INFRASTRUCTURE FINANCE

A ROAD AHEAD
 CERTIFICATE

Ms. ))))))))))))))))))) a student of IV semester, M.B.A in this institute has prepared the
project report titled, “Infrastructure Financing A Road Ahead” - A study in India
Infrastructure Finance Company Limited, New Delhi, In partial fulfillment of the
requirement of IV semester M.B.A Degree examination of 2009 .

Date:
(Director)

2
 GUIDE CERTIFICATE

The project report titled, “Infrastructure Financing A Road Ahead” - A study in India
Infrastructure Finance Company Ltd., New Delhi, is written by Ms. student of IV
semester, under my guidance. This report is submitted to University in partial fulfillment
of the requirement of IV semester M.B.A Degree examination of 2009.

Date: Prof.
Assistant Professor

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 ACKNOWLEDGEMENT

I would like to convey my gratitude to ______________________ for his guidance

and encouragement during the course of this project, which has helped me in the
successful completion of this project.

I am grateful to Mr. Amit Kumar (Accounts Manager), Mr. Arun Kumar

(Associate Vice President Accounts) who gave me the opportunity to undertake
this project.

I would also acknowledge how much I have learned from meeting with industry
experts of India Infrastructure Finance Company Ltd. who have given me
updates on the latest industry trends.

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 Table of Contents
Executive Summary

Chapter 1
Preface 9

Chapter 2
Infrastructure and Economic Growth 14

Chapter 3
Role of Government in Infrastructure Financing 18
Present Scenario 18
Emerging Scenario 21
Need for Private Sector Participation 21
Initiative by Government: NHAI 23
Initiates have been undertaken 24

Chapter 4
India Infrastructure Finance Company Ltd.
Revolutionary Idea 28
IIFCL at a Glance 29

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Chapter 5
Infrastructure Financing: The Changing Perspective 33
Advantages form Private Sector Participation 35
Financial and budgetary benefits for the State 36
Economic and social benefits 38
Technological benefits 42
The political benefits 43

Chapter 6
Financing of NHAI Projects 45
Constraints in Implementation of the NHDP 50
Major Initiatives by the Government for bridging the Funding Gap 56

Chapter 7
Future Funding Needs 61
Infrastructure Financing Options 65
Major Financing Issues and Causes 68
Road Sector: Problems in Mobilising Resources 74
Potential Resources for National Highways and other Roads 76

Chapter 8
Recommendations 81

Chapter 9
Conclusion 87

References 88

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 Chapter 1

Preface

While the railways remain important for some bulk commodities and in some
passenger markets, India is increasingly dependent upon road transport. Rail
traffic continues to grow, but its share of freight and passengers has been falling
for many years. The growth in road transport has been accelerating; during the
1990’s, the national vehicle fleet grew from 21.3 million to 48.4 million. Faster
economic growth, especially in non-traditional sectors, and higher personal
incomes will undoubtedly continue the growth in demand on the road network.
However, unless major reforms as well as investment are made, India’s road
infrastructure will be an impediment to economic growth and social
development. The Indian Tenth National Plan (2002-2007), projects a GDP
growth rate of 8% per annum and an industrial growth of 10% per annum and
identified transport infrastructure as a major constraint on accelerated growth.

India has 3.5 million km of roads, which by international comparisons, provides

a relatively dense network. The major issues in the sector are not primarily the
length of the network but its low capacity and poor quality.

 During the 1990’s, the national highway network expanded from 33,700
km to 58,100 km9 and, though it constitutes only 2% of the network, it
carries about 45% of all road traffic. Most of the network is still two lane,
providing low service standards and slow vehicle speeds.
 At the other extreme, about 40% of villages are not connected by all
weather roads and have thus limited access to economic and social
infrastructure and opportunities.

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  Road maintenance throughout the network is dismal, contributing to both
poor pavement condition and the loss of all-weather accessibility.
Therefore, India combines both the need to increase very substantially the
maintenance of a very large network and the need to provide a high quality
highway system, sufficient to support the development of a rapidly developing
economy.

Highway Sector Financing Issues

Government expenditure on roads is significant, presuming 12% of capital and

3% of total expenditure; but road maintenance is grossly under-funded with only
one third of needs being met. The Union Government (GOI) recognizes the
deficiencies in the road network. The Tenth National Plan has assigned a high
priority to the National Highway Development Plan (NHDP) for the
construction of a Golden Quadrilateral of high capacity, high quality highways,
linking the four major cities, as well as similar highways along North-South and
East-West corridors. Very large investments are also envisaged on State
highways. The capital funding needs are immense:

 Over Rs.225,000 crore (US$50 billion) on highway improvements in the

period to 2011; and10
 Substantial investment (about Rs. 70,000 crore or US$15.6 billion), through
the Pradhan Mantri Gram Sadak Yojana (PMGSY), to connect villages

In addition, annual expenditure of about Rs.7,000 crore is essential to maintain

the 170,000 km of National and State Highways and further funding is required
to maintain the urban networks and district and rural roads. All these

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expenditures have to be financed within a constrained fiscal environment in
which the combined GOI and State Government deficits total about 9.5% of GDP.
There are major issues as to who will finance these expenditures and how the
financing will be structured.

It is not only the level of highway funding that is important but also the means
by which it is financed. The financing arrangements for the highway sector have
significant implications for overall government expenditure, the role of private
finance as well as having major impacts on the efficiency of the transport sector
and thus indirectly for the efficiency of the entire economy.

Approaches to Highway Financing

The management and financing of roads is not a new issue. With the growing
transport dominance of the motor vehicle, roads and highway finance has
assumed major importance and a number of approaches have been adopted.

Traditional- In this approach roads are treated much like public goods and
financed from general government revenue. There is little connection between
the costs of road provision and the taxes or charges paid by road users (though
fuel is often heavily taxed for general revenue purposed), and no attempts at
direct road pricing.

Commercial- In the commercial approach, governments deal with roads as a

business sector. Roads are treated as capital assets, commercial accounting is
applied and users are charged, either directly or indirectly, for their use of the
roads. Road transport remains a source of general revenue, but taxes are
designed to minimize distortions to transport patterns or choices. In some

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countries, road finance is being separated from general government
expenditures and road users are increasingly involved in decision-making.

Indian- The traditional approach largely persists in India, although a national

and some state fuel cesses have been introduced, tolls are increasingly applied
and substantial private sector financing is being sought. India may be early in a
transitional stage between the traditional and commercial approaches. Yet, the
present structure of financing contributes to the under-funding of road
maintenance, a distorted vehicle fleet, perverse incentives for traffic allocation
between road and rail, and substantial economic losses.

The Purpose of the Report

This report is designed to provide information and advice to the Indian

Union and States Governments on the principles and practicalities for
establishing a sound and sustainable system of highway financing.

 The report reviews the economic principles for establishing efficient and
equitable road user charges (road pricing), and examines the potential
mechanisms for charging road users. Present road taxation in India is
assessed in the light of these consideration and the levels of highway
funding required to meet government objectives.
 The report reviews the potential contribution of private sector finance to
the sector and assesses the present use of private finance and the
alternative possibilities for utilizing the private sector in the financing and
management of the network.
 The report also examines the need for an agenda of sector reform which
addresses both the financial and institutional frameworks needed to

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 achieve network sustainability and public acceptance of higher user
charges.

The report is specifically concerned with the main highway network (defined as
the 170,000 km of National and State Highways) which carries the great majority
of vehicle-km. There is also a very large network of rural roads which carry little
motorized traffic but which provides basic access for the rural population and
facilitates the administration of the country. These rural roads are crucial to the
social infrastructure of the country but their financing raises issues outside the
scope of this report. These roads generate major benefits but, in view of their low
traffic levels, it would be inconceivable to finance their construction and
maintenance from road users alone.

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 Chapter 2

Infrastructure and Economic growth

What is infrastructure? In Webster dictionary, one of the definitions of

infrastructure is the resources required for an activity. According to NATO,
infrastructure is a term generally applicable to all fixed and permanent
installations, fabrications, or facilities for the support and control of military
forces. In civilian world the concept of infrastructure was adapted but lost some
of its contents. Many authors believe that infrastructure refers to the foundation
or underlying framework of basic services, facilities and institutions upon which
the growth and development of an area, community, or a system depend.
Infrastructure can also be defined as the physical framework through which
goods and services are provided to the public. As generally understood and
accepted, infrastructure facilities include any form of facility, whether in the
nature of a physical structure or a resource, commodity, or a service, that is
provided with an objective to be either directly used or be ultimately used by a
society or a section of society. Infrastructure contributes to economic
development both by increasing productivity and by providing amenities that
enhance the quality of life. The infrastructure sector covers a wide spectrum of
facilities: transportation, power, ports, water supply, irrigation, urban
development, etc. the term “Infrastructure facilities” used in general and wide
meaning describes what could be more appropriately termed as “Public
infrastructure facilities” or “Public works”.

