEBI should considerregulatory reforms that would help develophedging tools for investors and traders: e.g.,credit derivatives, bond futures and options.

Increasing the appetite of long-terminvestors. Given the current stage of marketdevelopment, where long term institutionalinvestors are yet to develop, the bankingsystem could play an important role in thedevelopment of the corporate debt market;regulatory caps on banks’ investments incorporate bonds could be relaxed (limited to10 percent of their total non-SLR investments)as could the minimum rating requirement(minimum investment grade, i.e. AA andabove). While not an immediate constraint,over the medium term, the debenture trusteesystem needs to be strengthened toencourage retail investment in infrastructureby providing protection from default by thecompany in payment of timely interest.40

Other measures also need to be taken toencourage insurance companies and pensionfunds to step-up their investment ininfrastructure projects. These are discussedbelow.

Encouraging participation by FIsin infrastructure financing

Investment policies and regulatory guidelines forinsurance companies, pension funds, mutualfunds, banks and other FIs need to be sufficientlyflexible for these entities to choose anappropriate risk-return profile within fiduciary

39 For example, regulators could consider an extension of shelf registrations of prospectuses to all companies that offerdebt instruments to Qualified Institutional Buyers (QIBs) rather than only to PFIs. Alternatively it could adopt similarpractices to those found in the Eurobond market, where issuers who tap the market frequently, are permitted to use ashort form listing agreement, and are given regulatory approval as a condition to an offer closing with the consequencethat an issue can be launched more easily with the documentation and approvals to follow.40 The debenture trustee has a fiduciary responsibility to protect the interest of the debenture holder and is expected toenforce security in the event of default by the issuer company to the bond holders.


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constraints. This will also help professionalizefund management. While it would not beappropriate or practical to introduce radicalchanges in investment guidelines at this stage,primarily because issues such as high rate ofassured return, deficiencies in the accountingmethodology, lack of skills in fund managementneed to be resolved first, there is certainly a needto deregulate these sources of long-term financeand formulate prudential norms for infrastructurerelated projects. The authorities should look atthe existing investment norms prescribed forinsurance, EPF and PPF with a view to relaxingthem so that these institutions can commitsignificantly larger amounts of long-term fundsfor infrastructure.

The investment guidelines for insurancecompanies need to be modified to allowinvestment in instruments with a rating ofless than AA. At present these investmentsare counted towards ‘unapproved’investments. This, in conjunction withdevelopment of credit enhancementproducts should enable insurance companiesto invest in infrastructure projects.

Investment guidelines for pension fundsshould be modified to allow them to investin infrastructure projects, which have aguarantee from the central government ormultilateral agencies. The cost of suchfunding will also be lower since these willnot carry any currency risk.

Going forward, with appropriate changes inthe investment guidelines, three mechanismscould be used to channel pension funds in toinfrastructure projects without distorting theirrisk-return profile. First, to initialize entry into such projects at the lowest risk level,pension funds should be allowed to invest inprojects where a multilateral agency orcentral government extends a guarantee onthe minimum rate of return. The multilateralagency in turn could charge the project

sponsor (such as NHAI) a commercial fee toextend this guarantee. Second, pensionfunds should be permitted to deposit part oftheir funds with banks for long periods andensure that the banks use them exclusivelyfor infrastructure financing. Third, in thelonger term, pension funds should be allowedto deploy funds in projects appraised by theall-India FIs.

There exists an urgent need for specializedinfrastructure financing institutions such asIL&FS and IDFC to participate at the designstage of a project. The backing of suchinstitutions at an early stage would carry atleast two advantages. First, it would make iteasier for project developers to obtainfinance from other sources. Second, it wouldprovide the developer with the opportunityto use the expertise of such institutions inproject designing and financial structuring. Itmust be noted, of course, that potentialconflicts of interest could arise in instanceswhere the specialized infrastructurefinancing institution provides advisoryservices for the project and also bids for therole of structuring the financing package.Such potential conflicts of interest wouldneed to be handled carefully.

Project evaluation and fund managementskills at banks and other FIs with long termfunds (insurance companies and pensionfunds) need to be strengthened. In particular,insurance companies need to be encouragedto develop specialized appraisal skills in theinfrastructure projects. Given the largecorpus of funds available with thesecompanies, going forward, they will need tobecome lead financiers in infrastructureprojects. However, at present, they do nothave the requisite appraisal skills toappropriately evaluate project viability.

There is a need to create a debt recoverymechanism for pension and provident fund


55

on the lines of the Debt Recovery Tribunal(DRT)41. While the need for such a tribunal isnot felt at present due to the restrictedinvestment profile, it will be critical if pensionand provident funds are to have anysignificant exposure in the infrastructuresector.

In order to provide an active incentive forbanks to scale-up infrastructure financing,the RBI could consider classifyinginfrastructure as one of the priority sectors.Moreover, as far as banks are concerned,liabilities created by the sale of long terminfrastructure bonds may be kept outside thepurview of SLR and CRR.

3.2 Fiscal measures that wouldsupport private financing ofinfrastructure and financialmarket innovation

While it should be noted that fiscal concessionsare not necessarily desirable, per se, they mighthelp increase returns and hence, investment. Inthis context:

The Ministry of Finance could considerreducing the customs duty on capital goodsand machinery that are critical for roads,ports, airports, power, railways,telecommunication, oil and gas pipelines andsupply and distribution of water. This fiscalincentive would significantly reduce the costof many infrastructure projects.

With respect to the fiscal concessions undersection 80IA and 80IB, the government couldconsider extending the time horizon from thepresent 10+5 years (0 percent tax on the first,and 50 percent tax liabilities in the secondperiod) to a 20 year time horizon — wherethe project would be tax free for the first 10years, pay a third of the tax liabilities in thenext five and 50 percent of it in the final five.

In addition the government could alsoconsider removing the provisions of MAT forthose infrastructure companies which areavailing the benefits under sections 80IA and80IB. Another alternative would be to removesections 80IA and 80IB altogether and,instead, allow for unlimited carry-forward oflosses. This would allow all infrastructurecompanies to set off the large losses in theinitial years of operations against the profitsof the later period — and, in effect, create amore transparent fiscal incentive than 80IAor 80IB.

The fiscal benefits given under section10(23G) should be approved at one shot forthe stipulated 10-year period, instead of thepresent practice of the companies or SPVsgetting annual approval from the CBDT.Moreover, the government should seriouslyconsider eliminating the word “wholly” —which prevents any infrastructure SPV fromredeploying its investible surplus in anothergroup infrastructure SPV — and substitutingit by “substantially”. The tax implications ofthis is minuscule compared to the operationalflexibility that it will give to companies whichhave more than one infrastructure SPV. Theconcept of escalating section 10(23G)benefits to umbrella infrastructure companiesshould be investigated — something thatcould be possible if the word “wholly” isreplaced by “substantially”. This will allowsponsors to consolidate their infrastructureSPVs under a single holding company, whichwill have the critical threshold to carry out asuccessful public offering. Such a mechanismwill give sponsors and FIs an exit option fromequity participation, which could be recycledfor new projects. Also, the government oughtto consider making the benefits of 10(23G)available to retail investors, who could theninvest in dedicated infrastructure mutualfunds which would use the finances so

41 Established under the Recovery of Debts Due to Banks and FIs Act, 1993.


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obtained to offer longer term credit facilitiesto infrastructure projects.

3.3 Streamlining Approvals,Cutting Down on Red Tape andEnhancing InfrastructureRegulation

Governments need to assure potentialinvestors that there is an intention to lay outclear policy frameworks for each sector andreduce uncertainties arising out of policyimplementations and arbitrary actions incontractual commitments of thegovernments.

All infrastructure projects involve multipleclearances from different Ministries andDepartments — which contribute tosignificant delays. In order to mitigate thisproblem, the GoI needs to set up sufficientlyhigh-level Inter-Ministerial Groups (IMG) forroads, power, telecom, ports and airports.Ministries which are represented in each ofthese groups would vary according to thesector. It would be useful for these groups tobe formed under the aegis of the PlanningCommission, and for them to meet onceevery 45 or 60 days to discuss and resolve alloutstanding Inter-Ministerial issues.

In addition, each Ministry substantivelydealing with the infrastructure should adoptthe practice introduced by the Ministry ofPower by setting up IIGs. These would consistof the infrastructure developers and seniorrepresentatives from banks and FIs. Underthe leadership of the Secretary of theconcerned Ministry, the IIGs would meet oncea month to discuss the progress of specific

infrastructure projects and to resolve anyoutstanding issues or disputes between thedevelopers and various funding agencies.This experiment has been very successful inthe case of Power and should be replicatedin other key Ministries.

Infrastructure is an urgent national priority.To give it the importance it deserves, therehas to be a clear signal that the ownershiplies at the highest level of government.Therefore, it would be advisable for thePrime Minister’s office (PMO) to have adedicated infrastructure secretariat whichwould not only monitor the status of projectsin different sectors but also convenequarterly meetings between the PrimeMinister and those of his cabinet colleaguesin charge of infrastructure ministries. Thissecretariat could ensure consistency in policyformulation and implementation for variousinfrastructure sectors, and would liaise withvarious government agencies to present asingle window clearance to the privatesector42. This act alone would demonstratethe governments focused commitment toinfrastructure.

Develop a policy and regulatory frameworkfor sectors where no framework has beenarticulated (airports, railways) and establishindependent regulators (See Annex F fordetails).

3.4 Stimulating Public PrivatePartnerships—BuildingGovernment Capacity43

There is a need to encourage entry of the privatesector in infrastructure development through viable

42 The government has constituted a Committee on Infrastructure chaired by the Prime Minister. This Committee has asecretariat in the Planning Commission. This committee does focus on policy direction for improving infrastructure inthe country and is aimed at ensuring inter-ministerial coordination on infrastructure issues. However, there is also a needfor a more operational role for a secretariat as suggested here (to monitor progress of individual projects, responsiblefor inter-departmental coordination, facilitate approvals and setting up of important projects etc).43 For a detailed discussion on this issue please see ‘India: Building capacity for Public Private Partnerships’, World Bank,May 2005.


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PPP projects, and it is a fact that private investorsin infrastructure look for stable and friendly sector-specific policies. An example of a PPP which hasworked in the power sector is PowerlinksTransmission Ltd. The project is a joint venturebetween PowerGrid, a sovereign owned entity, andTata Power, a private sector entity. The project willestablish a 1,200 km transmission line betweenthe Indo-Bhutan border and Bhandaula near Delhiand ship power generated by the 1,000 megawattpower plant in Bhutan which is largely financed byGoI. The state owned entity provides the guaranteefor the use of the facility, on the back of which theprivate sector lenders and investors haveparticipated in the financing. A few conclusionsfrom IFC’s experience with infrastructure projectsis given in Box 6.

Developing domestic capabilities to manage,participate in and finance private infrastructureprojects is important to broaden the constituencyof PPPs, enlarge the pool of funding, and mitigateforeign exchange risk. In industrialized countries,and increasingly in more mature reformeddeveloping countries, one of the largest sources

of financing for investment is the utility’s owncash flow. But additional funding will have tocome from domestic capital markets and frompension funds/ insurance companies. This willrequire strong macroeconomic framework anda solid financial infrastructure, as well asattractive investment opportunities as detailedin the earlier sections.

To encourage PPPs, the GoI has announced that itwill provide viability gap financing for selectedinfrastructure projects which are socially andeconomically necessary but carry either high riskor inadequate IRRs to be fully funded by the privatesector. (See Box 7). According to the policy, up to40 percent of the financing needs of such projectscould be met through VGFs. This is a step in theright direction and could help to hasten the financialclosure of many infrastructure projects. Forinstance, the 22.5 km long Trans-Harbor Bridgethat is proposed for Mumbai and costing over $1billion is not feasible without at least 30 percentviability gap funding. So too is the case for almostall major bridges as well as large sections of India’snational and state highways. Assuming that the

Box 6: Critical Success Factors for Private Sector Participation in Infrastructure —Conclusions from IFC’s experience·

The uneven pace of private infrastructure growth in developing countries is due to varying degree of politicalcommitment to liberalization in the sector. Soundly structured investment opportunities have attracted privatefinancing.

Private sector participation in infrastructure, wherever successful, is yielding significant gains in constructionand operational efficiencies.

There is no single method of private sector participation, although economic benefits generally increasewith the volume of assets under private control and the extent of competition. The options depend on acountry’s creditworthiness, the extent of political commitment, and investor interest. Nevertheless,transactions are more likely to achieve financial closure and be sustainable if they are transparent in thebroadest sense: clear, predictable and competitive.

Well structured private sector infrastructure projects can be financed in countries with low income or highrisk, or both. Some projects are easier to finance in such circumstances: smaller projects, those not facingsevere market risk, those with strong sponsors and government support arrangements, and those earningforeign exchange.

Stable regulatory regime is the key success factor. Investors get nervous very quickly and governmentsmust make sure that they present a stable, transparent and fast acting regulatory environment. If forsome reason, the concessions need to be revoked, then strong termination clauses, which provide adequateprotection to lenders and investors should be built in.


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viability gap funding policy is credible, its successwill require, among other things, strengthening theinstitutional capacity of government to manage,participate in, and monitor PPPs.

Capacities for identifying, procuring andmanaging PPPs could be strengthened in Indiaso that they can make a larger contribution tomeeting basic infrastructure needs. The steps

that the Centre could take to achieve this are44:

Issuing a policy statement on the use of PPPs,including rationale and benefits expected;

The creation of a national level PPP unit forinformation dissemination and guidancefunctions, plus transactions advisory supportto central agencies and ministries in their PPPprograms45;

Box 7: Proposed GoI initiatives for increased infrastructure financing

In the Union Budget 2005, the Finance Minister (FM) re-iterated the importance of infrastructure for rapideconomic development and acknowledged that in the government’s view “the most glaring deficit in India isthe “infrastructure deficit”. In this context, he proposed to continue (and enhance) budgetary support forinvestment in infrastructure, including through viability gap funding and a proposed SPV.

