MBA (Finance specialisation)

&
MBA Banking and Finance
(Trimester)
Term V
Module : PROJECT FINANCE AND MANAGEMENT
Unit V: Project Review and Contemporary issues
Lesson 5.2 Financing infrastructure projects & PPP model

Introduction
Traditionally, infrastructure projects in India were owned and managed by the
government or a government undertaking. Given the massive investments
required infrastructure, there is now a broad consensus that private sector
participation in this activity must be encouraged
Private initiative in infrastructure projects can take many forms, ranging from
contracted operation of public utilities to full ownership, operation and
maintenance of these facilities
A typical example is an electricity generation project which the private sector
builds, owns, operates for a certain period of time (called the Concession
Period) and finally transfers back to the government. This concept is called
BOOT.
For a road project, the private sector may be invited simply to build the
facility, operate it during Concession Period and finally, at the end of the
concession period, transfer the facility back to the government (BOT) without
actually ever owning the same.
Typical Project Configuration
The project is implemented by a Special Purpose Vehicle, which is a distinct
corporate entity.
Project sponsors take an equity stake in the SPV.
The SPV enters into contractual arrangements with project contractors,
offtakers, operators, government, and project lenders.
The dependence on debt is usually high and lenders generally lend on a non-
recourse basis. This means that project lenders would not have any fall-back on
the resources/assets of the sponsors if the SPV fails to meet debt servicing
obligations.
The contracts are as ironclad as possible and are less left to subjective
interpretation as possible.
Key Project Parties
Project sponsors
Project vehicle
Project lenders
EPC (engineering, procurement, and construction) contractor
O & M (operations and maintenance) contractor
Government
Project Contracts
Through a comprehensive web of contracts, every major risk inherent in
the project is allocated to the party / parties that is best able to assess and
manage the risk
The project contracts are:
Shareholders Agreement
EPC Contract
Project Loan Agreements
O & M Contract
Parties in a Power Project
EPC
Contractor
Sponsors/Other
Shareholders
Fuel
Supplier
State Electricity
Board (Offtaker)
Project Company (SPV)
O and M
Contractor
Project Lenders State Government
Features of a Power Purchase Agreement (PPA)
The PPA establishes the conditions under which the SPV would sell power to
the SEB
The SEB guarantees a minimum offtake from the SPV or, if it fails to do, a
minimum payment
A payment mechanism and and a security mechanism that ensures availability
of payments on time is established. In India, several large projects have been
financed on the basis of a 3 tier security mechanism
Level 1 : Letter of credit
Level 2 : Escrow account
Level 3 : Irrevocable guarantee of the state government
The formula for computing tariffs
Termination under conditions of sustained default by either the SPV or the
SEB.
Infrastructure Financing Scenario in India
Due to their complex nature, infrastructure projects have historically been funded by
banks and financial institutions, SBI, IDFC, ICICI, IDBI, and PFC being the key
financiers.
In recent times, there has been an increasing interest from the capital markets in
financing equity requirements in well-structured infrastructure projects.
Banks have become more responsive and are now willing to lend upto tenors of 12
to 20 years.
A large part of the Golden Quadrilateral is based on a fixed annuity payment to
contractors on a build-operate-transfer (BOT) model.
An operate-maintain-transfer (OMT) model is emerging for road financing. Under
this arrangement, the government funds the road while the contractor operates and
maintains it for a fee and then transfers it for a fee.
There has been a fair amount of action in seaports in the last few years
The Government of India has recently approved five ultra- mega power projects to
come up in the private sector.
Telecom operators in the private sector have been funded by debt and equity, coming
in good measure from foreign sources.
What Is a PPP?
Broadly a PPP refers to a contractual partnership between the public and
private sector agencies in which the private sector is entrusted with the
task of providing infrastructure facilities and services that were
traditionally provided by the public sector. An example of a PPP is a toll
expressway project financed, constructed, and operated by a private
developer.
According to the Government of India, a PPP project is a project
based on a contract or concession agreement between a government or
statutory entity and a private sector company for delivering an
infrastructure service on payment of user charges. A private sector
company is a company in which 51 percent or more of equity is owned
and controlled by a private entity.

Relevance of PPPs in India

India, the second fastest growing and the fourth largest economy of the world (in terms of
PPP), faces huge gaps between the demand and supply of essential social and economic
infrastructure and services. There is a shortage of power, roads, ports (airports and
seaports), irrigation facilities, water and sanitation services, and so on. The deficient
infrastructure is a major constraint in sustaining, deepening, and expanding Indias economic
growth and competitiveness. It also impedes inclusive growth and poverty alleviation.

Recognising the importance of infrastructure, the Government of India (GOI) has stepped
up its spending on infrastructure through a series of national programs such as the National
Highway Development Program (NHDP), Bharath Nirman, Providing Urban Services in
Rural Areas (PURA), Jawaharlal Nehru National Urban Renewal Mission (JNNURM), the
Prime Ministers Rural Road Program, National Rail Vikas Yojana, National Maritime
Development Program (NMDP), airport expansion program, and so on. However, the
estimated investment requirements are far greater than governmental resources. So, the
Approach Paper to the Eleventh Plan has argued for reaching out to the private sector and
private savings and aggressively promoting private partnership in infrastructure
development. The National Development Council (NDC) has passed a resolution which
says that increased private sector participation has now become a necessity for mobilising
the resources required for infrastructure expansion and upgradation.
Key Government Initiatives

To give impetus to PPPs several initiatives have been taken. The GOI
has established a Cabinet Committee on Infrastructure (COI), a high-
level Committee of Secretaries, a PPP Appraisal Committee (PPPAC) on
the model of the Public Investment Board (PIB), and several task forces
to streamline decision making and operationalise PPPs. It has
established the Viability Gap Funding (VGF) scheme and the India
Infrastructure Finance Company Limited (IIFCL) to provide long-term
finance to PPP projects.

The GOI is working on several initiatives to assist and encourage
capacity building at the state and central levels. It is providing assistance
for creating state level PPP cells as nodal agency, streamlining their
approval process, and developing PPP toolkits (model concession
agreements, project manuals, bidding documents, and project preparation
manuals).
Suggestions for improvement
In order to accelerate PPPs the following are needed:
A stronger policy and regulatory framework has to be created, both at the centre
and the states. The US-India CEO forum has called for a policy and regulatory
framework that fosters efficiency and transparency in the bidding process,
ensures sanctity of contracts, encourages competition, promotes market-driven
tariffs, and separates regulatory and adjudication authorities.
The availability of long term equity and debt for PPPs has to be augmented
through suitable instruments and mechanisms.
The shelf of bankable PPP projects has to be expanded.
The capacity of the government to manage PPP projects has to be substantially
strengthened.
The government should expeditiously award contracts, facilitate land acquisition,
and ensure better coordination between the centre and states. In particular, large
size PPP projects may be put out for bidding after obtaining mandatory
clearances and approvals, preferably through a Shell Company / Special Purpose
Vehicle as was done recently in the case of Ultra Mega Power Projects.