India has undergone a transformational change since early 1990s in its economic
development. The role of government has to change now from being a provider
to facilitator so that India can achieve the required economic growth. At 7%, it

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will take over 30 years to be at par with some of the South-East Asian countries
in terms of GDP and at 8% it will take 25 years. So India has to target and
achieve 8%+ economic growth to achieve the real benefits of the economic
revolution. Although the precise linkage between infrastructure and economic
growth is difficult to estimate, the World Development Report 1994 found that
broadly infrastructure capacity grows step by step with economic output; a 1
percent increase in the stock of infrastructure is associated with a 1 percent rise
in GDP across all the countries. Can India’s present infrastructure, controlled
and supported by government provide the requisite economic targets? At the
aggregate level, and at current prices, total investment in infrastructure increased
from Rs. 60 billion (approx.) in 1980-81 to Rs. 290 billion (approx.) in 1990-91 to
Rs. 1070 billion (approx.) in 2000-01. It is estimated that the total annual
investment in infrastructure would increase to Rs. 1800 billion in 2005-06. It is
also estimated that total investment in infrastructure would increase from a level
of 7% of GDP in 2000-01 to 8% in 2005-06. In future infrastructure in India, at its
current rate of growth in infrastructure is bound to create roadblocks for the
economic growth.

According to Dr. Manmohan Singh, Prime Minister of India, India needs US $150
billion for infrastructure development, while Planning Commission has
estimated than requirement is more than US $150 billion to be competitive with
other countries. Can Indian government provide the requisite infrastructure?
The PPI is a necessity not an option for the economic development. But is it
feasible for private players when the output from these projects is either sold for
free (water) or sold to government bodies which are not in position to pay for it
because of their financial conditions (power). IDP differs from other industrial
projects in the sense that they are high investment, high risk, and long gestation
period projects. In IDP not only are there greater risks due to the very size of the
project but also due to the very fact that generation of revenues for the use of the

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facilities or services by the consumer are highly uncertain. It is this characteristic
that makes IDP more risky than normal industrial ventures. In infrastructure
development there is little doubt that the facilities once developed would be
useful and used, but whether the users would actually pay the commercial
rates/charges required to make the project viable, is always considered to be
risky. Consequently, the implementation of and investment in IDP call for a
different approach and perspective than that adopted for industrial ventures.
Development of infrastructure projects with private participation requires
distinct approach that has to be project specific. This is because each project has
its distinct investment requirements, risk profile, user profile and gestation
period. Traditionally, the government or the public sector provided the
infrastructure services, the objective of which was not to make profits; however
that has resulted in making the public utilities financially unviable and
subsequently the quality of services, these utilities provided, has gone down. In
order to sustain the economic growth, India needs to develop new infrastructure
facilities and improve the existing facilities.

Infrastructure can well be dubbed as, if not the engine, the wheels of growth. The
adequacy of infrastructure can determine one country’s success and another’s
failure. Poor infrastructure is in fact proving to be a major bottleneck to
achieving high and sustainable rates of growth in most developing countries.
That infrastructure is inexplicably interwined with economic growth is amply
manifest from an input-output matrix of an economy which would show
telecommunications, electricity and water being used in the production process
of nearly every sector, and transport as an input in every commodity.

Empirical studies seek to quantify the link between infrastructure and economic
growth abound. For e.g. the NHDP has tremendous beneficial spin offs for the
economy. Some evidences are quoted here:

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  The Golden Quadrilateral (GQ) project alone is likely to generate
requirement of cement of 3 to 4 million Metric Tonne, and Steel of 2.5 to 3
lakh Metric Tonne. The project will also generate employment of about
189 million man-days. In 2002-03, about 2.5 lakh people are employed per
day on this project.
 Once completed, the GQ will result in saving of Rs. 8,000 crores (1999
prices) per year, according to a World Bank Report, through saving on
fuel consumption, reduced wear and tear of vehicles and faster
transportation.

With the implementation of NHDP, cement industry has registered a growth of

5.1 %, Steel industry a growth of 7.8% and Commercial vehicles also shown a
growth of 32% during April-September 2003.

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 Chapter 3

Role of Government in Infrastructure Financing

Present Scenario
It would be appropriate to briefly touch upon the present scenario of the
Highway projects in India, which would reflect the true state of affairs:

1. Construction Industry
The lack of well-developed highway contracting industry is the most important
factor, which came in way of upgradation of highway system in the country.
Professional management is now picking up. Increasing use of modern tools of
management viz computer programming and cost control methods is to be
accelerated. The domestic contractors are still not geared up for undertaking
large size projects and were not exposed to International Competitive Bidding
(ICB).

2. Quality construction
A new concept of ‘Quality Assurance’ has gained currency lately. It is an
important requirement of the day and this cannot be achieved without adequate
interest and a sense of commitment by the engineers and contractors. However,
we are still not in a position to guarantee quality Highways. Often, the life of
newly constructed work is less than what obtains elsewhere in the world.

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3. Design Approach
The empirical method of pavement design adopted by the Highway department
has worked well for low traffic volume roads. The increase in frequency of traffic
is causing fatigue failure, which is hardly covered in the present design
approach. This calls for a review of the present empirical design system and
adoption of more rational approach to cater the fatigue and rutting phenomena
as well.

4. Cost and Time Overruns

Cost and time overruns have been afflicting most of the projects. The analysis of
projects undertaken by the Ministry of Programme Implementation has
identified main reason for this as inability to use right management technique or
failure to apply the same in the matter of implementation.

5. Externally aided Projects

Experience on the current large sized externally aided projects has shown that in
spite of improved tender documents and contract conditions, the result have
been far from satisfactory. It has been experienced that either there are problems
and delays in supply of materials or there are problems and delays in obtaining
statutory permissions from the Department of Forest, Railway etc. and delay in
giving sites, drawing and other technical data that may be necessarily for
performance of the contract. Decisions to be given by the Government have
been much delayed resulting in set back to the progress of work.

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6. Contract Documents
The contract documents have been in vogue are one-sided favouring the
Government which in certain cases may not be maintainable under the law and
result in claims being won by contractors. The use of FIDIC conditions of
contract for works of highway project is not common. These are being adopted in
major projects like externally aided projects, but not in domestic projects.

7. Undertaking of Contractual Rights

It has to be admitted that neither the contractors nor the highway department
engineers are fully knowledgeable or aware of their rights and liabilities under
the contract. The fundamental principle of performance is that both the hands to
meet with each other so that the work for which the contract is signed can be
completed. It has been seen that in highway contracts that are executed by the
Government departments, the “engineer” feels that they have entered into the
relationship of a master and a servant. With this in mind, in Government
departments engineers sometime do not pay much attention to their obligations,
duties and responsibilities, which are essential inputs for successful and timely
performance of the contract.

8. Lack of Excellence
It has been observed that majority of engineers of the highway departments, are
not fully conversant with latest and appropriate technical developments in
modern methods of design. Construction and management and for
understandable reasons, have not maintained pace with the furious standards of
result and profit oriented workmanship and efficiency of the independent
professional consultants.

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Emerging Scenario
With advanced technology and fully mechanized construction of highways
coupled with stringent quality control standards highway construction work has
become highly complex and requires very high degree of planning and
monitoring in addition to execution o the work with heavy construction
equipment requiring construction management skills of a very high order. Since
highway construction has become highly capital intensive and fiscal resources
being always short, there is an urgent need to have a consortium of
entrepreneurs comprising of skilled contractors, professional consultants and
financiers for highway projects.

Need for Private Sector Participation

The National Highway system suffers from various deficiencies of capacity
constraints, payment crust, geometric features and safety features. About 19,000 Km of
National Highways has single/intermediate lane carriageway, which need to be
widened to two-way carriageway as per NH standard.

It has been assessed at the time of formulation of Tenth Five Year Plan that
removal of deficiencies on existing highways network will require huge
resources to the tune of Rs. 1,65,000 crores. While government is providing
increasing budgetary allocations for projects in highway sector and has taken
major upgradation initiatives in high density corridors, it has not been possible
to allocate sufficient funds matching the need due to competing demands from
other sectors.

In flow of private sector funds thus, is expected to bridge the gap of demand and
supply to some extent.

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The nation has been losing Rs. 15,000 crores per annum due to congestion and
other bad functional conditions of roads leading to avoidable excessive
consumption of fuel and increase in vehicle operating costs (wear & tear).

The investment could come from domestic or foreign firms opting for Build,
Operate and Transfer (BOT) concept. Improvement in credit rating of the
country due to impressive economic growth could induce confidence in foreign
investors and could further encourage foreign direct investment, provided level
playing fields; all-round transparency in actions and some fiscal/tax concessions
has to be guaranteed.

Hence, private investment is now inevitable in the Road sector to provide

additional road capacity to match the demand and price these facilities.
Therefore, there is an urgent need to tap new avenues of financing for
improvement to country’s road network.

Legislation by the Government of India

 Road sector has been declared as an industry to facilitate commercial

borrowing.
 The Government has amended the National Highways Act, 1956 to
provide for the legal framework for private sector participation. Under
the amended Act, it is possible to:
o Assign to the private entrepreneur responsibility for
implementation and operation of projects for specified period
given by an agreement with the Government.
o Authorize the entrepreneur to collect and retain the users’ fee (toll).
o Authorize entrepreneur to regulate traffic on BOT road.