Viability Gap FundingViability Gap FundingViability Gap FundingViability Gap FundingViability Gap Funding: GoI acknowledges that the needed infrastructure investments for India may not bepossible out of the budgetary resources of Government of India alone. In order to remove these shortcomingsand to bring in private sector resources as well as techno-managerial efficiencies, the Government has committedto promoting Public Private Partnerships (PPPs) in infrastructure development. That said, it is also recognizedthat infrastructure projects have a long gestation period and may not all be fully financially viable on theirown. On the other hand, financial viability can often be ensured through a mechanism that provides governmentsupport to reduce project costs. The GoI has therefore proposed to set up a special facility to provide suchsupport to PPP projects. This support is generically termed as ‘viability gap funding’ and this facility will behoused in the DEA. Suitable budgetary provisions will be made on a year-to-year basis. In the last couple ofyears, the central government has made available budgetary resources towards viability-gap funding. However,till date no amount has been drawn down. The guidelines to avail this funding were released in August 2004.These guidelines laid out ‘eligibility criteria for projects to receive viability gap funding support from GoI –including the minimum private equity participation and sector (roads, railways, seaports, airports, power,water supply, sewerage and solid waste disposal in urban areas, and international convention centers).

A provision of Rs.1500 crore for “viability gap” funding for infrastructure projects has been made for thecurrent fiscal year. This is now being converted into a scheme, the details of which are being finalized.

A proposed SPV for long-term financingA proposed SPV for long-term financingA proposed SPV for long-term financingA proposed SPV for long-term financingA proposed SPV for long-term financing: GoI believes that there are many infrastructure projects that arefinancially viable but, in the current situation, face difficulties in raising resources. Hence, it proposes thatsuch projects may be funded through a financial SPV. Accordingly, an SPV will be established to financeinfrastructure projects in specified sectors. Roads, ports, airports and tourism would be sectors that are statedas the most likely beneficiaries of the SPV’s funding. The projects will be appraised by an IIG of banks andfinancial institutions. The SPV is expected to lend funds, especially debt of longer term maturity, directly tothe eligible projects to supplement other loans from banks and financial institutions. The government willcommunicate the borrowing limit to the SPV at the beginning of each fiscal year. When large infrastructureprojects are implemented, the foreign exchange resources could also be drawn for financing necessary imports,where relevant. For 2005-06, the borrowing limit has been fixed at Rs.10,000 crore. Details about the SPV –structure and the mechanics of lending - are expected to be announced shortly. The SPV funding will be usedin conjunction with the Viability Gap Funding support.

44 see ‘India: Building capacity for Public Private Partnerships’, World Bank, May 2005.45 In announcing the VGF scheme , GoI did lay down the rationale for and benefits of PPPs in general. It may benecessary to reinforce this more prominently and across infrastructure related departments encouraging the use of PPPmodels in infrastructure provisioning. Recently, GoI has also set up a PPP cell within the Department of EconomicAffairs, Ministry of Finance mainly to process proposals under the VGF scheme and a PPP Appraisal Unit has been set upwithin the Planning Commission to review Central Government PPPs. The capacities of these units need to be built up tobe able to meet current demand and to be able to play the role of a facilitation unit through information disseminationand guidance as well.


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Setting up a project preparation fund foridentifying and procuring PPPs; and

Setting up a fund to partly cover the cost ofgovernment participation under PPPs.

In addition, if there is to be an increase in theusage of PPPs, the Centre would have to workto strengthen oversight of their fiscal costs andassist state governments in doing the same.

The investment needs for infrastructure areenormous. India faces a very large financing gapwhich needs to be bridged by domestic as wellas foreign private sector investments. Successin attracting private funding to infrastructure willdepend partly on India’s ability to develop a moresophisticated financial sector, requiring reformsthat facilitate the use of diverse financialinstruments by investors, and address the currentbarriers to increased participation by bothsponsors and financial institutions. But increasing

private investment will also require addressingfiscal barriers, red tape and proceduralinefficiencies that have contributed to projectdelays and discouraged private investors, and thesignificant constraints arising from the absenceof adequate infrastructure regulation thatexacerbates risks and uncertainties for investors.In summary, securing increased private fundingfor infrastructure on a sustained basis will requirewidespread reforms in infrastructure — reformsthat go well beyond the financial sector. In theforeseeable future, Government will remain thekey investor in critical infrastructure sectors,although PPPs could help reduce some of thefunding pressure on Government. TheGovernment’s ability to finance infrastructurewill, of course, depend crucially on the successwith which it is able to progressively reduce thefiscal deficit to make available public funds forinfrastructure investment.

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3-i network. Various years. “India InfrastructureReport”.

Central Electric Authority. 2004. “NationalElectricity Policy”.

Central Electricity Regulatory Commission.Various Years. “Annual Reports”.

Department of Industrial Policy & Promotion,Ministry of Commerce. Government of India.2004. “Opportunities in Infrastructure in India”.Background Paper for OECD India Workshop.New Delhi.

Department of Telecommunications, Ministry ofCommunications & Information Technology,Government of India. 2002. “Report of theWorking Group on the Telecom Sector for theXth Five-Year Plan”. New Delhi.

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Griffith-Jones, Stephany and A. T. Fuzzo De Lima.2004. Alternative Loan Guarantee Mechanismsand Project Finance for Infrastructure in

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Ministry of Power, Government of India. 2002.“Report of the Committee on Financing of PowerSector during the Xth and XIth Five Year Plan”.

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There is a ‘rough-and-ready’ way of estimatingthe annual infrastructure needs for India. Thisinvolves projecting the country’s GDP growth overthe period, and then attributing a certain‘desirable’ percentage of the GDP asinfrastructure needs. This is far from exact, butserves the purpose of giving a very broad ideaof the investment requirements — to be a macroguidepost against which one can evaluate moredetailed estimates. Assuming that (i) the averageannual infrastructure investment needs vary froma low of 5 percent of GDP to a high of 7 percent,and (ii) a nominal GDP growth rate of 12.5percent per year going forward, the ‘first-cut’estimate of investments needed during the period2001-02 and 2010-11 is between Rs.17,967billion and Rs.25,154 billion at current prices.Table A1 gives the data.

It so happens that the more detailed sector-wiseinvestment needs for roads, power, telecom,railways, ports and airports (calculated in this

ANNEX A: INVESTMENT NEEDS FORINFRASTRUCTURE, 2001-02 TO 2010-11

section of the note) adds up to Rs.19,143 billion.If one were to add investments for the urbansector as well as for the supply and distributionof water, the overall need would be in the regionof Rs.25,000 billion, or what has been estimatedbased on 7 percent of nominal GDP. Therefore,if nothing else, the broad brush-stroke estimatesgiven in Table A1 are in line with those givenbelow — which ought to give some additionalcredibility to those numbers.

Having said that, it needs to be recognized thatestimating the investments required forinfrastructure is not an easy task. First, demandprojections are notoriously difficult to calculatewith a reasonable degree of accuracy. Second,even if there is a consensus on the demand side,there is the additional problem relating to theprices at which these investments are evaluated.Third, there is the issue of productivity. Theefficiency and productivity of governmentagencies engaged in setting up infrastructure

Table A1: A Rough Estimate of Investments needed in Infrastructure, 2001-02 to 2010-11

Rs. BillionRs. BillionRs. BillionRs. BillionRs. Billion GDP at current pricesGDP at current pricesGDP at current pricesGDP at current pricesGDP at current prices Growth rateGrowth rateGrowth rateGrowth rateGrowth rate 5% need5% need5% need5% need5% need 6% need6% need6% need6% need6% need 7% need7% need7% need7% need7% need

FY2002 20,815 8.3% 1,041 1,249 1,457

FY2003 22,549 11.7% 1,127 1,353 1,578

FY2004 25,198 12.6% 1,260 1,512 1,764

FY2005 28,381 12.5% 1,419 1,703 1,987

FY2006 31,929 12.5% 1,596 1,916 2,235

FY2007 35,920 12.5% 1,796 2,155 2,514

FY2008 40,410 12.5% 2,020 2,425 2,829

FY2009 45,461 12.5% 2,273 2,728 3,182

FY2010 51,143 12.5% 2,557 3,069 3,580

FY2011 57,536 2,877 3,452 4,028

TotalTotalTotalTotalTotal 17,967 17,967 17,967 17,967 17,967 21,560 21,560 21,560 21,560 21,560 25,154 25,154 25,154 25,154 25,154

Source: Economic Survey 2004-05 , CERG. World Bank


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tends to be different from that of the privatesector; and the investment requirements woulddiffer depending on the activity mix betweengovernment and private participants. Therefore,the estimates in this section are not exact.Instead, these indicate broad orders ofmagnitude.

A1 Roads

India has the second largest road network in theworld with a total length of about 3.3 millionkilometers. Barring some sections of nationalhighways, it is also a network that badly needsupgrading.

For administrative purposes, the network isdivided into:

i) national highways,

ii) state highways,

iii) major district roads,

iv) other district roads, and

v) village roads.

While the Ministry of Road Transport & Highwaysis primarily responsible for the construction andmaintenance of national highways, all other roadsfall within the jurisdiction of the stategovernments. The development andmaintenance of national highways is dividedamong:

National Highways Authority of India(NHAI). Of the total national highwayslength of 65,569 km, 14,279 km (or 21.7percent) have been entrusted to NHAI undervarious phases of the National HighwayDevelopment Project (NHDP), portconnectivity and other schemes.

State Public Works Departments (PWDs).Of the remaining non-NHDP sections of

national highways, 46,045 km are under thecharge of PWDs

Border Road Organization (BRO). Isentrusted with the residual 5,245 km ofnational highways.

State highways comprise approximately anadditional 137,000 km, and link major centerswithin a state. Together, the national and statehighways are estimated to carry nearly 60percent of road freight, and 87 percent of roadpassenger traffic. The remaining road networkcomprises district and village roads, whichconstitute more than 90 percent of the total, butare largely un-surfaced and of very poor quality.

Since independence, the main thrust in roaddevelopment in India was primarily on increasingroad length. Little or no attention was paid towidening and maintaining existing facilities. Thistook its toll on road quality, and resulted incongested roads, higher travel time, excessivewear and tear of vehicles and a terrible recordof highway safety.46

The first focused attempt at improving the qualityof roads occurred in 1998-99, with theannouncement of the NHDP. This program hasthree major components:

1. The Golden Quadrilateral (GQ) or NHDPPhase I, which involves four-or-six laning ofhighways connecting four metro cities —Delhi, Mumbai, Chennai and Kolkata — witha network length of 5,846 km. As ofNovember 30, 2004, 4,203 km of the GQnetwork (or 72 percent) has been completed.The residual 1,716 km are underimplementation.

2. The North-South and East-WestCorridors (NS-EW) or NHDP Phase II, witha total road length of 7,274 km,47 envisages

46 In 2001, there were over 405,000 road accidents in India that killed almost 81,000 people. The number of peoplekilled per 10,000 vehicles was 14.71.47 This excludes 442 km which is in common with the GQ.

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four-or-six laning of highways connectingSrinagar in the north to Kanyakumari in thesouth, and Silchar in the east to Porbandarin the west. Compared to the GQ, not muchhas occurred on the NS-EW front. OnNovember 30, 2004, only 675 km (or 9percent of the total length) has been four-laned. In addition, 356 km of four-laned roadsare planned to connect 10 major ports to thenational highways, of which 69 km werecompleted and 244 were underimplementation as on November 30, 2004.Furthermore, 777 km of other importantstretches in various states are also a part ofNHDP, of which 194 km have been four-lanedand another 121 km are underimplementation

3. The NHAI has also embarked on NHDPPhase III — earlier known as the PradhanMantri Bharat Jodo Prayojana — whichinvolves four-laning of about 10,000 km ofthose stretches of national highways thatconnect to state capitals.

4. Future expansion plans also announced— improvement of 20,000 km to 2 laneswith paved shoulders (NHDP Phase IV); 6-laning of selected stretches (6500 km) ofNHDP I and II (NHDP Phase V); Constructionof 1,000 km Expressways (NHDP Phase VI);Ring Roads, Bypasses, Grade Separators,Service Roads etc. (NHDP Phase VII)

Over the last four years, the NHDP has been asuccess story. There are problems that havecropped up from time to time. Nevertheless, it isa fact that NHDP Phases I and II constitute India’slargest, most comprehensive and concentratedroad building program.

In addition, there is the village roads program orthe PMGSY, which was launched in December2000. The objective is to construct all-weatherroads to provide connectivity with all habitationshaving a population of more than 500 persons.This program is entirely funded by the central

government, while the planning and executionof road works is carried out by the states. Whilethe initial investment requirements was peggedat Rs. 600 billion, present indications are that,with somewhat greater coverage, the costswould more than double to about Rs.1,320 billion.Moreover, given past trends, it seems unlikelythat providing comprehensive village connectivitywill be achieved by the target date of 2007.

Roads: Investment needs

Investment needs in the road sector up to2010-11, excluding village roads under PMGSY,have been outlined in the Road DevelopmentPlan: Vision 2021, prepared by the IndianRoads Congress (IRC) under the Ministry ofRoad Transport & Highways. Funds needed forthe PMGSY have been separately estimatedby the Ministry of Rural Development.Although the government has assumed thatthe targets of the PMGSY project will beachieved by 2007, present data suggests thatthis is unreal ist ic. Therefore, theseinvestments have also been aggregated as apart of the funding requirement up to 2010-11. Table A2 gives the data on investmentsneeded in roads from 2001-02 to 2010-11.

The estimates in Table A2 exclude annualmaintenance costs. According to the Ministry ofRoad Transport & Highways, these are:

Rs.20 billion per year for national highways,or Rs.200 billion for 2001-02 to 2010-11; and

Rs.50 billion per year for state highways andmajor district roads, or Rs.500 billion for theperiod.48

Road: Investments Needed

For the period 2001-02 to 2010-11, at today’s pricesand including annual maintenance, upgrading theroad system in India will cost at least:

Rs.3,350 billion for national and state highwaysand major district roads, and

Rs.4,670 billion if we also include village roads.

48 There are no estimates for maintenance cost of village roads.


66

A2 PowerThe power sector leaves much to be desired.The country faced a shortfall of 7.1 percent ofenergy requirements and 11.2 percent of peakdemand in 2003-2004. A look at Table A3confirms that deficit levels have remained in thevicinity of 7.5 percent in the last five years. Inthe first nine months of fiscal 2006, the countryfaced a power shortage of 35,701 million units,representing 7.7 percent of the totalrequirement.

Generation

As of January 31, 2006, India had an installedcapacity of 123,901 MW, the bulk of which (56.5percent) is owned by state governments. Afurther 32 percent of the capacity was from SOEsowned or controlled by the central government,namely NTPC, National Hydro Electric PowerCorporation (NHPC), North Eastern ElectricPower Corporation (NEEPCO) and the NeyveliLignite Corporation (NLC). Privately ownedenterprises account for the remaining around11.5 percent of the generating capacity. Amongthese, the more notable players are RelianceEnergy, Tata Power, the RPG group and Torrent.49

Both the SOEs and the independent powerproducers (IPPs) have long term PPAs withspecific SEBs, or their transmission companies.