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 o Punish any person encroaching and misusing the highway
developed by the entrepreneur.

Initiative by Government: National Highway Authority of India (NHAI)

In 1988 the National Highway Authority of India Act was enacted by the
Parliament, which provided for the setting up of a central Authority for the
Development, maintenance and management of National Highways vested
to it. The authority became operational in 1995 with the appointment of a full
time Chairman and Members.

NHAI is an autonomous organisation under the Ministry of Surface Transport

has been entrusted with task of executing externally aided projects as well as
implementation of private sector participation in the National Highways.
Among its other functions is to develop wayside amenities on National
Highways. The NHAI provided with a capital of Rs. 7 billion (US$ 234 million)
to leverage funds for Road Development from the capital market.

The mandate of NHAI under the Act is briefly as under:

 Develop, maintain and manage National Highways vested in it by the

government.
 Collect fees on National highways, regulate and control the plying of
vehicles on National highways for its proper management.
 Develop and provide consultancy and construction services in India and
abroad and carry on research activities in relation to the development,
maintenance and management of Highways or any other facilities thereat.
 Advice the Central Government on matters relating to highways.

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  Assist on such terms and conditions as may be mutually agreed upon, any
State Government in the formulation and implementation of schemes for
highway development.

Initiatives Taken by Government to Encourage Private Participation

In view of the budgetary constraints and in order to bring in new management

techniques as well as latest technological inputs, to improve the efficiency,
productivity and to bring-in competitiveness in providing highways services to
the road user, the scope for private sector participation, both domestic and
foreign, in the road development programme is quite large.

Following Initiatives have been undertaken:

Policy

The government has adopted the following policy measures in order to

encourage Private Sector Participation. The major extracts are as follows:

 Amendment in the National Highway Act, 1956 to provide for the

building, maintenance, management and operation of the National
Highways by private agencies for stipulated periods, and authorize the
levy of fees to cover their costs and generate reasonable rates of return.
 Declaration of the road sector as an industry.
 Provision of capital subsidy up to 40 percent of project cost to make
projects viable.
 Duty free import of high capacity and modern construction equipment.

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  100 per cent tax exemption in any consecutive 10 years out of 20 year of
operations.
 Provision of encumbrance free site for work, i.e., the Government shall
meet all expenses relating to acquisition of land and other pre-
construction activities.
 Foreign Direct Investment up to 100 per cent in road sector.
 Easier External Commercial Borrowing norms.
 Higher concession period up to 30 years in specific cases.
 Right to collect and retain toll.
 Four lane sections (both, budgetary as well as privately funded) to be
tolled.
o Toll in perpetuity.
 Revision of fee linked to Wholesale Price Index (WPI).
 Risk sharing:
o Private sector to be compensated for Force Majeure.
o NHAI to provide short-term credit for temporary short fall in
revenue due to reduced traffic diversion.
o Foreign exchange risk sharing pattern being worked out.
 Detailed Guidelines for BOT projects issued.
o Emphasis on transparency, competitiveness and fair contract
conditions.

Tax/Fiscal Concessions
The government has introduced various tax and fiscal concessions in order to
encourage Private Participation. These are broadly classified as follows:

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Concessions available for enterprise undertaking any project

 Under section 80(1)(A), corporations operating infrastructure facilities

have been offered:
o 100% deduction in profits for the tax purposes.
o Such deduction to run for a continuous 10 out of 20 fiscal years at
the assessee’s choice.
 Reduction in the rate of import duty in respect of specified construction
plant and equipment.

Concessions available for Lenders/Investors

 As an incentive to financial institutions to provide finance for the

infrastructure projects, deduction upto 40% of their income derived from
financing of these investments is available provided the amount is kept in
a special reserve.
 Exemption for infrastructure funds from Income Tax on the incomes from
dividend, interest on long term capital gains of such funds or companies
from investments in the form of shares or long term finance in any
enterprise set up to develop, maintain and operate an infrastructure
facility.
 Subscription to equity shares or debentures issued by a public company
formed and registered in India and the issue is wholly and exclusively for
the purpose of developing, maintaining and operating and infrastructure
facility, will be eligible for deduction equal to 20% of the tax payable by
the subscriber. In case of such investment, the limit of Rs.60,000/- per
year under Section 88 has been raised to Rs. 70,000/-.

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Availability of Long Term Finance

The Government of India and Reserve Bank of India have decided to establish an
Infrastructure Development Finance Company (IDFC), with an authorized
capital of Rs. 5,000 crores. The IDFC will be a direct lender, refinancing
institution and provide financial guarantees for the infrastructure projects.

Government Support
The government will carry out all preparatory works for the projects identified
for private investment and meet the cost of following items:

 Detailed feasibility Study.

 Land for right-of-way and enroute facilities.
 Relocation of utility services, resettlement and rehabilitation of the
affected establishment.
 Environmental clearances- not necessary for existing routes.
 Land acquisition procedures streamlined.

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 Chapter 4

IIFCL
India Infrastructure Finance Company Limited

A Revolutionary Idea
Indian government has approved plans to set up a new company (a special
purpose vehicle or SPV) to undertake financing of infrastructure projects
including viable private projects seeking financial closure. For 2005-06, the extent
of guarantee to be provided by the government will not exceed Rs.100 billion
($2.2 billion).

The new company, India Infrastructure Finance Company Ltd (IIFCL), would be
a 100 percent state-owned entity that will fund infrastructure projects through
long-term debt raised from the market apart from equity resources.

The IIFCL would finance up to 20 percent of the commercially viable project

costs. The independently appraised projects for viability could include those
sponsored by any entity whether public sector, private sector or public private
partnerships.

The Prime Minister’s Office (PMO) is set to initiate measures to give a push to
both domestic and foreign funding for infrastructure. This is because efforts to
beef up infrastructure funding have not gathered the desired pace. The PM has
convened a meeting of core infrastructure sector ministers, industry
representatives, both domestic and international, and states, on October 7 to
review the progress of various existing funding models for core sector projects.

The idea is to ascertain whether the current government policies were sufficient
to encourage private participation in infrastructure projects, the sources said. The
viability gap funding (VGF), enabled by government incentives to lending
agencies is one extant model to induce confidence in private players looking at
financing infrastructure projects.
Recently, the government had set up a special purpose vehicle (SPV) - India
Infrastructure Finance Company Ltd (IIFCL) - for part-funding of select
infrastructure projects. IIFCL is supposed to act in conjunction with the VGF
model.
Incorporated as 100 per cent government-owned company, IIFCL is yet to

26
establish itself. Sources said the finance ministry has proposed changes in the
structure of the SPV to facilitate funding of infrastructure projects. A Cabinet
note prepared by the ministry has proposed that IIFCL be exempted from rules
and regulations applicable to other banks and non-banking companies (NBFCs).

The Planning Commission is learnt to have supported both the proposals at a

meeting held here recently. The government will require huge funds for
infrastructure development to achieve the targeted 12 per cent growth in
manufacturing and 3.9 per cent growth in agriculture.

IIFCL AT A GLANCE
Setting up IIFCL
India Infrastructure Finance Company Limited (IIFCL) was incorporated on January 5,
2006 under the Companies Act 1956 as a wholly Government owned Company. The
authorized capital of the Company is Rs. 1,000 crore of which, paid up capital, at present,
is Rs. 300 crore. Besides, the borrowing programme of the Company would have
sovereign support, wherever required.
“The importance of infrastructure for rapid economic development cannot be overstated.
The most glaring deficit in India is the infrastructure deficit Investment in infrastructure
will continue to be funded through the Budget. However, there are many infrastructure
projects that are financially viable but, in the current situation, face difficulties in raising
resources. I propose that such projects may be funded through a financial Special Purpose
Vehicle……. The SPV will lend funds, especially debt of longer-term maturity, directly
to the eligible projects to supplement other loans from banks and finance.

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VISION of IIFCL
“Provide innovative financing solutions to prompt and develop world class infrastructure
in India”

MISSION of IIFCL
Adopt best practices in financing infrastructure and develop core competencies in
facilitating infrastructure development, develop a team of highly engaged employees to
deliver services in a professional manner and to the satisfaction of all stakeholders.”

OBJECTIVE of IIFCL
The basic objective of IIFCL is to provide long term fund for infrastructure projects and
thus has to play a developmental role for infrastructure financing in the country. To
achieve this objective Company requires persons with key skills of credit / project
Appraisal, Resource mobilization, Treasury/Fund Management, Risk Management,
Human Resource Management and with legal background.

Funding through IIFCL

 IIFCL funds commercially viable infrastructure projects in the country in

accordance with the SIFTI. Broadly IIFCL will fund such projects by way of:
 Long Term Debt
 Refinance to banks and financial institutions for loans with tenor of more than 10
years, granted by them.
 Any other method approved by Government of India
 Some other salient features of financing and development include:
 Loans assistance from IIFCL ordinarily shall not exceed 20 percent of the project
cost;

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 A project awarded to a private sector company through competitive bidding for
development, financing and construction through Public Private Partnership(PPP)
shall have overriding priority under SIFTI. A PPP project has been defined as a
project based on a contract or concession agreement between a government or a
statutory entity on one side and a private sector company on the other side, for
delivering an infrastructure service on payment of user charges.
 IIFCL would rely on project appraisal by the lead bank and not normally subject
the project to an independent appraisal
 Financial assistance from IIFCL would be available for eligible projects in the
following sectors:
 Roads & bridges, railways, seaports, airports, inland waterways, other
transportation projects;
 Power;
 Urban transport, water supply, sewerage, solid waste management and other
physical infrastructure in urban areas;
 Gas pipelines
 Infrastructure projects in special economic zones
 International convention centers, other tourism related infrastructure; and
 Other infrastructure projects, as may be determined from time to time.

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30
 Chapter 5

Infrastructure Financing: The Changing Perspective

Historically, infrastructure projects have been public works funded by public
funds, usually either tax revenues or proceeds from government bonds
(McCutcheon, 1998). From the early 1950s to the 1990s, in India, the government
was the only provider of the infrastructure facilities. The government had a
monopoly as the provider of the public services like electricity, water, and
transportation.

In the developing countries, due to the monopoly, the spread in the coverage
was very slow. An estimated 1.2 billion people in the developing world have no
access to electricity, more than 1 billion lack accesses to clean water, and nearly
1.2 billion lack adequate sanitation. Moreover, inefficiency has been high.
Technical inefficiencies in roads, railways, power, and water alone caused losses
estimated at $55 billion a year in the early 1990s—equivalent to 1% of the GDP of
all developing countries, a quarter of their annual investment in infrastructure,
and twice the annual development finance for infrastructure in the developing
world (World Development Report 1994, p.11). Developed countries have a
strong tax base provided by their stable economy, but public funds raised from
taxation in developing countries are inadequate to finance these projects due to
their low tax base, caused by their low level of commercial and industrial
investments.

At present the developing countries are faced with a situation where the demand
of infrastructure development is high with little funding or no money to finance
these projects. This has led to many countries, both developed and developing,
to re-adopt private finance for the procurement of publicly funded infrastructure

31
projects. But these investments are considered too costly for private sector
participation because of the large initial capital outlay, the slow rate of return,
and the risk that the project may never be profitable (McCutcheon, 1998). These
inefficiencies led the governments to look for an alternate way of funding the
infrastructure requirements of the nation. In doing so, governments also
reexamined their own role and are seeking to transform it—moving away from
being the exclusive financiers, managers, and operators of infrastructure to being
facilitators and regulators of services provided by private firms. This all led to
the reforms in the direction of liberalization and privatization of the
infrastructure development. Only a few countries took the initiatives in this
direction. According to the World Bank’s Private Participation in Infrastructure
(PPI) Project Database, 26 developing countries awarded 72 infrastructure
projects with private participation in 1984–89, attracting almost $19 billion in
investment commitments. In the 1990s the trend turned into a wave that swept
the developing world, with 132 low- and middle-income countries pursuing
private participation in infrastructure—57 of them in three of the sectors covered
here or in all four (transport, energy, telecommunications, and water and
sewerage). In 1990–2001 developing countries transferred to the private sector
the operating risk for almost 2,500 infrastructure projects, attracting investment
commitments of more than $750 billion. Those projects were implemented under
schemes ranging from management contracts to divestitures to Greenfield
facilities under build-operate-own (BOO) contracts, build-operate-transfer (BOT)
contracts, or merchant facilities.

32
Advantages form Private Sector Participation

A Partnership that provides services of the highest quality at the lowest cost to
the public
At the outset, it is fundamental to observe that reliance upon public-private
partnership for the provision of public services and infrastructure represents a
solution offering a considerable number advantage, yet one which remains
difficult to implement and fully accompany throughout its duration. Public-
private partnership set-ups are, by their very nature, partnerships built between
public authorities and private-sector firms/investors in the overall aim of
designing, planning, financing, building and operating infrastructure projects,
which are usually developed through more conventional market mechanisms,
such as public procurement procedures.

Public-private partnership does not only signify reliance upon the private sector
for financing capital investment projects on the basis of revenue streams to be
generated by the future facility, but also incorporates the use of private-sector
skill and managerial expertise in building and operating public service projects
more efficiently throughout the project life cycle. In this respect, the core of a
public-private partnership encompasses more the notion of service provision
than simply infrastructure financing and construction. This observation leads to
describing the basic advantages associated with the introduction of a public-
private partnership approach, along with the implications of such an approach in
terms of the public authority’s role.

33
Financial and Budgetary benefits for the State

Easing budgetary constraints

By making it possible to employ private-sector financing, public-private
partnership enables developing some projects at little or even no expense on the
part of the public authority (albeit with the need in most instances for a certain
level of project subsidization). The cost of service provision can often be
transferred onto users (e.g. road tolls, water bills) by charging rates close to real
costs, provided an adequate user acceptance campaign has been conducted
beforehand – a task expected of the public authority. Some financially-profitable
projects serve to generate new resources by means of sharing profits between
operator and public authority (e.g. tolls, taxes, etc.). Projects can thereby be
developed without increasing debt exposure or overextending the national
budget. Public resources are then available for meeting other policy objectives,
such as education or health. As a result, a country’s image – or even its financial
rating – gets upgraded, which in turn makes capital markets less expensive to
access and foreign investment easier to attract.

“Value for money” issues

In addition to easing budgetary constraints, the use of effective public-private
partnership set-ups – provided they have been applied to well-suited projects –
allows
optimizing project impacts while raising profitability for a given level of
investment, in comparison with a basic public procurement contract. Such
advantages are manifested in the following aspects:
 better coordination and greater synergy between the phases of design,
construction and operations, under the condition that a sole tender be
held for all three phases together;

34
  an innovative design, the application of reengineering principles and
efficient management techniques;
 emphasis placed on the quality of service offered to the user-customer;
 an approach aimed at minimizing total project costs throughout the entire
project life cycle (capital investment + maintenance + operations);
 a more effective use of capital, coupled with the generation of
complementary revenue.

Optimal allocation and transfer of part of the risks onto the private sector
Public-private partnership-type projects almost always comprise a high level of
risk, due to: the magnitude of the financial stakes involved, uncertainties over
construction and operating costs, and revenue-related uncertainties. A
partnership-based project organization relies upon a balanced allocation of these
risks (once they have been properly identified) and enables transferring a certain
portion of them onto the private operator when said operator is better able to
shoulder them than the public authority. In return, the public authority can
significantly reduce its risk exposure (even though certain risks must remain on
the authority’s side), while overseeing project optimization efforts. The analysis,
mitigation and allocation of a project’s risks will be discussed in Chapter II-B
further on.

A realistic evaluation and control of costs

A public-private partnership set-up enables public authorities to better evaluate
a project’s actual cost. A precise and realistic assessment of costs is of
fundamental
importance to project sponsors with respect to attracting financing, both on the
equity and borrowing side. Public-private partnership also enables preventing
against

35
most types of cost overruns encountered all too often in major infrastructure
projects. Indeed, by conferring a broad range of responsibilities upon the private
public-private partnership partner, it becomes possible to avoid underestimating
actual projectrelated costs early on in the process and, at the same time, to
tighten cost (and schedule) controls by virtue of the bond developed between
project builder, financial sponsor and operator. This actual cost then serves as a
benchmark for all subsequent improvements to the quality and efficiency of
other public services.

Economic and social benefits

Should the primary concern of actors appear exclusively oriented towards

“financial” considerations, the momentum of a public-private partnership project
may eventually stall. Of critical importance herein is for the economic and social
benefits to remain at the core of the project’s rationale, first and foremost because
the project (to be financed in large part from operating revenue) must be
designed from the standpoint of obtaining the best service at the most
competitive price in meeting the needs of the largest customer base. A public-
private partnership’s underlying principle stems from the fact that the public
authority remains responsible for service provided to the public, without
necessarily being responsible for the corresponding investment. By means of the
public private partnership set-up, the public authority is therefore relieved of all
investment related obligations and able to concentrate on service quality control,
while the private operator seeks to optimize its capital outlay in its provision of
service at this specified level of quality. Furthermore, by extension the user
becomes a customer, and the operator is thus in a situation of having to optimize
the quality of service offered.

36
A streamlined construction schedule and reliable project implementation able to
enhance economic development
Whenever a project is deemed beneficial to society, a public-private partnership
set-up allows speeding up both implementation and construction. In this respect,
it depends to a much lesser extent on budgetary resources, a condition which
often leads to project postponement; it then incorporates a more political
dimension. This accelerated construction schedule, in turn, makes it possible to
realize benefits more quickly for both the private company and the politicians
backing such projects. This perspective remains valid regardless of the level of
development of the countries which implement public-private partnership
projects.

Modernization of the economy and indirect benefits

By accelerating project implementation, these types of project set-ups help
stimulate economic modernization as well: infrastructure gets built and new
technologies introduced more quickly. Given their service quality-oriented
implementation, projects (construction + operations) are better able to respond to
demand and adapt fast to changes in demand, thereby giving rise to a more
dynamic modernization of the economy. Sizable indirect benefits for the
country’s overall economic development are engendered as a result.