Table A4 shows that thermal plants are themainstay of power generation in India with ashare of 66 percent in total generation capacity.This is followed by hydroelectric with 26 percent,and nuclear and renewable energy sources with3 and 5 percent respectively.

Transmission and power trading

The Power Grid Corporation of India Limited(PGCIL) is responsible for all inter-state powertransfers, which is presently mainly between thecentral government SOEs and the various SEBs.50

The states (or their new corporations) still own

their internal transmission.

Operationally, India, today, does not yet have anational, synchronous grid. The country is dividedinto five regions (northern, eastern, north-eastern, southern and western), each of whichoperate somewhat independently of the others.The five regional grids are to be graduallyintegrated to form a modern national grid whichcould wheel surplus power from a region to adeficit zone. This task has been entrusted to thePGCIL, which is expected to achieve a nationalgrid capacity of 37,000 MW by 2012.

As it stands, inter-regional power transfers aremodest, partially because of limited surplus inany one region and also because of inadequatetransmission line capacity between the regions.With the advent of the Electricity Act, 2003, thescope for power trading has been enhanced inlaw. Some players have come into the business,such as the Power Trading Corporation, theNTPC Vidyut Vyapar Nigam Limited (an NTPCsubsidiary) and the Tata Power Trading CompanyPrivate Limited. However, the volume oftransaction is still very low.

There in only one major case of private sectorinvolvement in power transmission — namely,the joint venture between Tata Power (51percent) and PGCIL (49 percent) to develop a1,200 km transmission line from Bhutan to carrysurplus power from the Tata hydroelectric powerstation in Bhutan to the north-east. In this case,Tata Power has been guaranteed a fixed returnfrom PGCIL which, in turn, will undertake thetask of collecting the revenue from the SEBs.

Distribution

Transmission and distribution have the chokepoints in power — transmission because ofinadequate capacity and distribution because ofobsolescence, poor pricing, over-manning,inefficiencies, lack of adequate metering andoutright power theft. The focus of recent reforms

49 Since 1991 till March 2004, a total capacity of around 7,400 MW from 37 private power plants were commissioned.50 IPPs that are not purely intra-state also rely on PGCIL for transmission. But this is a minuscule part of IPP transmission.

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Table A2: Investment needed in roads, 2001-02 to 2010-11, excluding maintenance (Rs. billion)

Types of RoadsTypes of RoadsTypes of RoadsTypes of RoadsTypes of Roads Km Km Km Km Km Investment needed Investment needed Investment needed Investment needed Investment needed

A.A.A.A.A. National Highways, incl. ExpresswaysNational Highways, incl. ExpresswaysNational Highways, incl. ExpresswaysNational Highways, incl. ExpresswaysNational Highways, incl. Expressways

1. Expressways 3,000 300.0 2. 4/6 laning 16,000 640.0 3. Two-Laning with hard shoulders 15,000 187.5 4. Strengthening Weak Pavements 20,000 150.0 5. Bypass, bridges, over-bridges, safety & drainage measures Lump sum 72.5 6. Expansion of NH system 10,000 150.0

Total: NH, incl. Expressways 64,000 1,500.0

B.B.B.B.B. State HighwaysState HighwaysState HighwaysState HighwaysState Highways

1. 4/6 laning 3,000 100.02. Two-Laning with hard shoulders 35,000 280.03. Strengthening Weak Pavements 30,000 220.04. Bypass, bridges, over-bridges, safety & drainage measures Lump sum 100.05. Expansion of SH system 10,000 50.0

Total: SH 78,000 750.0

C.C.C.C.C. Major District RoadsMajor District RoadsMajor District RoadsMajor District RoadsMajor District Roads

1. 2-Laning 20,000 120.02. Strengthening Weak Pavements 30,000 150.03. Improving riding quality 50,000 50.04. Bypass, bridges, over-bridges, safety & drainage measures Lump sum 50.05. Expansion of MDR system Lump sum 30.0Total: Major District Roads 100,000 400.0

D.D.D.D.D. Village Roads (PMGSY)Village Roads (PMGSY)Village Roads (PMGSY)Village Roads (PMGSY)Village Roads (PMGSY)

1. Last mile connectivity: 174,000 habitations* average length of 2.16 km * Rs.2.1 million/km 790.0

2. Upgrading existing village roads: 359,000 km * Rs.1.48 million/km 530.0

Total: Village roads under PMGSYTotal: Village roads under PMGSYTotal: Village roads under PMGSYTotal: Village roads under PMGSYTotal: Village roads under PMGSY 1,320.0 1,320.0 1,320.0 1,320.0 1,320.0

Total investment without village roads (A+B+C)Total investment without village roads (A+B+C)Total investment without village roads (A+B+C)Total investment without village roads (A+B+C)Total investment without village roads (A+B+C) 2,650.0 2,650.0 2,650.0 2,650.0 2,650.0

Total investment including village roads (A+B+C+D)Total investment including village roads (A+B+C+D)Total investment including village roads (A+B+C+D)Total investment including village roads (A+B+C+D)Total investment including village roads (A+B+C+D) 3,970.0 3,970.0 3,970.0 3,970.0 3,970.0

Source: IRC, Road Development Plan: Vision 2021Table A3 : Actual power supply situation

Fiscal Year Requirement Availability Surplus/Deficit (+/-) (million units) (million units) (million units) % of requirement

2000 480,430 450,494 -29,836 -6.20%2001 507,216 467,400 -29,816 -7.80%2002 522,537 483,350 -39,817 -7.50%2003 545,983 497,890 -48,093 -8.80%2004 559,264 519,398 -39,866 -7.10%2005 591,373 548,115 -43,258 -7.30%2006 (Apr-Dec) 466,109 430,408 -35,701 -7.70%

Source: Central Electric Authority (CEA)

Source: IRC, Road Development Plan: Vision 2021


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51 The scheme has two components: (a) the investment component, where the GoI provides 50 percent of the projectcost as grants and loans for renovation and modernization of sub-stations, transmission lines and distributiontransformers, augmentation of feeders and transformers, high voltage distribution system, better feeder and consumermeters, computerized billing etc. The SEBs are expected to provide for the remaining 50 percent; (b) the incentivecomponent, which is equivalent to 50 percent of the actual cash loss reduction by SEBs/ utilities, and is provided asgrant.

has been on corporatizing and unbundling of theSEBs, involving the separation of generation,transmission and distribution into distinctlydifferent corporate entities. Moreover, theElectricity Act, 2003, has provided for openaccess, which legally allows any generator theright of non-discriminatory access to transmissionlines or distribution systems.

The government has also initiated theAccelerated Power Development and ReformsProgram (APDRP) to limit the average technicaland commercial losses in distribution to 15percent, foster commercial viability, reducepower outages, and increase consumer

satisfaction. Rs.400 billion has been allocated inthe Tenth Plan for this purpose.51

Power: Investment needs

Based on the findings of the 16th Electric PowerSurvey, the Government of India produced ablueprint document called Mission 2012: Poweron Demand in 2001. This envisages power forall villages by 2007, and all households by 2012.The goal is based on the survey projections which

Table A4: All-India installed capacity as on January 31, 2006 (MW)

Thermal

Total Hydro Coal Gas Diesel Total Thermal Renewable Nuclear

State 70572 25053 38068 3478 477 42023 3496 0

Private 13420 910 4358 4765 725 9848 2663 0

Central 39909 6172 26008 4419 0 30427 0 3310

Total Total Total Total Total 123901123901123901123901123901 3213532135321353213532135 6843368433684336843368433 1266312663126631266312663 12021202120212021202 8229782297822978229782297 61586158615861586158 33103310331033103310


Power: Investments Needed

For the period 2001 to 2011-12, the investmentneeded will be at least Rs.10,591 billion.

Table A5: Demand for power in India based on 16th Electric Power Survey

Region Region Region Region Region Energy Requirement MkWh Energy Requirement MkWh Energy Requirement MkWh Energy Requirement MkWh Energy Requirement MkWh Peak Load (MW) Peak Load (MW) Peak Load (MW) Peak Load (MW) Peak Load (MW)

2006-07 2006-07 2006-07 2006-07 2006-07 2011-12 2011-12 2011-12 2011-12 2011-12 2016-17 2016-17 2016-17 2016-17 2016-17 2006-07 2006-07 2006-07 2006-07 2006-07 2011-12 2011-12 2011-12 2011-12 2011-12 2016-17 2016-17 2016-17 2016-17 2016-17

Northern Region 220,820 308,528 429,480 35,540 49,674 69,178

Western Region 224,927 299,075 395,859 35,223 46,825 61,966

Southern Region 194,102 262,718 354,599 31,017 42,061 56,883

Eastern Region 69,467 90,396 117,248 11,990 15,664 20,416

North-Eastern Region 9,501 14,061 20,756 1,875 2,789 4,134

Andaman and Nicobar 236 374 591 49 77 122

Lakshadweep 44 70 Nil 111 17 26

Total All-India 719,097 975,222 1,318,644 115,705 157,107 212,725


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predict that India will require 719,097 MkWh ofpower in 2006-07, 975,222 MkWh in 2011-12and 1,318,644 MkWh in 2016-17 (Table A5).

To achieve the targets set out by Mission 2012,the funding requirement was calculated by theKohli committee setup under the aegis of theMinistry of Power. The committee estimatedthe funds needed to add 100,000 MW capacity— an extra 41,000 MW in the Tenth Planperiod and the remaining 59,000 MW in theEleventh Plan— along with the requisitebalancing investments needed for transmissionand distribution. The estimates are given inTable A6.

A3 Telecom

The telecom sector in India is a case study ofhow the interplay of competition and technologycan radically change the business landscape ofinfrastructure. Before opening-up in 1994,52 thesector was characterized by underinvestment,outdated technology and limited growth. In 1994,the waiting list for telephone connections wasas high as 2.2 million or almost 31 percent of thetotal installed base. The constraint was notdemand, but the lack of resources of the publicsector enterprises. Today, thanks to the boom in

cellular services, India’s tele-density has reached8.62 percent (92.76 million subscribers) withabout 22 million new subscribers being added in2004. The collective revenues of telecomoperators (except Internet Service Providers orISPs) increased by 30 percent from Rs.470 billionin 2003 to Rs.610 billion in 2004.

Liberalization with policy quirks

The first move towards liberalization came in1994, with the introduction of the NationalTelecom Policy in 1994 which gave the broadguidelines for private operator entry into basicservices. However, the sector remained avictim of government’s policy quirks for almostfive years. The initial approach was restrictedto maximizing revenues from the privatesector by charging exorbitant licence feesfrom sealed bid auctions. Consequently,growth in the first five years of liberalizationremained largely unsatisfactory and thegovernment was forced to change its stance.This was done in the New Telecom Policy in1999 (NTP 99) which significantly helped thesector in breaking the shackles. Given belowis a brief description of the policy regime since1994.

Table A6: Investments requirement for power sector, 2002-2012 (Rs. billion)

Central Sector* State Sector* Private Sector* Total

Generation 3,227 1,200 1,105 5,532

Transmission 496 560 209 1,265

Distribution - 950 - 950

Rural Electrification - 999 - 999

R&M - 250 - 250

TotalTotalTotalTotalTotal 3,723 3,723 3,723 3,723 3,723 3,959 3,959 3,959 3,959 3,959 1,314 1,314 1,314 1,314 1,314 8,996 8,996 8,996 8,996 8,996

Other investments Other investments Other investments Other investments Other investments

Funds required for restructuring SEBs (APDRP) 1,000

Non conventional energy projects 595

Grand total required for 2002-2012Grand total required for 2002-2012Grand total required for 2002-2012Grand total required for 2002-2012Grand total required for 2002-2012 10,591 10,591 10,591 10,591 10,591

Note: *Forecast of likely participation by each sector.Source: Ministry of Power

52 The telecom equipment manufacturing was opened to the private sector in 1984.


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Cellular services

Initially, for cellular services licences, thegovernment divided the country into 23 regions,each with two players, who were not allowedto bid in multiple regions. While this did bring inlarge number of players who paid huge licencefee (in some cases in excess of Rs.100 billion),none of them could achieve the requisiteeconomies of scale. The result: extremely hightariff rates of almost Rs.16 (34 cents) per minute,low subscriber levels and huge losses forcompanies who were unable to pay the licencefees. Poor design of auctions and the licencingconditions resulted in legal wrangles with thegovernment and, by the late 1990s, many foreignoperators withdrew from the market altogether.This forced the government, through NTP 99, toallow old licencees of cellular services to migrateto a regime of revenue sharing based on apercentage of “Adjusted Gross Revenue” (AGR).The government then granted cellular mobilelicence to the two central SOEs, namelyMahanagar Telephone Nigam Limited (MTNL)and Bharat Sanchar Nigam Limited (BSNL) in1997 and 2000 respectively. In 2001, thegovernment also decided to bring in the fourthoperator in each zone.

Basic Services

Competition in basic telecom services wasintroduced in 1997-98. Initially, this segment wasonly allowed to have a duopoly, where one ofthe players was either of the two SOEs. Thesegment was opened up to allow up to fouroperators by NTP 99. These service operatorswere then permitted to offer limited mobilityservices in 2001.

Long-distance services

The long-distance services were the last ones tobe opened to competition and remained themonopoly of SOEs until 2001. The first NationalLong Distance (NLD) licence was awarded in2001 and the first International Long Distance(ILD) licence was awarded in 2002. Presentlythere are 4 NLD and 5 ILD operators.

The situation today

As of December 2004, cellular services had asubscriber base of 48 million, of whichapproximately 78 percent were GSM subscribersand 22 percent were under the CDMA platform.On an average, 1.62 million subscribers wereadded each month in 2004. The sector has seen

Chart B: Mobile subscribers and effective charge per minute

Source: TRAI

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tremendous mergers & acquisitions (M&A)activities in the last couple of years and is nowleft with five major players who control almost85 percent of the market.

The number of fixed line telephone (includingfixed line WiLL) subscribers stood at 44.76 millionas of December 30, 2004. There are five privatelicence operators, apart from the governmentowned BSNL and MTNL. However, the SOEs stillcontrol the majority of the market with 83percent and 9 percent market share respectively.Growth in the segment has remained almoststagnant as compared to the cellular segment.

There were 5.32 million internet subscribers inthe country as of September 30, 2004. Thesewere serviced by 188 ISPs, again led by BSNL.

Regrettably, however, the domestic telecominstrument manufacturing industry has not beenable to keep pace with the demands of theservices sector. Today, bulk of the telecomequipment is imported and the entire demandfor GSM and CDMA technologies are being metthrough import.