Access to financial markets, combined with the development of local financial

markets
Reliance upon private-sector financing also displays a decisively beneficial
impact from a macroeconomic standpoint for developing countries. Such
initiatives allow improving access to international financial markets, by means
of: attracting international capital; strengthening the country’s image in the
capital markets, and utilizing well-renowned operators enjoying special access to
these markets. In the long run, this reliance also enables developing a local

37
financial market. Complex project configurations imply a number of financing
sources and often act to catalyze the local market, which is then led to modernize
(or evolve) and adapt.

Social benefits: improvements in services to local residents

By refocusing the role of the public authority, in enabling it to better identify its
expenses and in scaling back budget allocations, major public-private
partnership projects allow better earmarking resources for financing the
unprofitable portion of a project’s public service provision. Yet, for the most part,
financial resources are freed up for other public services not compatible with the
public-private partnership framework (health, education, social welfare, etc.). As
such, local public agencies are able to channel resources and energy into their
social service missions. Furthermore, some of the case studies developed in Parts
III and IV of this book reveal that public-private partnership set-ups can provide
highly-innovative solutions for accommodating the less well-off population
segments (e.g. water supply in La Paz or Manila, waste services in Caracas).

Sights set on sustainable and environmentally-compatible development

As opposed to a commonly-held misconception, involvement of the private
sector (within the scope of a public-private partnership) may actually enhance
the environmental aspects associated with a development project, from two
vantage points. First of all, the creation and expansion of environmental services
(primarily sewerage and waste removal/treatment) has become a fundamental
component of any sustainable development program. The infrastructure needed
to operate such services requires sizable capital investment, and collection
functions (as regards waste) must be run under flexible conditions. In this vein, a
public-private partnership approach allows creating these services more quickly
and efficiently at a considerably lower cost for public-sector budgets. The second
positive environmental impact of public-private partnership pertains to the

38
involvement, across the entire range of public services, of major international
corporations with access to the most up-to-date and “environment-friendly”
technologies. These corporate groups are increasingly cognizant of environment-
related needs (noise control, air pollution mitigation) and have considerable
experiencing adapting to the strictest of regulatory systems found throughout
the world. Moreover, they are capable of innovating and tailoring their service
provision to changes in environmental demands. Building a partnership between
public authority and private operators enables designing solutions better
adapted to reconciling service quality demands, the economic profiles of both
users and the public authority, and environmental imperatives.

Refocusing the role of the State on its regulatory functions

By relieving the public authority of its role of service operator, the public-private
partnership gives the authority the opportunity to pursue its regulatory mission
exclusively, which may consist of more accurately identifying public service
demands and their corresponding costs. In this manner, the authority is in a
position to effectively assess the optimal level of service provision desired by the
society, along with the associated cost, in order to reach an appropriate tradeoff
between economic and social efficiency. Public-private partnership set-ups also
make it possible to determine users’ «ability to pay» threshold as well as the
amount of subsidies necessary to maintain unprofitable services deemed of
public interest: the aim herein is to optimize financing of such services or at least
to initiate a critical examination of this topic.

39
Technological benefits

Public-private project partnerships serve to attract high-level experts who have

already acquired broad international experience: builders, operators, along with
specialists and consultants in the engineering, finance and legal fields. While this
highlevel expertise is naturally exhibited by the private partner, it must also be
accessible for the public authority, either in-house or through retained advisers.
The resultant transfer in technology or know-how turns out to be significant
from several points of view:
 construction and operating systems (the most modern techniques can be
proposed in a way that has been adapted to meet local conditions);
 project and operations management;
 financial engineering;
 institutional engineering;
 etc.

This transfer in technology and know-how exerts an impact not only on local
firms, whether directly involved in the project or not (by means of benchmarking
for industry-wide standards), but also on the administrative agencies responsible
for monitoring the project, local financial institutions and other context-specific
actors. Another important factor pertains to the training of local personnel.
Within a partnership involving an international consortium, foreign firms will
first seek to rely upon local personnel which it can train at the outset of the
project, therefore leaving on site just a minimum number of foreign office
executive staff beyond the transition phase.

40
The political benefits

A new role for the public authority

The political benefits also prove to be significant. By refocusing public authority
action on its regulatory missions, a public-private partnership strategy
transforms the authority’s role from a service owner/operator into a regulator
and controller. This newfound role then provides the opportunity for promoting
efficient demand oriented services of social benefit. The public authority comes
out a winner by virtue of providing a better quality of service, while
concentrating its resources on social welfare issues. In addition, the introduction
of a public-private partnership allows rethinking the breakdown of public vs.
private roles outside the confines of a purely dualistic mindset. This political
advantage, however, may backfire if the public-private partnership is not
applied under adequate conditions and if the State has not procured the means
for: establishing its objectives realistically, preparing its agencies and institutions
for the successful implementation of public-private partnership formulae, and in
particular conducting effective regulatory action.

Allocation and not “abdication”

Although the term privatization sometimes gets abusively used in public-private
partnership cases, keep in mind that a public-private partnership is not a
privatization
program. Rather, it serves to attract private investors without abdicating public
service missions to the benefit of private concerns. In sum, the public-private
partnership can be defined as the delegation of a public service provision to a
private operator for a given period of time. In no way does it alter the public
sector’s ownership rights to the service infrastructure (as those facilities existing
prior to the concessionary contract as well as those built during the concession
return under public authority possession upon contract expiration). The

41
authority maintains both its role of shaping public service missions and its
regulatory oversight. Moreover, this process is indeed reversible, either at the
end of the stipulated contract period or (in exceptional cases of serious conflict)
during the contract’s execution. The public private partnership approach thereby
allows retaining the “public” essence of these services while steadfastly refuting
all accusations of “selling off ” national public assets (or service activities) to
foreign interests or third parties.

Project stability
The social and economic advantages described above exert obvious impacts on a
country’s economic, hence political, stability. For one thing, contracts are signed
for periods exceeding the terms of elected officials. As a result, the public
services considered tend to be less sensitive to both direct and indirect
“electoral” effects. The parameters of maintenance and quality of service are less
likely to be subjected to uncertainty, and projects will be required to display a
tangible socioeconomic value in order to be selected. Secondly, by enhancing the
quality of public services without drastically increasing fiscal pressures, public-
private partnership projects are able to instill economic well-being in addition to
social stability. Here again, any hasty introduction of a public-private
partnership-type partnership must be avoided: taking the time necessary to
prepare both the population and local administration and to plan out the
transition periods is crucial to ensure not only acceptance of the notion that one
should pay for service (at least in part), but also an appropriate regulatory
framework to prevent against abusive practices.

42
 Chapter 6

Financing of NHAI Projects

For implementation of NHDP Phase I and Phase II, the main source of finance of
NHAI is the fuel cess . The present rate of cess is Re.2.00 per litre on both petrol
and diesel. A part of this cess is allocated to NHAI to fund the NHDP. The share
of NHDP is leveraged to borrow additional funds from the domestic market
through bonds that qualify for capital gains tax exemption. Besides, Government
has also negotiated loans from World Bank (US$1,965 million), Asian
Development Bank (US$1,605 million) and Japan Bank of International
Cooperation (JBIC) (Jap. Yen 32,060 million) for financing various projects under
NHDP. These loans from the multilateral institutions are passed on to NHAI by
the Government partly in the form of grants and partly as loans. NHAI also
negotiated a direct loan of US$165 million from Asian Development Bank for one
of its projects. The funds provided to NHAI, including the borrowings from the
market, are utilized for meeting the expenditure on the projects as well as for
servicing and repayment of borrowings from the domestic market.

For providing adequate funds to the Authority for implementation of the

projects entrusted to it, Government has levied Cess on the consumption of
diesel and petrol. The proceeds of the cess are distributed as per the guidelines
given in the CRF Act, 2000. In addition to the cess, Government also provides
budgetary support by the way of grant and loan for the projects which are
executed with the assistance of multilateral funding agencies like World
Bank/ADB and JBIC.

43
Under the National Highway Authority of India, NHAI with the consent of
Central Govt., can borrow money from any source by issue of bonds, dividends
or such other instruments as it may deem fit for discharging its functions. NHAI
leverage its cess receipts for borrowing money from the market to finance its
projects. It is also one of the agencies, which are authorized to issue Capital gain
Tax Exemption Bonds under Section 54 EC of the Income Tax Act.

NHAI does the financing of its projects as follows:

Through budgetary allocations from the Government of India.

A certain percentage of amounts are fixed every year in the union budget of
India for the infrastructure development. The said amount includes the sum
allocated for the development of roads in India.

Cess
Government of India introduced a Cess on both Petrol and Diesel. This amount
at that time (at 1999 prices) came to a total of approximately Rs. 2,000 crores per
annum. Further, Parliament decreed that the fund so collected were to be put
aside in a Central Road Fund (CRF) for exclusive utilization for the development
of a modern road network. Today, The Cess contributes between Rs 5 to 6
Thousands crores per annum towards NHDP.

Loan assistance from International Funding Agencies.

Loan assistance is available from multilateral development agencies like Asian
Development Bank and World Bank or Other overseas lending agencies like
Japanese Bank of International Co - Operation.

44
Market Borrowing
NHAI proposes to tap the market by securities cess receipts

Private Sector Participation

Major policy initiatives have been taken by the Government to attract foreign as
well as domestic private investments. To promote involvement of the private
sector in construction and maintenance of National Highways, Some Projects are
offered on Build Operate and Transfer (BOT) and Annuity basis to private
agencies.

The following table shows the procurement of financial resources for the road
development in India:

Total cost Rs. 54,000 Crores US$ 13.2 Billion

Likely sources Rs. Cr. (on 1999 prices) US$ Billion (1999 prices)
Cess on Petrol and Diesel 20,000 4.90
External assistance 20,000 4.90
Market borrowings 10,000 2.40
Private Sector
4,000 1.00
Participation

The financing plans of Phase-I, Phase-II and Phase-III (Part-A) as approved by

the Government are as under:

Phase I (Rs. In crores at 1999 prices)

Particulars Projected (for 6359 Km) Actuals/Tied-up as on

30/4/05
Cess/Market 18,846 20,341#
Borrowings
External Assistance 7,862 7,862*

45
Share of Private Sector 3,592 3,644
Total (excluding IDC 30,300 31,514
and escalation)
# Cess (Rs. 10,933 crores), Market Borrowings (Rs. 7,054 crores), & 8 BOT/Annuity Projects-476 km (Rs.
2,354 crores).
*Loan executed wit World Bank US$ 1345 million, ADB US$ 665 million and JBIC Japanese Yen 32060
million.

Phase II (Rs. In crores at 2002 prices)

Particulars For 6195 Km For 507 Km Total (6702 Km)

(Gujarat Packages)
Cess/Market Borrowings 22715 705 23420
External Assistance# 6022 1587 7609
BOT (Share of Private 3094 216 3310
Sector)*
Sub-Total (excluding IDC 31831 2508 34339
and Escalation.)
Interest During 5332 65 5397
Construction (IDC)
Total (excluding 37163 2573 39736
Escalation)
# Loan tied up with ADB for East-West corridor in Gujarat US$ 320 million, Sector 1 loan US$ 400 million,
Sector II Loan US$ 400 million and with World Bank (Lucknow-Muzzafarpur) US$ 620 million.
* BOT 1142 Km and Annuity 1037 Km.
Phase III (A) (Rs. In crores at 2004 prices)

Particulars Projected (For 4000 Km)

Budgetary Support 10,000
BOT (Share of Private Sector) 12,000
Total (excluding IDC and Escalation) 22,000

{The funds approved by the government and the funds actually received during
the last 5 years are as per the details given in the status report of NHAI, May
2005.}

46
Central Road Fund

In recognition of the need of funds for road infrastructure, the Union Budget for
1998-99 had provided for the levy of additional excise duty and additional
custom duty of Rs. 1 per litre of petrol. Subsequently, in the Union Budget of
1999-2000, an additional duty of Rs. 1 per litre of high speed diesel was levied. In
2003-04, an additional levy of cess of Rs.0.50 per litre was levied on petrol and
high speed diesel. The revenue from the cess would be used to finance all
categories of roads. This fund has been given the statutory status by Central
Road Fund Act 2000.

An allocation of Rs. 5361 crores has been made under the CRF for 2004-05 as
follows:
(Rs. In crores)
Grants to state government and Union territories for state roads 868
Grants to States and Union territories for roads of inter-state 96
connectivity and economic importance.
National Highways 1848
Rural Roads 2148
Railways 401
Total 5361

 The funds earmarked for NH are being allocated to the NHAI for the
NHDP.
 The funds for State Roads are disbursed to the states for development of
state highways and major district roads.
 A total of 272 works for improvement of state roads involving
expenditure of Rs. 589.14 crore have been sanctioned from the CRF for
2004-05 till 30th November 2004.

47
The Government is planning to raise the Cess on Petrol and Diesel to Rs. 2 a
litre from Rs. 1.50 a litre.

Constraints in Implementation of the National Highway

Development Program (NHDP)

The following are the problems that were encountered during the execution of
the PFI for development of road infrastructure:

Involvement of political leaders

Many times, political leaders lead agitations against projects on the pretext of
representing social causes without understanding the engineering and the legal
position. The work has to be suspended and the concessionaire has to then
convince the leader, through a series of negotiations, which in most cases serves
only vested interest and very little public interest.

Traffic discipline
The concession agreements envisage proper traffic movements and devolve the
responsibility for traffic management to the concessionaire albeit without the
state government support. The concessionaire is not vested with the power to
initiate legal action against traffic offenders. Support from the police also does
not come forth as envisaged in the split of the contract.

Illegal encroachments
The concession agreements envisage upkeep of the “right of way”. The
concessionaire does not have the legal power to enforce the eviction of illegal

48
encroachments. Even if intimation is given to police authorities in writing, they
register a “non-cognizable report” and not a “first information report” because of
the present legal framework, moreover on timely action can be initiated to clear
encroachments.

Multiple agencies
There are many agencies involved in project implementation – NHAI,
concessionaire, lenders, contractors etc. each party has its own engineers to
supervise the work on their behalf, which leads to:

 Duplication of the “supervision” exercise, which could be easily

dispensed with.
 Increase in project cost due to fee and reimbursement of allowances of all
supervising agencies.
 Unnecessary trouble for the construction executives as they have to deal
with so many monitoring agencies.
 Conflicts in cases were the reports of any two agencies differ from each
other.
 Ego clashes amongst the engineers and supervising authorities.

Too many Auditors

There are many auditors involved in a BOT project such as statutory auditors,
lenders auditors, NHAI auditors and investor’s auditors. This leads to
duplication of work and increase in the project cost.

49
Responsibilities of loan syndicate lead manager
Big projects envisage the appointment of an agency that syndicates the loan and
the lead manager charges a fee. He should also be made responsible for timely
arrangement of funds.

Problems at NHAI
Decision-making: Since no time frame is allotted to the governing body it
provides for an opportunity for certain officials to ‘test’ the urgency of the
concessionaire and the potential for exploitation at the hands of certain non-
upright officials. There are penal clauses for delay on the part of the
concessionaire. Ironically, there is no penal clause for any delay on the part of the
employer in delivering timely decision.
Secondly, payments for the work done should be released strictly as per
schedule. Though the contract provides for levying of interest for delay in the
release of due payments, this only addresses the financial side of the problem
and does not help the project, which suffers from delays.

Decentralization of decision-making
Most decisions are referred by the project implementation units to the
headquarters. PIU’s also seek recommendation of independent engineers and
local offices before it could be forwarded to the HQ. Each decision takes months
along with the communication, which further add to delays.

Land Acquisition
There has been inordinate delay in acquisition of land in some States mostly due
to procedural formalities, court cases and low-level cooperation from the State
Govt. officials. There have been delays in disbursement of compensation by the
Competent Authority to the affected landowners, although NHAI deposits the
compensation amount determined by the competent authority well in advance.

50
As on 31.5.2005, 42% of land in Tamil Nadu and 28% land in Maharashtra are yet
to be acquired.

Environment and Forest Clearances

There have been considerable delays in getting the forest clearance. Besides the
conditions stipulated by the Central Government (MOEF) in the first stage
clearance (in-principle approval), the State forest departments impose additional
conditions which are, at times, unreasonable and difficult to meet. Demands
have been made for staff quarters, wireless systems, vehicles etc. without
apparent justification. The demand for compensatory afforestation also varies
greatly from state to state from two times to as much as twelve times.

The Government of U.P. imposes an additional conditional for providing a

dedicated strip of 10 m for plantation all along the highway. Such a condition is
very difficult to meet and creates problems in the implementation of works.
The Net Present Value (NPV) of the diverted ‘forest land’ is demanded even for
the road side lands belonging to PWD/NHAI (notified as protected forest for
management purposes). Demand of NPV alone will have a financial implication
of about Rs 1100 crore for the North-South and East-West Corridor taking the
lowest NPV rate of Rs 5.80 lakh per ha.

In a few projects widening involves diversion of small strip of land in the

wildlife areas(National Park/Sanctuary). The application for forest clearance in
such cases is to be first submitted to the National Board of Wildlife. Approval of
the Board is required at various stages, including the very first step of
undertaking survey and investigation for preparation of Detailed Project Report.
The process of approval at each stage takes a long time as the Board meets only
once in three months. Moreover, there remains an uncertainty with regard to
whether the projects on such alignments would receive final approval.

51
Clearance of Railways for ROB designs
Under NHDP Phases-I&II and other projects about 229 (84 on GQ alone) Rail
Over-Bridges (ROB)/Rail Under-Bridges (RUB) have to be constructed.
Approvals have to be obtained from Railways for the following:
 General Agreement Drawing (GAD) submitted by NHAI.
 Permission of the Commissioner of Railway Safety (CRS) for shifting of
level crossing.
 Approval of detailed designs and drawings of sub structures and super
structures submitted by NHAI after proof checking by consultants.
 Approval of drawings for temporary arrangement.
 CRS sanction for super structures.

Obtaining the above clearances/approval from the Railways involves

coordination with several departments within Railways and it takes a long time
to get the necessary approvals. Also, in the packages where ROBs are being
constructed by the Railways themselves, progress has not been satisfactory.