The key growth drivers in telecom have been (i)competition, (ii) effective regulation, and (iii) anunderstanding of the potential market size. Eachdeserve some comments.

Competition: This is particularly true in thecellular market, and has ensured that Indianow has one of the lowest tariff regimes inthe world, as shown in Chart B.

Effective regulator: Telecom has had thefortune of having an unbiased, transparentand efficient regulator in the form of TRAIand its appellate body Telecom DisputeSettlement Appellate Tribunal (TDSAT).Though TRAI was formed almost two yearsafter the cellular market was opened-up andfaced the risk of regulatory capture by theDepartment of Telecom (DoT), it has nowestablished itself as an effective, trusted and

independent regulator. Today, the TRAI isfocusing on quality of services, which aremonitored and disclosed on a regular basis.

Market Potential: As the only other billion-plus country, India is being seen as a naturalheir to the Chinese telecom sector boom.The market for telecom has been vibrant.Falling tariffs have reflected in increasingusage levels. The Minutes of Usage (MoU) inthe post–paid category increased by 148percent from 238 minutes per subscriber permonth in 2000 to 590 in 2004 and 53 percent,in the pre-paid category from 197 in 2000 to302 in 2004.

Investment requirement intelecom

The target as set out in NTP 99 was to achieve atele-density of 7 percent (75 million connections)by 2005 and 15 percent (175 million connections)by 2010. The 2005 target has been more thanachieved and, at current rates, the 2010 targetwill be achieved well ahead of time. Therefore,the investment needs calculated in the Tenth Planto achieve a tele-density of 9.91 by March 2007is understated. India will have achieved higherdensities and will have different investmentneeds. Table A7 examines investment needsunder different growth scenarios.

In addition, there has to be investment inbroadband to provide high speed, reliable, on-demand internet connectivity with a speed of atleast 256 Kbps. Based on the report of the CIIBroadband Committee, it is projected that Indiawill have 10.1 million to 10.6 million subscribers

Telecom: Investments Needed

Assuming 25 percent annual growth, and atele-density of 25 percent by 2010-11, theinvestment needed will be Rs.1,996 billion.

To this should be added an extra Rs.147 billionfor broadband.


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53 72 percent of the route kilometres is broad gauge, 23 percent is metre gauge and 5 percent is narrow gauge. Thefleet consists of 214,760 wagons, 39,852 coaches and 7,681 locomotives. IR runs 14,761 trains daily, which includeabout 8,927 passenger trains.

by 2010 and will require an investment ofRs.147.4 billion.

A4 Railways

The Indian Railways (IR) is the second largestrailway network in the world with 63,122 routekilometer (rkm) operating out of 16 zones and67 divisions53. But it is in distress. Unlike othermodes of transport, IR has failed to rise to thechallenge of being an efficient and reliableprovider of transport infrastructure. Politicalcompulsions have forced the IR to expandnetworks to commercially unviable areas, highlysubsidize passenger fares and raise freight tariffsto a point where traditional long haul goods trafficin items such as cement, iron and steel andpetroleum has shifted to roads or pipelines.

These issues have severely eroded the costcompetitiveness of the railways and it finds itselfin the midst of financial distress. As observed by

the standing committee of the Parliament in2004, the share of planned investment throughinternal generation has touched the lowest pointyet and is likely to go down to about 20 percentduring the Tenth Plan in comparison to 58 percentin Eighth Plan. The market borrowings haveincreased substantially, and is expected to beRs.147.74 billion during the Tenth Plan.

According to the IR, there are two majorongoing projects. The first is the National RailVikas Yojana (NRVY), which was announcedon August 15, 2002, and consists of thefollowing components:

Strengthening of the GQ connecting the fourmetro cities at an estimated cost Rs.80 billion.

Providing rail based port-connectivity anddevelopment of corridors to hinterlandincluding multi-modal corridors for movementof containers, estimated at Rs.30 billion.

Table A7: Investments in telecom under different growth scenarios (Rs. billion)

Subscriber BaseSubscriber BaseSubscriber BaseSubscriber BaseSubscriber Base Assumed CAGRAssumed CAGRAssumed CAGRAssumed CAGRAssumed CAGR AmountAmountAmountAmountAmount

200 million subscribers (tele-density of 17%) 13.7% 1,012

250 million subscribers (tele-density of 21.3%) 18.0% 1,496





Notes and assumptions1. According to latest estimates it costs Rs.20,000 to setup a new fixed line and Rs.5,000 to setup a cellular phoneline.2. The first two estimates (investments needed for 200 and 250 million subscribers) are based on the statement ofthe Minister of Telecom in Parliament on December 22, 2004.3. Working backwards from the Minister’s statement, the per line estimate works out to be in the range of Rs.9,600to 9,900 per line.4. We assume per line cost to be Rs.10,000 beyond the 250 million mark. This implicitly assumes that the marketwould have a structure of 2/3 mobile phones and 1/3 fixed line.3. Exchange rate assumed is vis-à-vis the USD: 1$=Rs.44.4. The population in 2010 is assumed to be 1.174 billion based on UNDP projections.

Source : Authors’ analysis

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Constructing major bridges — at Patna andMunger over the Ganga, at Bogibeel overthe Brahmaputra and at Nirmali over the Kosi— which is estimated to cost Rs.35 billion toRs.40 billion.

Thus, the total estimated investment in NRVY isexpected to be Rs.150 billion. Under the presentfunding plan for NRVY, the GoI will providebudgetary funds as equity of Rs.30 billion(including Rs.15 billion of ADB funding) for theGQ projects. The balance Rs.120 billion for otherprojects is expected to be mobilized through themarket which may include BOT schemes,domestic borrowings, SPVs, etc.

The second project envisaged by the railwayswas announced in the interim Budget of 2004-05 and is called Remote Area Rail SamparkYojana (RARSY). This involves executing andcompleting hitherto sanctioned projects relatedto connecting remote and backward areas withthe rail network till 2010. The total investmentsin these projects is valued at Rs.200 billion.Presumably this is to be entirely funded by budgetsupport.

Investment needs of the Railwaystill 2010

Given below are two estimates of the investmentneeds of the railways in the next five years. Thefirst is based on the report of the Expert Groupon Railways (Rakesh Mohan Committee) whichwas released in 2001; and the second is basedon the estimated investment of the IR for theschemes and projects it has announced orlaunched.

Expert Group on Railways: The Expert Groupsuggested capital expenditure requirements forIR under three scenarios — business as usual lowgrowth, medium to high growth, and strategichigh growth. All estimates are at constant prices.The low growth variant was considered

Indian Railways: Investments Needed

According to the medium-to-high growthprojected by the Rakesh Mohan Group, theinvestment needs at constant prices up to 2010-11 are Rs.1,101 billion. Assuming 5 percentannual inflation, this translates to Rs.1,242 billionat current prices.

According to IR’s own estimates, all it needs isRs.700 billion. This is an underestimate.

Table A8: Investment requirements in IR till 2010, Rakesh Mohan Group (Rs. billion) (Footnotes)

Medium to high growth Medium to high growth(constant price) (current price)

2001-02 107 97

2002-03 124 118

2003-04 126 126

2004-05 128 134

2005-06 130 143

2006-07 105 122

2007-08 92 112

2008-09 94 120

2009-10 97 130

2010-11 99 139

TotalTotalTotalTotalTotal 1,1011,1011,1011,1011,101 1,242 1,242 1,242 1,242 1,242

Source: Rakesh Mohan Committee report and authors’ analysis


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54 The GoI has taken a decision on the development of the 35 non-metro airports in three phases. An Inter-MinisterialCommittee (IMC) has also been set up to suggest the financing pattern for these investments.

unsustainable for IR. Table A8 gives the data forthe more realistic medium to high growth scenarioat constant and current prices, the latterassuming 5 percent annual inflation.

Estimate based on the various programs beingundertaken by IR: The other estimate is basedon the funds required to complete the announcedIR projects. The data has been collated from variousspeeches, budget documents and news reports,and is given in Table A9.

A5 Airports

There are 449 airports/airstrips in the country.Of these, 126 airports — which include 11international airports, 89 domestic airports and26 civil enclaves — are owned, managed andoperated by the Airports Authority of India (AAI)under the Ministry of Civil Aviation. The trafficflow at these airports is very uneven. Six airports(Mumbai, Delhi, Chennai, Bangalore, Kolkata andHyderabad) account for 90.5 percent of the totalinternational passenger traffic and 91.7 percentof total passenger traffic. At present, only 61airports are being used by various airlines. Mostof the airports are underdeveloped andunderutilized while others have becomeovercrowded and are stretched to capacity. 54

A survey done by the International Air TransportAssociation (IATA) in 1999 ranked the Mumbaiand Delhi airports amongst the three worst

airports in the Asia-Pacific region for all 19 serviceparameters included in the survey. With a ratingof 2.3 and 2.6 on a scale of 1 (very poor) to 5(excellent) for Mumbai and Delhi airportsrespectively, these airports were adjudged tooffer the lowest service levels in terms of overallsatisfaction.

The need for airport up-gradation has assumedfurther urgency with a spurt in domestic andinternational passenger traffic. With the additionof many new private airlines, varying fares includingcut-rate cheap fares, the traffic at the metroairports has grown by more than 20 percent. Theurgent need for reforms was reiterated by theNaresh Chandra Committee, which suggestedunbundling of the AAI and corporatization of largeairports. It also recommended that smaller airportscould be grouped together on regional basis andcorporatized.

Ongoing status of airportdevelopment in India

While many plans for airport development havebeen extensively discussed and debated, nonehas been actually implemented due to politicalpressures as well as bureaucratic inertia. A lookat the annual report of Ministry of Civil Aviationconfirms that the development work undertakenby AAI at various airports is restricted to regularmaintenance or minor modernization activities.For Mumbai and Delhi Airports, because of the

Table A9: Investment requirements for railways for projects announced/undertaken (Rs. billion)

HeadsHeadsHeadsHeadsHeads AmountAmountAmountAmountAmount

National Rail Vikas Yojana (NRVY) 150

Remote Area Rail Sampark Yojana (RARSY) 200

Modernization Plan 240

Other projects in the pipeline 110

Total Total Total Total Total 700700700700700

Source: Various news reports

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proposed privatization, the AAI has beenpostponing undertaking any projects costingmore than Rs.100 million since 2000 (Box A1).

Investments required in airports

Two estimates are considered. The first is basedon various secondary sources such as newsreports, public statements and press releases bythe Minister in charge, while the second is based

on capital expenditure estimates presented bythe AAI to the Standing Committee of theParliament in 2002.

Box A1: The story of Mumbai and Delhi airport privatization

The decision to invite private sector participants to modernize the airports in Mumbai and Delhi was taken bythe Government in January 2000. Here is the story of how, six years after the initial decision, the Mumbai andDelhi airports have only been recently awarded for modernization and privatization.

January 2000: Government decides to restructure the airports through long-term lease route and conductsroad-shows abroad. Parliament objects on the ground that the AAI does not have the power under theAirports Authority of India Act, 1994, to transfer airports on long-term lease to private investors.

June 2003: Airports Authority of India (Amendment) Bill passed by the Parliament authorizing AAI totransfer the operations and management of its existing airports by way of long-term lease to privateinvestors.

September 2003: Cabinet decides to instead adopt the Joint Venture route and accords approval for therestructuring of Delhi and Mumbai airports.

September 2003: Cabinet constitutes an Empowered Group of Ministers (EGOM) to take decisions onvarious issues connected with the restructuring of Mumbai and Delhi airports. Also constitutes IMG toassist EGOM.

January 2004: ABN AMRO selected as financial consultants.

February 2004: EGOM allows for registration of expressions of interest from interested parties to acquire74 percent equity stake in the JV. Last date for submission set at June 4, 2004.

June 2004: With the formation of the new government, the last date of submission is extended to July 20,2004. The cabinet reconstitutes the EGOM.

July 2004: The reconstituted EGOM decides to reduce cap on Foreign Direct Investment (FDI) to 49percent, allows equity participation by Indian scheduled airlines up to 10 percent, increases the deputationperiod of employees in the JVCs from 2 to 3 years. The EGOM also decides to give weightage to bidderswho induct more employees of AAI over and above the mandatory induction of 40 percent. Further, theEGOM approves the appointment of Airplan, Australia as the Global Technical Advisor. Six consortia bidfor the Mumbai airport revamp while five of them bid for the Delhi airport.· The process of invitingbids, putting them through a pre-qualifying selection round, and then shortlisting them before opening thefinancial bids went on for nine months.

January 12, 2006 The Group of Ministers asked the Delhi Metro Rail Corporation managing director E.Sreedharan to re-evaluate all six bidders, including four who had initially filed tenders to bag the Delhiand Mumbai airport contracts.

The Sreedharan panel of experts at the final stage of the evaluation process found only one consortiumqualified for bidding.Recently, the government has completed the process of inviting private sectorparticipants to modernize the airports in Delhi and Mumbai, nearly six years after it initiated the process.The Government chose two private consortia for modernising and restructuring the Delhi and Mumbaiairports. While the GMR-Fraport consortium won the bid for the Delhi airport, the GVK-South AfricanAirports combine have been awarded the Mumbai airport project.

Source : Various news reports

Airports: Investments Needed

Based on various secondary sources, theinvestment needed is around Rs.145 billion.

According to the Standing Committee ofParliament, it is Rs.191 billion.


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Estimate 1. Based on various secondary sources.This is given in Table A10.

Estimate 2. Based on the report of the StandingCommittee of Parliament and given in TableA11.55

A6 Ports

India has 12 major and 185 minor/intermediateports covering its 6,000 km coastline. The majorports handle about 76 percent of the totalmaritime traffic and are managed by Port Trustof India under the central government. Minorports are managed by the state governments.Lately, the minor ports have emerged as a majorplayer in cargo handling. Their share in traffichas gone up from 10 percent in 1996-97 to 24percent in 2003-04.

The development of ports in India has been apart-success story. The major positives have beenthe improvement in technical parameters at mostof the major ports and the involvement of theprivate sector in port development and handling.The major negative still continues to be theproblem of lack of adequate road and railconnectivity.

Key issues and trends

In 2003-04, the total cargo traffic at majorports increased by 9.9 percent to 344.5million metric tons (MT).

Almost, 80 percent of the traffic handled in2003-04 was in the form of day and liquidbulk, the rest 20 percent was in the form ofgeneral cargo including containers. In thepast five years container traffic has grownby over 15 percent and is expected to forma sizeable part of traffic in future.