Shifting of Utilities
Utilities of different type e.g. electric lines, water pipelines, sewer lines,
telecommunication lines have to be relocated with the assistance of concerned
utilities owning agencies. Shifting of utilities, especially water-pipe-lines, takes
considerable time. Moreover, relocation of utilities can only be taken up after
acquisition of land.

Local Law and Order problems

In many states works have been affected because of adverse Law and Order
conditions and activities of anti-social groups. Law and order was a serious issue

52
in Bihar and Jharkhand affecting the progress of work on NH-2 where work was
completely paralyzed and camps of contractors were attacked. In pursuance of
orders of High Court of Bihar, the Government of Bihar tightened the security
for NHDP projects and progress of works improved considerably thereafter.
Stoppage of work by the local population demanding additional
underpasses/bypasses, flyover etc. is also frequent.

Poor performance by some contractors

Performance by some contractors has been very poor. Cash flow problems have
been one of the major reasons for poor performance. Termination of such
contracts often results in long drawn litigation and further delays in the works.

53
Major Initiatives by the Government for bridging the Funding Gap

Taking cognizance of the advantages that PPP offers in terms of cost saving,
access to specialized expertise and proprietary technology, sharing of risks with
the private sector and the ability to take up a larger shelf of infrastructure
investments, Government of India is actively encouraging them. To expedite the
PPP projects in the Central sector, the need for streamlining the appraisal process
was felt and accordingly an appraisal mechanism has been notified including the
setting up of the PPP Appraisal Committee that will be responsible for the
appraisal of PPP projects in the Central sector. To accelerate and increase PPPs in
infrastructure, two major initiatives have been taken by the Government:

(a) Provision of viability gap funding; and

(b) Setting up of a SPV, India Infrastructure Finance Company Limited
(IIFCL) to meet the long term financing requirements of potential
investors.

The “Viability gap funding” will normally be in the form of a capital grant at
the stage of project construction, not exceeding 20 per cent of the total project
cost. In order to be eligible for funding under this viability gap support scheme,
the PPP must be implemented by an entity with at least 51 per cent private
equity. Although a provision of Rs.1,500 crore for ‘ viability gap’ funding for
infrastructure projects was made in the Budget, projects are yet to be sanctioned
under the scheme.

Viability Gap Funding (VGF) For Infrastructure

Infrastructure projects have long gestation periods and, in most cases, are not
financially viable on their own. It may not be possible to fund the very large
investment requirements of these projects fully from the budgetary resources of

54
the government of India alone. In order to remove this shortcoming and to bring
in private sector resources and techno-managerial efficiencies, the Govt. is
promoting Public Private Partnerships (PPP) in infrastructure development
through a special facility envisaging support to PPP projects through ‘viability
gap funding’. Primarily, this facility is meant to reduce capital cost of the projects
by capital enhancement, and to make them viable and attractive for private
investments through supplementary grant funding. Provisions for this facility is
made on year-to-year basis.

Criteria
The criteria for eligibility for funding are:

The project must be implemented, i.e. constructed, maintained and operated

during the project term, by an entity with at least 40 per cent private equity.

The project must belong to one of the following sectors:

 Roads, railways, seaports, airports;

 Power;
 Water supply, sewerage and solid waste disposal in urban areas and
International convention centers.
 The projects should have been vetted/ endorsed by the concerned line
ministries in the Government of India
 All central projects should have received requisite Government approval
at the appropriate level.

55
How VGF is done

Viability gap funding can take various forms, including but not limited to capital
grant, subordinated loans, O&H support grants of interest subsidy. A mix of
capital and revenue support may also be considered.

The funding is to be disbursed contingent on agreed milestones, preferably

physical, and performance levels being achieved, as detailed in funding
agreements.

The funding is to be provided in installments, preferably in the form of annuities,

and with at least 15 per cent of the funding to be disbursed only after the project
is fully functional.

In the first year of the facility, funding is to be allocated to projects on first come
first served basis subject to meeting the eligibility criteria.

The operationalisation of the IIFCL.

India Infrastructure Finance Company Limited (IIFCL) was incorporated on

January 5, 2006 with a paid up capital of Rs.10 crore and an authorized capital
of Rs. 1,000 crore. Apart from its equity, IIFCL will be funded through long term
debt raised from the open market. To enable the company to do so, the
Government may extend a guarantee for repayment of principal and interest.
The extent of guarantee provided by Government of India in the first year of
operations is expected at around Rs.10,000 crore. The setting up of IIFCL as a
wholly owned Government company redeems the promise made in the Budget
Speech for 2005-06. There were many infrastructure projects which were

56
financially viable but, in the current situation, faced difficulties in raising
resources. It was proposed that such projects in specified sectors- roads, ports,
airports and tourism be funded through a financial SPV. The SPV would lend
funds, especially debt of longer term maturity, directly to the eligible projects to
supplement other loans from banks and financial institutions Government will
communicate the borrowing limit to the SPV at the beginning of each fiscal year.
For 2005-06, the borrowing limit was fixed at Rs.10,000 crore. IIFCL is the SPV
created. In keeping with the Budget announcement, the company would render
financial assistance through:

 Direct lending to eligible projects

 Refinance to banks and financial institutions (FIs) for loans with tenor of
five years or more
 Any other method approved by GOI

The other salient features of infrastructure funding through the company are:

 Loan assistance from SPV shall not exceed 20 per cent of project cost.
 A project awarded to a private sector company for development,
financing, construction through PPP shall have overriding priority under
the scheme.
 Private sector companies will not be eligible for direct lending and only
the refinancing option will be available in such cases. Further, the total
lending to such projects will be kept within 20 per cent of the lending
programme of the IIFCL.
 The rate of interest charged by IIFCL shall be such as to cover all fund
costs including guarantee fee as well as administrative cost.

57
IIFCL is expected to be a very lean organization which would keep overheads to
the minimum and thus keep the cost of funds for infrastructure at a competitive
level. The company would fill the gap for long term infrastructure finance which
the banks are not in a position to address owing to concerns relating to
mismatches in assets and liabilities.

58
 Chapter 7

Future Funding Needs

Highway Maintenance
Maintaining India’s present highway network to full maintenance standards will
require annual funding of about Rs. 70 billion, three times the current level of
expenditure. Some may argue that India cannot afford to maintain fully its roads
and priority should be given to expanding the network. All the evidence
suggests that India cannot afford not to maintain its highway network – valued
at roughly Rs.240,000 crore (US$53 billion). A recent study analyzed the
economic impact of inadequate road maintenance30 and found that:
 The economic road user costs are 23% higher on roads in poor condition
than on good roads, and 55% higher, if the roads are in very poor
condition;
 The cost of surface dressing (for roads in good condition) is 66% lower
than resurfacing or strengthening (for roads in fair condition); and only
25% of the reconstruction cost;
 The annual maintenance backlogs range from 2.5 – 4 times the required
steady state expenditures; and
 In some states, for every one Rupee spent on maintaining the network,
there are net benefits (NPV) in excess of Rs 7.

The study makes a strong case for substantial increases to the level of
maintenance expenditure, if necessary by reallocating from capital expenditure.
Extrapolating the results to India gives a maintenance backlog in the order of Rs.
130 billion. Cutting back on road maintenance neither makes economic sense nor
long-term fiscal sense as the future costs for road reconstruction will be much
higher.

59
Highway Investment

The Central and State Governments have realized the importance of improving
India’s road system, both in terms of providing wider accessibility to rural areas,
and adding traffic capacity and improving service levels on the primary highway
network. These improvements are essential if the Governments are to meet their
objectives of achieving high economic growth rates and reducing poverty.

Plans have been prepared for road development by the MORTH and the
Planning Commission. The GOI’s Vision 2021 assessed the demand for road
transport, based on the desired future annual economic growth of the 6-8%, and
estimated the need for road development in the country for the next 20 years.
Vision 2021 sets out physical and financial targets for highway development. In
broad terms, the investment needs of the Expressways, National Highways, and
State Highways, in the ten years 2001 – 2011, are estimated as Rs.300, Rs.1,200
and Rs.750 billion respectively (1999 prices), over Rs.2 trillion in all (the estimates
are summarized in Annex 8). In addition, the PMGSY program will require
substantial funding, of the order of Rs.70,000 crore over the period to 2010, to
connect every village with all weather road access.

So far, significant progress has been made by central government in the

implementation of the National Highway Development Program and PMGSY,
and state
governments have made improvements to about 20,000 km of the State Highway
network.

The Funding Gap

60
This section estimates the overall financial resources needed, over the next 10
years, to develop and maintain the primary highway network, assesses the likely
revenue from road user charges, and compares the likely expenditures and road
user charge revenues. The estimates are based on network wide analysis using
the HDM4 model.

 Road user charge revenues are estimated on the traffic growth rates for
different vehicles types, based on projected economic growth, and the
present charges for each vehicle category. No allowance is made for the
widespread imposition of tolls.
 The maintenance costs are based on the norms recommended in the
‘Report of the Committee on Norms for Maintenance of Roads in India -
2000’.
 Capital investment (four/two laning existing two/intermediate) lane
highways were assumed necessary when traffic levels reached category C
as per IRC norms.