Efficiency of the major ports has improvedover time. The average turnaround time hascome down to almost 3.5 days at presentfrom 5.7 days in 1998-99. The average outputper ship-berth-day has increased to almost9,000 MT in 2003-04 compared to 8,500 MTin 2002-03. Pre-berthing time has alsodropped from 6.9 hours in 2002-03 to 5 hoursin 2003-04.

The port sector does not have a full-fledgedregulator yet. However, the government hasset-up and independent body called TariffAuthority for Major Ports (TAMP) to regulatetariffs at major ports. The TAMP has beenfairly successful in regulating tariff levels

Table A10: Estimated investments for airports (Rs. billion)Table A10: Estimated investments for airports (Rs. billion)Table A10: Estimated investments for airports (Rs. billion)Table A10: Estimated investments for airports (Rs. billion)Table A10: Estimated investments for airports (Rs. billion)

Category Category Category Category Category AmountAmountAmountAmountAmount

Greenfield airport at Bangalore 12.6

Greenfield airport at Hyderabad (phase I) 12.0

Modernization of Delhi and Mumbai Airports 45.0

Greenfield airports at Goa, Navi Mumbai, Pune, Kanpur and Nagpur 60.0

Up gradation of Chennai airport* 15.0

Total Total Total Total Total 144.6144.6144.6144.6144.6

Source: Various news reports. *The estimated cost of upgrading Chennai airport has been assumed, in absencereliable estimates .

55 These estimates are based on the following paragraph of the report: “In addition to the planned outlays, preliminaryfeasibility studies and proposals being reviewed by the state governments and the private sector. “Other” initiatives, notincluded in the Airports Authority of India’s plan, are in the range of about Rs.19,100 crores. These investments arecontemplated for new airports - Mumbai, Bangalore, Goa and Hyderabad amounting to about Rs.14,600 crores,terminal buildings at various airport locations amounting to Rs.2,400 crores, related supporting airport infrastructure ofRs.1,500 crores and cargo facilities of Rs.600 crores.”

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while still giving major ports some amount offlexibility in tariff setting. However, as aregulator it lacks operational flexibility dueto its limited mandate.

Indian ports are progressively moving to amodel where major ports have becomelandlords, while cargo-handling services aregiven out to private players. In the last fiveyears, five container terminals have beenhanded to private players. The biggestsuccess story of this model is the NhavaSheva International Container Terminal(NSICT). Promoted by P&O Port of Australia,the NSICT was the first private containerterminal in India and constructioncommenced on the 30-year BOT in 1997. TheP&O operations at NSICT has set newcompetency benchmarks for ports in India.Not only was the construction completedbefore the due date but also efficiency levelsare at least two-thirds higher than JawaharlalNehru Port Trust (JNPT). In 2003-04, thetraffic at NSICT increased to 12.3 milliontwenty-foot Equivalent Units (TEUs), while itwas projected to be 5 million TEUs at thetime of construction.

The biggest constraint to port developmenttoday remains the bottlenecks of inlandconnectivity through railways and roads.CONCOR, a subsidiary of Indian Railways, hasthe monopoly of managing and linking upICDs with CFSs at ports. This CONCORmonopoly does not auger well for portdevelopment.

A 1996 study undertaken by the IndianInstitute of Management (IIM) and theRailway Staff College, Baroda cited thefollowing reasons on why shippers preferredroads to railways for freight movement:

1. Irregular supply of wagons: Shippers arenot often sure of the availability of wagonstock on demand. The variability in supplyof wagons complicates the planningprocess for shippers and also increasesinventory costs.

2. Irregular delivery at destination: Shippersare not assured of the arrival of theirconsignments within a specified timeframe.

3. Inflexibility in service. While roadtransport provides door-to-door service,a similar service is not provided to theshipper by railways. All shipments by rail,which necessarily have a component ofroad transport at the dispatch anddestination ends, have to be arrangedby shippers themselves.

Private sector involvement inports

Ports were opened-up to the private sector in1996. The objectives were primarily two-fold —to attract new technology and increaseinvestments — and led to a series of privatizationinitiatives in various segments of the Indian portsector. This included container terminals, liquidcargo berths and terminals, solid bulk terminals,

Table A11: Standing Committee of Parliament’s estimates of investments in airports (Rs. billion)

Category Category Category Category Category AmountAmountAmountAmountAmount

New airports at Mumbai, Bangalore, Goa and Hyderabad 146

Terminal buildings at various airport locations 24

Supporting airport infrastructure 15

Cargo facilities 6

Total Total Total Total Total 191191191191191

Source: Extract from report of the Standing Committee of Parliament


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Table A12: Estimated investments for ports up to 2010-11 (Rs. billion)

CategoryCategoryCategoryCategoryCategory AmountAmountAmountAmountAmount

Modernization of JNPT and Kochi ports 75

Capacity addition of 266 tonnes at major ports 160

Capacity addition of 118 tonnes at minor ports 71

TotalTotalTotalTotalTotal 306306306306306

Source: Budget 2003-04 and own analysis

Table A13: Overall investment needs in infrastructure up to 2010-11 (Rs. billion)

Rs. billionRs. billionRs. billionRs. billionRs. billion

Roads* 4,670

Power** 10,591

Telecommunications*** 2,143

Railways**** 1,242

Airports***** 191

Ports 306

TotalTotalTotalTotalTotal 19,143 19,143 19,143 19,143 19,143

*: Including village roads under PMGSY and cost of maintenance. **: Up to 2011-12. ***: Including investment inbroadband. ****: The medium-to-high growth scenario of the Rakesh Mohan Expert Group. *****: As given bythe Standing Committee of Parliament.

Source:Summary of earlier tables.

and other warehousing and logisticsinfrastructure facilities.

Private sector participation was not restricted tomajor ports. New minor ports were alsodeveloped by private players — the twoexamples being Mundra and Pipavav ports onthe Gujarat coast. Three new private ports inGujarat are also expected to be fully-operationalin the next few years at Dholera, Hazira andMarol. The major international players in theIndian ports sector include P&O Ports (Australia),Port of Singapore (PSA), Dubai Port Authority,Maersk Logistics while Adani Exports andSeaking Infrastructure (though it has sold itsstake at Pipavav to Maersk) are two of the biggerdomestic companies.

Investments have been flowing in the sector. TillMarch 2004, 11 private or captive projects withcapacity addition of around 38.2 MT had been

operationalized, with an investment of Rs.20billion. At least 25 projects with capacity additionof around 85.3 MT and investment of Rs.55billion are at various stages of evaluation/implementation.

Investments required for ports

It is difficult to quantify the investments neededfor ports primarily due to two reasons. First, theinvestment cost of per unit capacity additionvaries enormously on a case to case basis anddepends on, among other factors, the amountof dredging required, construction of breakwaterfacilities, the kind of traffic to be handled etc.Second, the cost of green-field ports also variesconsiderably.

However, assuming a conservative CompoundedAnnual Growth Rate (CAGR) of 10 percent of

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traffic at major ports till 2010-11, the requiredcapacity addition at major ports comes toapproximately 266 MT or 44 MT annually. Also,assuming a conservative CAGR of 15 percentgrowth in traffic at minor ports, the requiredcapacity addition at minor ports will be 118 MTtill 2010-11. The rough investment requirementestimates for these and the modernization plansfor Cochin and JNPT ports as announced in thebudget of 2003-04 is given in Table A12.

A7 The overall investment needsin infrastructure up to 2010-11

Table A13 gives the overall investment needs inkey infrastructure sectors up to 2010-11. As isevident, mobilizing the necessary funds presentsa daunting challenge.

A8 Estimating the Financing Gap

It is not easy to estimate the financing gap ininfrastructure. There are multiple data sourcesas well as estimates, and integrating these intoa consistent whole is not straightforward. Moresignificantly, there are definitional issuesregarding the concept of the financing gap.Therefore, just as in the previous section, theestimates given here should be treated as broadlyindicative.

A8.1 Financing gap in roads

There seem to be two ways of defining the gap.The first is to estimate the investmentrequirements and then to net out that part ofthe tax revenue from roads (vehicle registrationfees, tolls, etc.) which is assumed to be ploughedback to the sector. While conceptually correct,this method has two major empirical lacunae.First, it assumes a robust knowledge of the futuregrowth of traffic, which is notoriously easy tooverestimate. And second, in a milieu of centraland state government budget deficits, it assumesex ante credibility — namely, that a percentageof the amount collected from registration and

tolls will be unfailingly reinvested in roads. A gapcalculated by this method could, therefore,understate the actual private sector fundingneeds.

The other approach is to deduct the grossbudgetary support (GBS) as well as the internaland extra-budgetary resources (IEBR) as statedin the central and state plan documents fromthe investment needs of the sector. This method,too, has its disadvantages, for it assumes thegovernment financing estimates are both correctand credible. However, it does away with thedifficulties of estimating revenues from uncertainfuture traffic flows. This note has adopted thesecond approach. Table A14 gives an estimateof this financing gap for 2001-02 to 2010-11.From this is netted out the finances that havealready flowed from government to roads up to2003-04. The residual, therefore, is the financinggap for 2004-05 to 2010-11.

As Table A14 shows, the financing gap for roadsover 2001-02 to 2010-11 is Rs.1,106 billion (orRs.110,600 crore). Assuming that governmentoutlays — including budget support, internal andextra budgetary resources of NHAI and fundsavailable to government from multilateral agencies— can be no more than what is given in Table 14,then this is the amount which needs to be metthrough private sector investments as well asrevenue from tolls and vehicle registrations.

A8.2 Financing gap in power

Here, too, is subtracted the government outlays(grants, gross budgetary support and IEBR of thepower SOEs) from the overall investment needsof the sector. The estimate is given in Table A15.

A8.3 Financing gap in telecom

It is assumed that India will continue itsaccelerated pace of telecom penetration andincrease its tele-density from 8.6 percent to 25.6percent in 2010-11 — i.e., it will grow at acompound annual rate of 25 percent. In other


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words, India will have 300 million subscribers, upfrom 93 million in 2004. Table A16 gives anestimate of the financing gap.

A8.4 Financing gap in railways

Based on the investment needs at current pricesto fund the medium-to-high growth scenariooutlined by the Rakesh Mohan Expert Group, the

Table A14: Estimate of the financing gap for roads, 2001-02 to 2010-11 (Rs. billion)

(In Rs. billion)(In Rs. billion)(In Rs. billion)(In Rs. billion)(In Rs. billion)

Investment needed 2001-02 to 2010-11 (see Table 1)

Investment needed for NH and expressways 1,500

Investment needed for state highways 750

Investment needed for major district roads 400

Investment needed for village roads under PMGSY 1,320

Total investment including village roads (a)Total investment including village roads (a)Total investment including village roads (a)Total investment including village roads (a)Total investment including village roads (a) 3,970 3,970 3,970 3,970 3,970

Government Plan OutlaysGovernment Plan OutlaysGovernment Plan OutlaysGovernment Plan OutlaysGovernment Plan Outlays GBSa GBSa GBSa GBSa GBSa IEBRb IEBRb IEBRb IEBRb IEBRb Total Total Total Total Total

A1. Central Govt., 10th Five Year Plan, 2002-03 to 2006-07

1. Ministry of Roads & Highways 348 247 595

2. Ministry of Rural Development (for PMGSY) 125 - 125

Total of (A1) Total of (A1) Total of (A1) Total of (A1) Total of (A1) 720 720 720 720 720

A2. Central Govt., likely financing in 11th Plan, 2007-08 to 2010-11

1.Ministry of Roads & Highways* 417 296 714

2.Ministry of Rural Development (for PMGSY)* 150 - 150

Total of (A2) Total of (A2) Total of (A2) Total of (A2) Total of (A2) 864 864 864 864 864

A3. State and UT Plan outlays, 2002-03 to 2006-07

1. States’ Plan Outlay on Roads and Bridges 471

2. Union Territories’ Plan Outlay 32

Total of (A3)Total of (A3)Total of (A3)Total of (A3)Total of (A3) 503 503 503 503 503

A4. State and UT Plan likely outlays, 2007-08 to 2010-11

1. State’s Plan Outlay on Roads and Bridges** 528

2. Union Territories’ Plan Outlay* 38

Total of (A4)Total of (A4)Total of (A4)Total of (A4)Total of (A4) 566 566 566 566 566

A5. Central Govt. Plan outlay for 2001-02 120

A6. States’ and UT’s outlay for 2001-02 91

Grand Total (A1+A2+A3+A4+A5+A6) (b)Grand Total (A1+A2+A3+A4+A5+A6) (b)Grand Total (A1+A2+A3+A4+A5+A6) (b)Grand Total (A1+A2+A3+A4+A5+A6) (b)Grand Total (A1+A2+A3+A4+A5+A6) (b) 2,864 2,864 2,864 2,864 2,864

Finance gap: (a) minus (b)Finance gap: (a) minus (b)Finance gap: (a) minus (b)Finance gap: (a) minus (b)Finance gap: (a) minus (b) 1,106 1,106 1,106 1,106 1,106

Notes: a: GBS: Gross Budgetary Support of the central government. b: IEBR: Internal and Extra-Budgetary Resourcesof central government undertakings, here the NHAI. *: Assumes a 50 percent growth in outlay in 11th Plan over10th Plan, of which four-fifths is spent across 2007-08, 2008-09, 2009-10 and 2010-11. **: Assumes a 40 percentgrowth in outlay.:

Source: Planning Commission

finance gap for Indian Railways is a relativelymodest Rs.151 billion, as shown in Table A17.

A8.5 Financing gap in airports

The estimate of investments in airports is basedon the Standing Committee’s estimates. Thefinancing gap is arrived by deducting thegovernment outlays from the required

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Table A15: Estimate of the financing gap for power, 2001-02 to 2011-12 (Rs. billion)

Total RequirementTotal RequirementTotal RequirementTotal RequirementTotal Requirement 10,591 10,591 10,591 10,591 10,591

Government PlansGovernment PlansGovernment PlansGovernment PlansGovernment Plans

Tenth Plan OutlaysTenth Plan OutlaysTenth Plan OutlaysTenth Plan OutlaysTenth Plan Outlays

A. Ministry of Power 1,434

B. Department of Atomic Energy 256

C. Ministry of Non-Conventional Energy 17

D. Towards APDRP* 400

E States & Union Territories 948

F. Towards PMGY & Kutir Jyoti* 60

Total for the Tenth Plan (a)Total for the Tenth Plan (a)Total for the Tenth Plan (a)Total for the Tenth Plan (a)Total for the Tenth Plan (a) 3,115 3,115 3,115 3,115 3,115

Likely Eleventh Plan OutlaysLikely Eleventh Plan OutlaysLikely Eleventh Plan OutlaysLikely Eleventh Plan OutlaysLikely Eleventh Plan Outlays

E. Ministry of Power 2,151

F. Department of Atomic Energy 384

G. Ministry of Non-Conventional Energy 25

H. Towards APDRP* -

I. State & Union Territories 1,328

J. Towards PMGY & Kutir Jyoti* 90

Total for the Eleventh Plan (b)Total for the Eleventh Plan (b)Total for the Eleventh Plan (b)Total for the Eleventh Plan (b)Total for the Eleventh Plan (b) 3,977 3,977 3,977 3,977 3,977

Total government outlays in the Tenth and Eleventh Plans (a)+(b)Total government outlays in the Tenth and Eleventh Plans (a)+(b)Total government outlays in the Tenth and Eleventh Plans (a)+(b)Total government outlays in the Tenth and Eleventh Plans (a)+(b)Total government outlays in the Tenth and Eleventh Plans (a)+(b) 7,092 7,092 7,092 7,092 7,092

Financing gapFinancing gapFinancing gapFinancing gapFinancing gap 3,500 3,500 3,500 3,500 3,500

*Additional Central Assistance. Notes: 1) Only power sector related outlays of Department of Atomic Energyand Ministry of Non-conventional Energy have been taken 2) Planned outlay assumed to grow at 50 percentfor Central Government Ministries and 40 percent for State Government outlays in the Eleventh Plan.3)APDRP is envisaged to end after the Tenth Plan.


investments, and is given in Table A18.

A8.6 Financing gap in ports

Based on an investment need of Rs.306 billion,the financing gap is estimated in Table A19.

A8.7 Total financing gap

Based on the calculations above, the totalfinancing gap is Rs.5,542 billion. Table A20 givesthe break-up of the total financing gap.

It would be a mistake if the challenges toresource mobilization were ranked merely interms of the magnitude of the financing gaps.The financing gaps in some sectors can be filledby private sector more easily than in others. Forinstance, even though the gap for telecoms isconsiderably larger than that for railways, underthe present scenario it seems much moreplausible to mobilize Rs.478 billion of privateinvestment for telecom than the Rs.151 billionfor railways.56

56 In India, the two key issues which make some infrastructure sectors more attractive than others are the risks ofuncertainty in demand and the degree of regulatory barriers. Thus, on one end of the spectrum, private sectorinvestment in roads, greenfield ports and power are impeded by the traffic risks and risks of recovery, while on the otherend private investment in sectors like airports and railways has fallen victim to regulatory barriers. The success in telecomhas been possible due to a favourable mix of healthy demand and low regulatory barriers.


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Table A17: An estimate of the financing gap for IR, 2001-02 to 2010-11 (Rs. billion)

Investment requiredInvestment requiredInvestment requiredInvestment requiredInvestment required

Medium to high growth scenario (2001-02 to 2010-11) at current prices 1,242

Government OutlaysGovernment OutlaysGovernment OutlaysGovernment OutlaysGovernment Outlays

Tenth Plan Outlay: Ministry of RailwaysTenth Plan Outlay: Ministry of RailwaysTenth Plan Outlay: Ministry of RailwaysTenth Plan Outlay: Ministry of RailwaysTenth Plan Outlay: Ministry of Railways 606

Likely Eleventh Plan Outlay till 2010-11: Ministry of RailwaysLikely Eleventh Plan Outlay till 2010-11: Ministry of RailwaysLikely Eleventh Plan Outlay till 2010-11: Ministry of RailwaysLikely Eleventh Plan Outlay till 2010-11: Ministry of RailwaysLikely Eleventh Plan Outlay till 2010-11: Ministry of Railways 485

Total government resources available 1091

Financing gap Financing gap Financing gap Financing gap Financing gap 151 151 151 151 151

Note: Eleventh plan outlay for railways assumed to remain constant.


Table A18: An estimate of the finance gap for airports, 2001-02 to 2010-11 (Rs. billion)


Standing Committee Estimates 191

Government OutlaysGovernment OutlaysGovernment OutlaysGovernment OutlaysGovernment Outlays

Tenth Plan OutlayTenth Plan OutlayTenth Plan OutlayTenth Plan OutlayTenth Plan Outlay: Airport Authority of India 54

Likely Eleventh Plan Outlay till 2010-11: Likely Eleventh Plan Outlay till 2010-11: Likely Eleventh Plan Outlay till 2010-11: Likely Eleventh Plan Outlay till 2010-11: Likely Eleventh Plan Outlay till 2010-11: Airport Authority of India 64.9

Total government resources availableTotal government resources availableTotal government resources availableTotal government resources availableTotal government resources available 118.9118.9118.9118.9118.9

Financing gapFinancing gapFinancing gapFinancing gapFinancing gap 72.172.172.172.172.1

Note: Eleventh Plan outlay assumed to increase by 50 percent.


Table A16: An estimate of the finance gap for telecom, 2001-02 to 2010-11 (Rs. billion)


300 million subscribers 1996

Broadband 147

Total investment required (a)Total investment required (a)Total investment required (a)Total investment required (a)Total investment required (a) 21432143214321432143

Tenth Central Plan Budget Outlay Tenth Central Plan Budget Outlay Tenth Central Plan Budget Outlay Tenth Central Plan Budget Outlay Tenth Central Plan Budget Outlay

Bharat Sanchar Nigam Ltd. (BSNL) 664.1

Mahanagar Telephone Nigam Ltd. (MTNL) 119.6

Total Tenth Plan Outlay (b)Total Tenth Plan Outlay (b)Total Tenth Plan Outlay (b)Total Tenth Plan Outlay (b)Total Tenth Plan Outlay (b) 783.7783.7783.7783.7783.7

Likely Eleventh Plan Budget Outlay till 2010 Likely Eleventh Plan Budget Outlay till 2010 Likely Eleventh Plan Budget Outlay till 2010 Likely Eleventh Plan Budget Outlay till 2010 Likely Eleventh Plan Budget Outlay till 2010

Bharat Sanchar Nigam Ltd. (BSNL) 747.1

Mahanagar Telephone Nigam Ltd. (MTNL) 134.5

Total likely Eleventh Plan Outlay (c)Total likely Eleventh Plan Outlay (c)Total likely Eleventh Plan Outlay (c)Total likely Eleventh Plan Outlay (c)Total likely Eleventh Plan Outlay (c) 881.6881.6881.6881.6881.6

Financing Gap (a) – (b) – (c) Financing Gap (a) – (b) – (c) Financing Gap (a) – (b) – (c) Financing Gap (a) – (b) – (c) Financing Gap (a) – (b) – (c) 477.7477.7477.7477.7477.7

Notes: 1). Exchange rate assumed vis-à-vis the USD: 1$=Rs.44 2). Budget outlay for BSNL and MTNL assumedto grow by 50 percent in the Eleventh plan 3.) Eleventh Budget Outlay assumed to be used to the extend of75 percent till December 2010


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Table A19: An estimate of the finance gap for ports, 2001-02 to 2010-11 (Rs. billion)


Modernization and capacity addition 306

Government PlansGovernment PlansGovernment PlansGovernment PlansGovernment Plans

Tenth Plan OutlaysTenth Plan OutlaysTenth Plan OutlaysTenth Plan OutlaysTenth Plan Outlays

Ministry of Shipping (Ports) 54

State and UT’s 5

Total Tenth Plan OutlayTotal Tenth Plan OutlayTotal Tenth Plan OutlayTotal Tenth Plan OutlayTotal Tenth Plan Outlay 59

Likely Eleventh Plan Outlay till 2010-11 Likely Eleventh Plan Outlay till 2010-11 Likely Eleventh Plan Outlay till 2010-11 Likely Eleventh Plan Outlay till 2010-11 Likely Eleventh Plan Outlay till 2010-11

Ministry of Shipping (Ports) 65

State and UT’s 5

Total likely Eleventh Plan Outlay Total likely Eleventh Plan Outlay Total likely Eleventh Plan Outlay Total likely Eleventh Plan Outlay Total likely Eleventh Plan Outlay 70

Financing gap Financing gap Financing gap Financing gap Financing gap 235.6235.6235.6235.6235.6

Note: Eleventh Plan outlay assumed to increase by 50 percent


Table A20: Overall financing gap in infrastructure up to 2010-11 (Rs. billion)

SectorsSectorsSectorsSectorsSectors Investment neededInvestment neededInvestment neededInvestment neededInvestment needed Financing gapFinancing gapFinancing gapFinancing gapFinancing gap

Roads 4,670 1,106

Power 10,591 3,500

Telecommunications 2,143 478

Railways 1,242 151

Airports 191 72

Ports 306 236

TotalTotalTotalTotalTotal 19,14319,14319,14319,14319,143 5,5425,5425,5425,5425,542


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Company: Noida Toll Bridge Company Limited (NTBCL)

Project: Designing, constructing, maintaining and operating the 8-lane, 552.5 m long tollbridge across river Yamuna, along with approach roads. The project also includesa flyover at Ashram Chowk in South Delhi.

Promoters: Infrastructure Leasing and Financial Services Limited (“IL&FS”) and NOIDA.

Project Cost: Rs. 4.08 billion

Means of Finance

IDFC Assistance:IDFC Assistance:IDFC Assistance:IDFC Assistance:IDFC Assistance: Takeout Assistance

IDFC has provided Takeout assistance for the DDBs issued by NTBCL with aface value of Rs.300 million and the interest accrued thereon.

ANNEX B:CASE STUDY: TAKEOUT FINANCING

Source of FundsSource of FundsSource of FundsSource of FundsSource of Funds Amount (Rs. Million)Amount (Rs. Million)Amount (Rs. Million)Amount (Rs. Million)Amount (Rs. Million)

EquityEquityEquityEquityEquity

– IL&FS 360.0

– NOIDA 100.0

– IFCI 50.0

– Intertoll (O&M Contractor) 106.2

– Private Equity Funds 400.0

– Public 207.8

Sub TotalSub TotalSub TotalSub TotalSub Total 1224.01224.01224.01224.01224.0

Senior Debt 2357.7

Deep Discount Bonds (DDBs)57 500.0

Total Means of FinanceTotal Means of FinanceTotal Means of FinanceTotal Means of FinanceTotal Means of Finance 4081.74081.74081.74081.74081.7

57 With Takeout Assistance of Rs. 300 million by IDFC and Rs. 200 million by IL&FS. DDBs were subscribed to by retailinvestors.

TrancheTrancheTrancheTrancheTranche Rs. MillionRs. MillionRs. MillionRs. MillionRs. Million

Issue Date (ID) Nov 3, 1999

Face Value 500.0

Value of IDFC portion on

- Issue Date 300.0

- Takeout Date (5 yr from ID) 570.0

- Takeout Date (9 yr from ID) 990.0

- Redemption Date (16 yr from ID) 2700.0

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Key terms of the DDBs:Key terms of the DDBs:Key terms of the DDBs:Key terms of the DDBs:Key terms of the DDBs:

• Coupon rate till first Takeout Date: 13.70 percent p.a.

• Coupon rate till second Takeout Date: 14.19 percent p.a.

• Coupon rate till maturity: 14.72 percent p.a.

• Takeout Fee (upto Takeout Date): 1.6 percent p.a. on principalplus accrued interest

Security Package

• First charge on Company’s movable and immovable assets;

• Assignment of all rights, titles, interest, benefit, claims and demands underproject documents;

• Charge on the Debt Service Reserve Account, Trust and Retention Accountand other accounts of the Company.

Status: Takeout

On the first takeout date, Nov 3, 2004, 37.1 percent of the total DDBs issuedwas offered for takeout by the DDB holders. The total takeout amount wasRs.351.7 million and was funded by IDFC and IL&FS in the ratio 60:40.

As on date, IDFC has the following two exposures to the Company:

i. Funded exposure of Rs.211.5 million in the form of DDBs

ii. Non-funded exposure of Rs.358.5 million as takeout assistance on Nov 3,2004 and accrued interest thereon (Value of IDFC takeout portion on firstTakeout date (Rs.570 million) less actual amount taken-out (Rs.211.5million).

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Table C1: Cross country comparison of the size of the bond market

Nominal GDP Size of the total Size of the Total bond Corporate bond 2003 (USD bn) bond market corporate bond market size market size

2003 (USD bn) market (Dec. 2003) as % of GDP % of GDP(USD bn.) (USD bn.) (2003)

United States 11,004 17662.7 2484 160.5% 22.6%

Malaysia 104 98.7 44.9 95.2% 43.3%

South Korea 605 445.5 167.6 73.7% 27.7%

Singapore 92 58.3 5.3 63.1% 5.7%

Brazil 509 299.9 2.7 59.0% 0.5%

India 601 196.8 1.9 32.7% 0.3%

Source: BIS, DB research

Table C2: Primary issuance of long tenor (more than 10 years) government bonds since 1 April 2002

Issue DescriptionIssue DescriptionIssue DescriptionIssue DescriptionIssue Description Issue Dt.Issue Dt.Issue Dt.Issue Dt.Issue Dt. Mat Dt.Mat Dt.Mat Dt.Mat Dt.Mat Dt. YearsYearsYearsYearsYears Cpn RateCpn RateCpn RateCpn RateCpn Rate Last Trd.Last Trd.Last Trd.Last Trd.Last Trd. LastLastLastLastLastDateDateDateDateDate Trd. QtyTrd. QtyTrd. QtyTrd. QtyTrd. Qty

1 GOI LOAN 7.50% 2034 10-Aug-04 10-Aug-34 30 7.50 28-Feb-05 500


3 GOI LOAN 6.13% 2028 4-Jun-03 4-Jun-28 25 6.13 25-Feb-05 2500

4 GOI LOAN 6.01% 2028 8-Aug-03 25-Mar-28 25 6.01 19-Feb-05 230

5 GOI LOAN 5.97% 2025 25-Sep-03 25-Sep-25 22 5.97

6 GOI LOAN 6.17% 2023 12-Jun-03 12-Jun-23 20 6.17 28-Feb-05 30

7 GOI LOAN(20 YR STK)6.30% 2023 9-Apr-03 9-Apr-23 20 6.30 25-Feb-05 5000

8 GOI LOAN 8.35% 2022 14-May-02 14-May-22 20 8.35 28-Feb-05 1000

9 GOI 5.87% 2022 28-Aug-03 28-Aug-22 19 5.87 8-May-04 500

10 GOI LOAN 6.35% 2020 2-Jan-03 2-Jan-20 17 6.35 28-Feb-05 500

11 GOI LOAN 6.05% 2019 12-Jun-03 12-Jun-19 16 6.05 27-Dec-04 500

12 GOI LOAN 5.64% 2019 2-Jan-04 2-Jan-19 15 5.64 14-Sep-04 50

13 GOI LOAN 5.69% 2018 25-Sep-03 25-Sep-18 15 5.69 7-Jan-05 500

14 GOI LOAN 6.25% 2018 2-Jan-03 2-Jan-18 15 6.25 28-Feb-05 500


16 GOI FLOATING RATE +0.34% 2017 2-Jul-02 2-Jul-17 15 5.99 29-Sep-04 500

17 GOI LOAN 7.49% 2017 16-Apr-02 16-Apr-17 15 7.49 24-Jan-05 500

18 GOI LOAN 7.38% 2015 3-Sep-02 3-Sep-15 13 7.38 28-Feb-05 500

ANNEX C :STATUS OF DEBT MARKET IN INDIA

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Source: NSE

19 GOVT LOAN 5.59% 2016 4-Jun-04 4-Jun-16 12 5.59 7-Jan-05 500

20 GOI FRB +0.04% 2016 7-May-04 7-May-16 12 4.49 27-Dec-04 5000

21 GOI LOAN 7.37% 2014 16-Apr-02 16-Apr-14 12 7.37 22-Feb-05 500

22 GOI FLOATING RATE +0.50% 2015 10-Aug-04 10-Aug-15 11 5.12 15-Feb-05 1000

23 GOI FLOATING RATE +0.19% 2015 2-Jul-04 2-Jul-15 11 4.71 8-Feb-05 2000

24 GOI FLOATING RATE +0.14% 2014 20-May-03 20-May-14 11 4.59 8-Feb-05 2000

25 GOI LOAN 6.72% 2014 24-Feb-03 24-Feb-14 11 6.72 21-Dec-04 1000

26 GOI LOAN 7.27% 2013 3-Sep-02 3-Sep-13 11 7.27 26-Feb-05 500

27 GOI LOAN 5.32% 2014 16-Feb-04 16-Feb-14 10 5.32

28 GOI LOAN 6.72% 2012 18-Jul-02 18-Jul-12 10 6.72 25-Oct-04 500

29 GOI LOAN 6.85% 2012 5-Apr-02 5-Apr-12 10 6.85 9-Feb-05 500

30 GOI LOAN 7.40% 2012 3-May-02 3-May-12 10 7.40 28-Feb-05 500

Table C3: Range of YTMs in Primary Issues of Government Securities by tenor (%)

YearsYearsYearsYearsYears Under 5 yearsUnder 5 yearsUnder 5 yearsUnder 5 yearsUnder 5 years 5-10 years5-10 years5-10 years5-10 years5-10 years Over 10 yearsOver 10 yearsOver 10 yearsOver 10 yearsOver 10 years

1995-96 13.25-13.73 13.25-14.00 -

1996-97 13.40-13.72 13.55-13.85 -

1997-98 10.85-12.14 11.15-13.05 -

1998-99 11.40-11.68 11.10-12.25 12.25-12.60

199-00 - 10.73-11.99 10.77-12.45

2000-01 9.47-10.95 9.88-11.69 10.47-11.70

2001-02 - 6.98-9.81 7.18-11.00

2002-03 - 6.65-8.14 6.84-8.62

Table C:4 Trading in WDM at NSE

Month Number of trades Average daily value (Rs. billion)

Mar-05 6,486 22.4

Feb-05 10,156 30.7

Jan-05 8,384 25.5

Dec-04 10,321 27.9

Nov-04 5,767 19.8

Oct-04 8,437 24.2

Sep-04 12,659 35.1

Aug-04 9,241 25.5

Jul-04 9,303 24.4

Jun-04 11,382 31.7

May-04 13,097 38.1

Apr-04 19,075 60.7

Source: NSE

Source: NSE


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Table C5: Time-series of data on trading in WDM at NSE

YearYearYearYearYear Number of TradesNumber of TradesNumber of TradesNumber of TradesNumber of Trades Net Traded Value (Rs. billion)Net Traded Value (Rs. billion)Net Traded Value (Rs. billion)Net Traded Value (Rs. billion)Net Traded Value (Rs. billion)

2004-05 124,308 8,873

2003-04 189,518 13,161

2002-03 167,778 10,687

2001-02 144,851 9,472

2000-01 64,470 4,286

1999-00 46,987 3,042

1998-99 16,092 1,055

1997-98 16,821 1,113

1996-97 7,804 423

1995-96 2,991 119

1994-95 1,021 68

Source: NSE

Table C7: Details of trading of select government securities in WDM at NSE

No. of Trades Tenor (years) Average monthly(1 Apr 04-31 Mar 05) number of trades

CG2034- Issue Name 7.5% 525 30 44

CG2023 - Issue.Name 6.17% 972 20 81

CG2018 - Issue.Name 5.69% 168 15 14

CG2014 - Issue.Name 6.72% 495 10 41

Source: NSE

Table C6: Trading in Retail Debt Market (RDM) at NSE

Month / YearMonth / YearMonth / YearMonth / YearMonth / Year No of tradesNo of tradesNo of tradesNo of tradesNo of trades Traded quantityTraded quantityTraded quantityTraded quantityTraded quantity Traded Value (Rs. million)Traded Value (Rs. million)Traded Value (Rs. million)Traded Value (Rs. million)Traded Value (Rs. million)

Mar-05 - - -

Feb-05 - - -

Jan-05 - - -

Dec-04 2 20 0.0

Nov-04 - - -

Oct-04 - - -

Sep-04 1 300 0.0

Aug-04 1 290 0.0

Jul-04 6 10,310 1.3

Jun-04 2 140 0.0

May-04 15 57,000 7.2

Apr-04 4 54,330 6.4

Source: NSE

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ANNEX D: USE OF FINANCIAL INSTRUMENTSTO INCREASE LIQUIDITY

CountryCountryCountryCountryCountry Repos andRepos andRepos andRepos andRepos and Short sellingShort sellingShort sellingShort sellingShort selling SecuritiesSecuritiesSecuritiesSecuritiesSecurities Bond FuturesBond FuturesBond FuturesBond FuturesBond FuturesInterest RateInterest RateInterest RateInterest RateInterest RateReverse ReposReverse ReposReverse ReposReverse ReposReverse Repos BorrowingBorrowingBorrowingBorrowingBorrowing and Optionsand Optionsand Optionsand Optionsand Options SwapsSwapsSwapsSwapsSwaps

and lendingand lendingand lendingand lendingand lending

India Yes No Yes No Yes

Brazil Yes No No No No

Chinese Taipei Yes No No No Yes

Singapore Yes Yes No Yes Yes

South Africa Yes Yes Yes Yes Yes

Argentina Yes Yes No Yes Yes

Hungary Yes Yes Yes Yes Yes

Korea Yes Yes Yes Yes Yes

Thailand Yes Yes Yes No

Source: The development of corporate bond markets in emerging market countries, IOSCO publication, May 2002

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Infrastructure financing by FIs so far hasfallen short of estimated needs. The IndustrialDevelopment Bank of India (IDBI)’s58 report onthe sanctions and disbursements of FIs revealsthat the total loans sanctioned by theseinstitutions towards infrastructure in the firstthree years of the period 2001-02 to 2010-11has been Rs.460.6 billion, or a mere 8.3 percentof our estimated aggregate financing gap ofRs.5,542 billion. (Please refer Table E1, whichgives details of infrastructure loan sanctions anddisbursements of these FIs between 2001-02 and2003-04). At this rate, the total sanctions forinfrastructure projected forward for the decade2001-02 to 2010-11 turns out to be a little morethan Rs.1,500 billion, or 28 percent of theaggregate finance gap. Clearly, these FIs have along way to go.

Table E1 also highlights another disturbing trend.While sanctions have been low compared to thefinancing gaps in infrastructure, disbursementshave been lower still. For the three years ending

2003-04, total disbursement of the FIs has beRs.287.6 billion, which translates to 5.2 percentof the finance gap for 2001-02 to 2010-11.

Within the sectors, it is clear that the FIs have amuch higher appetite to lend for power projectsthan others. Power generation accounts for 62percent of the value of infrastructure loanssanctioned and 55 percent of disbursals.Telecommunication comes second, accountingfor 20 percent of total infrastructure sanctions,and 24 percent of disbursals (Table E2).

The increasing participation from LIC, is ahealthy sign of increasing supply of longtenor funds, albeit predominantly financingpublic sector infrastructure projects as ofnow. Despite sanctions and disbursals beinginadequate relative to the financing needs ofinfrastructure, LIC has emerged as the biggestterm lending institution with its disbursementsexceeding the combined disbursements of IDBI,IFCI, IDFC, IIBI and SIDBI. There are at least two

ANNEX E: PARTICIPATION BY FIs ININFRASTRUCTURE PROJECTS

Table E1: Sanctions and disbursement to infrastructure by FIs (Rs. billion)

SanctionedSanctionedSanctionedSanctionedSanctioned DisbursedDisbursedDisbursedDisbursedDisbursed

2001-022001-022001-022001-022001-02 2002-032002-032002-032002-032002-03 2003-042003-042003-042003-042003-04 3 years3 years3 years3 years3 years 2001-022001-022001-022001-022001-02 2002-032002-032002-032002-032002-03 2003-042003-042003-042003-042003-04 3 years3 years3 years3 years3 years

Electricity generation 63.0 11.8 209.1 283.9 54.2 37.8 65.2 157.2

Transmission & distribution 2.7 9.4 10.3 22.4 9.1 1.1 7.4 17.6

Telecommunications 56.2 4.2 31.7 92.1 39.1 6.0 25.3 70.4

Roads/ports/bridges/railways 21.0 17.2 24.0 62.2 18.4 9.1 14.9 42.4

Total Total Total Total Total 142.9142.9142.9142.9142.9 42.642.642.642.642.6 275.1275.1275.1275.1275.1 460.6460.6460.6460.6460.6 120.8120.8120.8120.8120.8 54.054.054.054.054.0 112.8112.8112.8112.8112.8 287.6287.6287.6287.6287.6

Source: IDBI, Report on Development Banking in India.

58 The Industrial Development Bank of India (IDBI)’s annually prepares a report of the sanctions and disbursements ofFIs, including towards the infrastructure sectors. The list of institutions included in this report are IDBI, IFCI, ICICI Bank,IIBI, IDFC and SIDBI (which are classified as all-India development banks), specialized FIs such as the Exim Bank andNABARD, and investment institutions i.e. LIC, GIC, NIC, NIA, OIC, UII and UTI.

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reasons why this is an encouraging development.The first is the sheer size of the long-term liabilityportfolio of insurance companies, most of whichare endowment and money-back policiesextending over a tenor of 15 years or longer.And second, the involvement of insurancecompanies in infrastructure project financinggives any such project greater credibility andopens the door for bank finance, mezzanine andtake out finance as well as other cheaper funds.

However, most of the involvement of LIC andthe other state-owned insurance companies isin infrastructure projects of the central and stategovernments’ SOEs backed by governmentguarantees. These are often not based oncredibility or the detailed economics of theproject. In fact, in the past, state governmentshave raised funds from the insurance SOEsostensibly for financing infrastructure, whichhave then been diverted to the state’sconsolidated finances.

Commercial banks have only been marginalplayers in terms of their share ofinfrastructure financing in the recent past,though this segment has registered stronggrowth in the last two years. Barring a few,banks in India have generally stayed away fromserious financing of infrastructure. While thismay have marginally changed in recent timeswith excess liquidity in the banking system, thefact of the matter is that most banks still appearto be very shy of funding infrastructureprojects.59 Table E3 gives the sector-wise detailson exposure of scheduled commercial banks ininfrastructure for the past three years.

That said, the encouraging development in therecent past has been that, despite their naturaldisinclination, banks are developing an increasingappetite for infrastructure funding. As Table E3shows, notwithstanding a low base, gross bankcredit for infrastructure increased by almost 31percent in 2002-03, and by 42 percent in the

Table E2: Share of sectors in loans sanctioned and disbursed by FIs

For 2001-02 to 2003-04For 2001-02 to 2003-04For 2001-02 to 2003-04For 2001-02 to 2003-04For 2001-02 to 2003-04 SanctionedSanctionedSanctionedSanctionedSanctioned DisbursedDisbursedDisbursedDisbursedDisbursed

Electricity generation 62% 55%

Transmission & distribution 5% 6%

Telecommunications 20% 24%

Roads/ports/bridges/railways 14% 15%

TotalTotalTotalTotalTotal 100%100%100%100%100% 100%100%100%100%100%

Source: IDBI, Report on Development Banking in India.

Table E3: Gross bank credit outstanding for infrastructure sectors from scheduled banks in India,2001-02 to 2003-04 (Rs. billion)

March-02March-02March-02March-02March-02 March-03March-03March-03March-03March-03 March-04March-04March-04March-04March-04 % of total% of total% of total% of total% of total

Power 108 150 197 53%

Telecommunications 41 58 84 23%

Roads and Ports 52 55 92 25%

TotalTotalTotalTotalTotal 201201201201201 263263263263263 373373373373373 100%100%100%100%100%

Source: RBI, Trends and Progress of Banking in India

59 The exceptions are ICICI Bank (which has leveraged its historical expertise in longer term project finance) and the StateBank of India. Of late, a few other state-owned banks have also shown somewhat greater appetite for being a part ofconsortium lending to infrastructure.


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following year. The credit to infrastructure asshare of total non-food credit increased from 2.4percent in 2001-02 to 4.8 percent in 2003-04.

What explains the limitedparticipation of FIs and banks ininfrastructure financing?

Regulatory uncertainty has increased therisk-profile of infrastructure sectors, limitingthe number of potentially viable projects andincreasing the risk-aversion towardsinfrastructure financing. The less-than-desirable participation of development FIs andbanks is in part due to the risk-aversion of theseinstitutions to lend to this sector, which ischaracterized by its unique, higher risk-profileas explained earlier in this section. Moreover, thehigh regulatory risk associated with theinfrastructure sectors in India further increasesthe risk perception (and hence risk-aversion)towards these sectors. Even in cases whereprojects are being ‘regulated through contracts’,the inability to enforce the contract conditionsand threat (and actual experience) of reopeningof these contracts by government, greatlyincreases the risk profile of the projects (adiscussion on regulatory constraints in differentsectors is presented in section 2.4).

The risk-aversion of FIs in financinginfrastructure projects also manifests itselfin the late entry of certain FIs into projects,resulting in delays or failure in achievingfinancial closure for many projects. One ofthe main reasons cited for viable projects notreaching financial closure quickly enough hasbeen the lack of financial support at the initialstage. In India, external equity financing is usuallyundertaken by specialized FIs. Commercial banksrarely take equity positions in infrastructureprojects. Unfortunately, in order to reduce therisk of non-performing loans, most FIs, including

Infrastructure Leasing and Financial Services Ld.(IL&FS) and Infrastructure Development FinanceCompany (IDFC), have preferred to enter projectsonly after the COD phase. One of the mainreasons cited for this is the high concentrationof project risks in the early phase of project lifecycle. However, critics state that a rationale forsetting up specialized infrastructure financinginstitutions such as IL&FS and IDFC — and forcreating the Infrastructure Development Fund(IDF) — was to carefully appraise such projectsand, after the green light was given, to take initialequity positions in these ventures, which wassupposed to signal confidence in the project andattract further capital. Thus, according to thecritics, while late entry of these specialized FIshas protected their balance sheets, this hindersadditional infrastructure financing. The reasonwhy Indian FIs are reluctant to get involved atearlier stages is linked to their mindset, i.e., riskaversion.60 This is changing, but only gradually.

Commercial banks also face constraints fromthe inherent asset-liability mismatch andlack of sufficient appraisal skills forinfrastructure financing. While, lack of ‘viable’projects resulting largely from regulatoryuncertainty in infrastructure sectors appears tobe the predominant reason for the limitedparticipation of the DFIs in infrastructurefinancing, the commercial banks’ disinclinationto lend to infrastructure sectors is explainedfurther by their asset-liability mismatch and lackof relevant project appraisal skills required forinfrastructure financing. The asset liabilitymismatch occurs on account of the difference intenor between the bank’s liabilities and the tenorof advances needed for infrastructure financing.For instance, while infrastructure lending has anaverage tenor of 7-10 years, the averagematurity period of 58 percent of deposits ofscheduled commercial banks in India was undertwo years as of March 2003. Thus, in absence

60 The risk aversion of Indian FIs may be linked, at least in part, to the regulatory/procedural uncertainties discussedabove.

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of a ‘take-out’ or mezzanine financemechanisms, it is difficult beyond a point forbanks to manage longer tenor assets withshorter-tenor liabilities.

Another important factor constraining thegrowth of the infrastructure business for banksis that, the banking sector (and even insurancecompanies and pension funds) lacks thespecialization and experience to appraise therisks and returns associated with large andcomplex infrastructure projects. Commercialbanks have generally focused on working capitalfinance, trade funding and bill discounting and,therefore, have not developed sufficientexpertise to appraise complex and riskyinfrastructure projects with long gestationperiods.61 Though, in recent times the State Bankof India (SBI) has developed relatively strong skillsin project evaluation and infrastructure projectadvisory, most banks know little about thesectors. Consequently, entities that have accessto large amounts of relatively cheap depositors’funds shy away from infrastructure investment,unless proposal s are appraised by specializedFIs like IDFC. Banks lack the incentive and thewherewithal to shore-up their appraisal skills.Additionally, the existing employees’ incentivestructure in the public sector, including promotionand rotation policies, of public sector banks,makes it difficult for these banks to develop and/or leverage on such a skill-set.

For commercial banks, regulatoryrestrictions also limit participation ininfrastructure financing to some extent.While there are no serious regulatory constraintsemanating from RBI guidelines, for banks toincrease their exposure to infrastructure sectors,a couple of regulations reduce the flexibility ofbanks in becoming more active in this segment,

if they should want to. As mentioned earlier, RBI’sregulations preventing banks from participatingin the credit derivatives markets, precludes themfrom taking on higher credit risk with the optionof hedging these risks to the extent neededthrough these products. Further, the similartreatment of subordinate and senior debt in NPAprovisioning, reduces the attractiveness of banks’participation in mezzanine financing.

Hence, faced with the uncertain regulatoryenvironment, asset-liability mismatch, lack ofsufficient appraisal skills and more attractiveyields from other business segments (retaillending, corporate, and G-sec market) on a riskadjusted basis, the banks have chosen to limittheir exposure to the infrastructure sectors in thepast few years. In other words, the incentiveshave not been strong enough for banks to investin building this segment of business.

Limited participation of insurancecompanies and pension funds is explainedlargely by their restrictive investmentguidelines and risk aversion. It is widelyaccepted that insurance companies and pensionfunds are ideal candidates for supplying longtenor financing given the long-tenor nature oftheir liabilities. The longer term debt market inIndia remains narrow as well as shallow due tolack of adequate activity from insurancecompanies and pension funds — whose fundshave been traditionally used by government toaugment its resources beyond tax revenues.

Instead of being active players in funding longterm corporate bonds for financinginfrastructure, almost all of their investmentshave been directed to purchasing governmentpaper. Although the tenure of liabilities ofinsurance companies are 15 years or longer, the

61 This has been a handicap in project risk management, which covers the entire gamut of exposure i.e. engineering,construction, start-up and operations. To evaluate and mitigate such risks requires comprehensive due diligence,including a rigorous analysis of the assumptions underpinning the financial model — which majority of the banks areill-equipped to handle.


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fact of the matter is that, barring LIC, in recenttimes, most life insurance companies have notfocused on funding infrastructure. Part of thishas to do with restrictions on the investmentportfolio imposed by the Insurance Regulatoryand Development Authority (IRDA). Additionally,to some extent, the internal investmentguidelines (and philosophy) of these entities hasbeen influenced by the historical lack ofcompetitive pressures to earn above-marketrates of returns. Until recently, before facingprivate competition and the transition to market-linked plans, the investment departments ofthese institutions were merely administrators offunds, without any significant performancepressures on returns. Any shortfall on guaranteedreturns to pension and insurance plans wereexpected to be met through government support.With these entities now competing to attractconsumers and with the fiscal supportincreasingly being withdrawn, these entitieswould need to enhance their investmentmanagement skills.

As regards insurance companies, it is noteworthythat the investment guidelines of insurancecompanies specified by IRDA require them toinvest not less than 15 percent of theirinvestments in infrastructure and social sectors.62

However, the guidelines also lay down aminimum rating of AA for investments in debtpaper which would automatically excludeinvestment by insurance companies in debt paperof private infrastructure sponsors. But most of itstems from the lack of sufficient knowledge andappraisal skills related to infrastructure projectsand, consequently, a notion that these are far

too risky investments for fiduciary entities.

Pension and provident funds, both EPF and PPF,are also repositories of large amount of long-term finance. However, as a legacy ofgovernment regulations, pension funds remaina notionally funded scheme. For one, almost 72percent of the fund exists in the form of specialdeposits with the central government. Under theexisting stipulations, these funds cannot bedrawn out for deployment in other avenues and,thus, remains a ‘black-hole’. For another, asignificant portion of the remaining funds aredeployed in government securities, which, too,remain locked in for two reasons. First, once agovernment security is subscribed, regulationsmandate that they be held till maturity. Second,investment guidelines also mandate that interestreceived from government securities be re-invested in those securities itself.

Investment guidelines for investing new moniesare given in Box 3. As can be seen, even morethan insurance companies, the investment profileof pension funds are highly regulated with amassive bias towards government securities. Thisprecludes the largest source of long-term fundsfrom bridging the financing gap in infrastructure.A survey of pension fund investment guidelinesof some of the Latin American countries63

suggest that while significant exposure togovernment debt is stipulated there isconsiderable freedom for these funds to investin a mix of financial instruments with varying risk-return profiles. While it would not be appropriateor practical64 to introduce radical changes ininvestment guidelines at this stage, there is

62 It is understood that most of the investments by insurance companies in infrastructure are made to State-ownedspecialized FIs such as National Thermal Power Corporation (NTPC), Power Finance Corporation (PFC) (which have a AAAratings) as also to housing sector which qualifies under infrastructure investments. This clearly indicates the low risk-taking outlook of the insurance companies.63 Since the early eighties, pension funds have become important players in capital markets of many Latin Americancountries due to radical reforms to the social security systems. However, Pension funds are subject to quantitativerestrictions including list of authorized assets, diversification rules, conflicts of interest regulation, valuation rules etc.64 Primarily because issues such as high rate of assured return, deficiencies in the accounting methodology, lack of skillsin fund management need to be resolved first.

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certainly a need to deregulate these sources oflong-term finance and formulate prudentialnorms for infrastructure related projects.

Going forward, with appropriate changes in theinvestment guidelines, three mechanisms couldbe used to channel pension funds in toinfrastructure projects without distorting theirrisk-return profile. First, to initialize entry in tosuch projects at the lowest risk level, pensionfunds should be allowed to invest in projectswhere a multilateral agency or central

government extends a guarantee on theminimum rate of return. The multilateral agencyin turn could charge the project sponsor (such asNHAI) a commercial fee to extend thisguarantee. Second, pension funds should bepermitted to deposit part of their funds withbanks for long periods and ensure that the banksuse them exclusively for infrastructure financing.Third, in the longer term, pension funds shouldbe allowed to deploy funds in projects appraisedby the all-India FIs.

■

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F1 Roads

Given the size of the national highwaynetwork that is to be 4- or 6-laned underNHDP II (the NS-EW corridor) and NHDPIII, it seems unlikely that the NHAI will havesufficient funds — both as equity from thefuel cess and from market borrowings —to finance all the projects. Thanks to theoverwhelming preponderance of awardingpure works contracts in NHDP I (the GQproject) as well as other demands for thecess, NHAI faces a serious danger of ashrinking corpus. The only way out of thisproblem is to focus much moreaggressively on pure PPPs involvingannuity, BOT as well as shadow tolling. Inother words, the proportion of PPP projectsfor national highways has to increasesubstantially.

For there to be a far greater number ofviable PPP projects in NHDP II and III, thecontracts have to be of significantly longerroad length. Awarding a large number ofsmall lot projects may be good for smalland medium size contractors, but itcertainly does not create an environmentthat will attract, create and foster globalsized players who can have the resourcesto build, operate and maintain a roadnetwork for 15 to 20 years. Without theemergence of these players, we will notsee a major structural shift in roads,notwithstanding all the good that hashappened in the recent past.

While the cess of Rs.1.50 on per liter of petroland diesel has worked very well, thegovernment may wish to consider having a

ANNEX F: SECTOR SPECIFICRECOMMENDATIONS TO IMPROVE THEREGULATORY ENVIRONMENT

statutorily independent body administeringthe Central Road Fund.

There are serious concerns about thefinancial and implementation capacity ofstates to modernize state highways andmajor district roads. As far as finances areconcerned, the states should consider levyinga cess to create statutorily protected,independently regulated ring-fenced corpusfor funding their road program. In this corpuscould also flow funds from the CRF, fees, tollsand fines collected from roads, paymentsmade by the concessionaire to thegovernment as per the concessionagreement etc.

F2 Power

The most important aspect of power sectorreform is to recognize the fundamental truthof the maxim, “No money no power”. Noamount of economic or financial sophistry canensure funding for projects where consumersdo not even pay for the marginal cost of agood or service sold. Unless this mindset ischanged — which will require changes in thepolitical economy — there can be nosignificant power sector reform orimprovement.

The Electricity Act, 2003, is a welcome stepin the right direction. However it needs tobe operationalized at the level of each state.The Planning Commission may considerleveraging its relationship with the states toaccelerate this process.

Thermal power projects depend criticallyupon the credibility of the fuel supply

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agreements. Of late, there have been manydelays and breakdowns on this front. It isimperative that senior representatives of theMinistries of Petroleum and Natural Gas andof Coal be a part of a coordinating groupwith the Ministry of Power to ensure ex antecredibility as well as ex post performance ofpower supply agreements.

Subject to the overriding issue of payingproper user charges, the power sector isbedeviled with problems of regulatorycapture of the SERCs as well as frequentreneging of escrows and PPAs by bankruptstate governments. This requires interventionat the highest level, without which the entirePPP framework for power and reformsenvisaged by the Electricity Act, 2003, willbe under risk.

F3 Railways

There are many reform issues related toIndian Railways — its serious financial state,inadequate investments in safety, lines,signaling and rolling stock, and others. Mostof these, however, fall outside the ambit ofthis note. There are two recommendationsthat are worth considering. First, the needfor Indian Railways to have an independentregulatory authority that can de-politicizefares, stipulate minimum service standardsfor freight and logistics, and ensure a levelplaying field between CONCOR and anyother potential entrant.

Second, it is important to ensure thatCONCOR provides competitively priced,world-class container transport services,especially between ports and inland containerdepots. International experience suggeststhat the best way of doing this is byintroducing at least one — preferably two— other global sized competitors. It is

precisely here that the role of an independentregulator would be critical.

F4 Ports

Although there have been considerablereforms in this sector, neither major norminor ports have independent regulatoryauthorit ies. TAMP has done acommendable job in creating a fair playregarding tariffs and charges levied onprivate service providers at major ports.However, TAMP’s remit is limited. Goingforward, the government should seriouslyconsider restructuring TAMP as anindependent authority with widerregulatory powers. Concomitantly, stategovernments should also consider creatingappropriate independent regulatory bodiesfor the minor ports that fall under theirjurisdiction.

As far as new ports are concerned,connectivity has been a major issue. It isimperative that Indian Railways, the Ministryof Roads, Transport and Highways and portauthorities actively coordinate with eachother at the time of project design andimplementation to eliminate connectivityproblems. This should not only result inconcurrent approvals but also expedite theprocess of financial closure.

Notwithstanding the groundswell of demandfor greenfield ports (especially fromdevelopers), there are good reasons tobelieve that such projects are not onlyexpensive but also very risky. Data suggeststhat the economic gains from sustainedprivatization of berths outweigh those fromsetting up new ports. Therefore, the majorthrust should be steady privatization of berthsand other facilities in existing major and minorports.

65 The Airport Regulatory Authority Bill to set up an independent regulator is currently under the considerationof the GoI


98

F5 Airports

Airports too have no independent regulatoryauthority.65 The AAI is a creation of theMinistry of Civil Aviation. Given the statedobjective of privatizing facilities in Mumbaiand Delhi airports as well as the approval ofnew private airports in Bangalore andHyderabad, it is imperative that the

government appoints an independentregulatory authority for this sector.

Besides this, the issue is one ofimplementation. Enough reform policies havebeen suggested in the report of the NareshChandra Committee on civil aviation. It istime that the Ministry focuses onimplementing them quickly.

Documents

Infrastructure-4col - ICISAicisa.cag.gov.in/resource_files/4ad63928a7679ad9c19dd533bdf2cea5.pdfEPF Employees Provident Fund ... JNPT Jawaharlal Nehru Port Trust ... MTNL Mahanagar