The analysis estimated the need to widen 15,000 km of national highways from
two to four lane, and a further 16,500 km from intermediate to two lane. The
total cost would be about Rs.1,098 billion (2003 prices), very close to the
estimates in Vision 2021. The analysis suggested that about 25,000 km of state
highways will need widening to two lanes, at a cost of about Rs.623 billion (2003
prices). This is a very conservative estimate. No allowance is made for
addressing the maintenance backlog, which may be considerable. However,
much of the backlog would be covered in the widening works, which would also
include rehabilitation. Nor is any allowance made for establishing an
expressway, which at roughly Rs. 15-20 crore per km would add considerably to
the financial requirement (Vision 2021 estimates a further Rs. 300 billion for
expressways from 2001-2011).

61
Revenue from road user charges will more than cover highway maintenance, if
the funding is dedicated to highways. However, even with this conservative
estimate of needs, the required capital investment cannot be fully funded by
road user charges.

The following graph predicts the Revenue from Sector Taxes V/s Highway
requirement:

With the revenue from the defined road user charges, the cumulative funding shortfall
over the 10 year period is estimated at Rs. 1,048 billion, 39% of the total requirement.
Highway maintenance represents about 35% of the total projected network cost,
considerably above the actual 22% allocation in FY2002. The funding gap assumes that
all the road user charges generated on the highways are returned to the highway sector. If
the current proportion of road-user charge revenue is returned (56%), then available
funding for highways would be only Rs.912 billion, less than the maintenance needs, and
the funding gap would rise to Rs.1,760 billion.

Infrastructure Financing Options

62
Traditional Approach

Under the traditional approach, the roads are considered as public goods and are financed
from the general revenue by raising funds through various tax schemes like cess on petro-
products and road tax to be paid at the time of purchase of the vehicle. In this type of
arrangement (refer Fig 1), the entire burden of raising funds for development and
maintenance of infrastructure facilities lies on the government bodies. To raise funds for
the same, these government bodies are dependent on the budget and other allocations by
the Union and/or State governments, who in turn collect the same by indirect routes from
the general public.

Fig 1 Infrastructure Financing for Road under Government Funding

63
Commercial Approach

Under the commercial approach, the roads are treated as separate revenue-
generating assets. Under this approach the roads are treated as capital assets,
commercial accounting is applied with a complete connection between costs
and revenues, and the users are directly charged for the usage. In this kind of
a system (refer Fig 2), the government either develops the infrastructure
through their own bodies or grants concession to private players and these
developers are held responsible for the development costs and are expected
to earn their returns from the payments made by users for the usage of the
facilities.

Fig 2 Infrastructure Financing for Road under PFI

64
Road Financing in India

In India, the traditional approach largely persists. The approach has contributed
to under-funding of road maintenance, a distorted vehicle fleet, perverse
incentives for traffic allocation between road and rail, and substantial
economic losses. A coherent structure for highway financing should have
high priority; otherwise the distortions and costs to the economy will rise as
overall expenditure on roads increases.
The following table shows the procurement of financial resources for the road
development in India:

Total cost Rs 54,000 Crore US$ 13.2 Billion

Likely sources Rs in crore (1999 prices) US$ Billion (1999 prices)
Cess on Petrol and Diesel 20,000 4.90
External assistance 20,000 4.90
Market borrowings 10,000 2.40
Private Sector
4,000 1.00
Participation

65
Major Financing Issues and Causes

Major Financing Issues

The major issues, requiring urgent attention, include the following.

Highway Financing

• Inadequate maintenance funding. This applies to both national and state

highways, and is partly due to the low political profile of road maintenance
(particularly at thestate level).
• Investment financing gap. This results from the very rapid increase in expected
road investment, from NHDP and PMGSY, and the inadequacy of budget funds
in the early years of the programs.

Road User Taxation

• Proliferation and overlapping of taxes. This arises from the allocation of

expenditure responsibilities and taxing powers to the states, together with the
lack of standardized approaches. Significant differences become entrenched and
are very difficult to eradicate.
• Regional disparities. The states have the constitutional prerogative to levy
charges on transport and there are neither national guidelines nor a consultative
forum to help ensure consistency.

66
Road User Charges
• Undercharging of heavy goods vehicles. This may result from the desire to
keep freight rates low but it is also a consequence of reliance on fuel taxes which
are inadequate to reflect the costs imposed by heavy vehicles. The costs are not
fully recovered by fixed annual fees, which are a state responsibility.
• Overcharging of buses. Both vehicle and passenger taxation are state functions
and bus transport is an easy revenue source. The levels of charges appear neither
equitable nor efficient.
• Urban congestion. There is neither urban road charging nor extensive traffic
management to control congestion. Costly additional infrastructure (e.g. the
Mumbai
overpasses) is constructed, with significant financial implications.
• Lack of Direct Charging. As most charges are not applied at the point of use,
consumers have no incentive to manage their demand for road transport.

Inter-modal Transport Policy

• Lack of coordinated inter-modal policies. There is limited coordination

between the policies of Indian Railways and the rest of the transport sector.
Railway pricing and road user charges encourage too much road freight and too
many rail passengers, resulting in an inefficient distribution of traffic.
The National Five-Year Plan has a clear vision of an improved/expanded
highway network as an essential foundation for faster economic growth. This
vision may be frustrated unless solutions are found to:

 The inadequate provision for road maintenance;

 The insufficient budgetary resources for the capital program; and
 The fragmented and inconsistent road tax and charging systems.

67
Solutions have to be found within a policy environment in which there is heavy
reliance on road-user taxes for general revenue, a fragmented decision making
structure and inadequate information.
Underlying Causes

Road users as general tax revenue generators: In India, only a third of road user
taxes are returned to the road sector as investment or maintenance; this is
comparable to Western Europe but much less than the USA (+90%, most road
taxes are hypothecated) 31 or Australia While road-related tax revenue in India,
as a share of GDP, is similar to other countries, road related tax revenue as a
share of total tax revenue is much higher.

Total tax revenue in India is only about 18% of GDP, and both the Government
of India and the State governments rely heavily on the road sector for general
revenue; road related taxes are generally cheap and easy to collect. A broadening
of India’s tax base may be desirable but perhaps not achievable in the short term.
Increasing expenditure in the road sector may thus require additional charges on
road users. These additional charges may be more acceptable to road users if, in

68
conjunction with the higher charges, there is greater earmarking of road user
taxes/ charges to the road sector. Some countries have accompanied higher
road-related taxation with giving road users some control over how the funds
are spent.
The high level of tax on the sector may have a profound effect on public
acceptability of tolls. Tolls are being set generally at a small fraction of the
operating cost savings expected for passenger vehicles and nominal toll rates in
India are some of the lowest in the world. However, in relation to average
incomes (the affordability index) the tolls may be considered as relatively high,
although private car users have much higher incomes than the average. The
Indian truck/car toll ratio also appears high but, on the other hand, two/three
axle trucks are generally much more heavily loaded than elsewhere and thus
impose much greater costs on the road network.

A study, commissioned by the Bank, concluded that the actual savings to trucks
may be much lower than is often used in toll studies. The study estimated time
costs at only about Rs.70-80/hour (perhaps slightly more than Rs. 2/km33), and
doubling speeds would only save truck owners about Rs.1/km. This limits the
potential for high tolls on freight vehicles unless there are also appreciable
distance savings, as generally the speed of the trucks establishes the speeds on
the un-tolled network. Tolls for trucks are often higher than this, even in India.
Overall, the survey suggested that the perceived user benefit of high quality toll
roads is relatively low at present, especially for freight vehicles.

So while general tax levels are so high and benefits, to commercial user at least,
from upgraded roads less certain, willingness to pay is low.

Fragmented tax decision-making structure: Highway financing is complicated

by the levels and types of sector taxation and expenditure which are established

69
by several different agencies and layers of government. The Constitution of India
incorporates detailed provisions relating to the enactment of laws and the
principles of devolution of taxation powers between the Central and the State
Governments.

 Central Government is responsible for customs duty, excise duty and

central sales tax on inter-state trade.
 Both the Central and the State Governments are empowered to legislate
on mechanically propelled vehicles including the principles on which
taxes on such vehicles are to be levied.
 State Governments have the right to levy taxes on motor vehicles (road
tax), on goods and passengers carried by road, tolls and octroi and entry
tax. Regulatory control is exercised under State specific rules, within the
broad framework of Motor Vehicles Act 1988.

There is no national road pricing/user charging policy or any procedures to

harmonize the type and level of road taxes. Consequently:

 There is multiplicity of taxes, duties and fees, levied at various

administrative levels;
 Motor vehicle taxes vary substantially between states without any
apparent rationale for the levels and differentials between vehicle
categories; and
 Tax rates appear to be fixed in an ad hoc, arbitrary manner.

70
The overriding motivation for changing tax levels appears to be generally to
increase tax revenue, with little regard to economic efficiency, equity or other
public policy objectives.

Lack of information for policy formulation: There is a lack of reliable, complete

and timely information on the current levels of road user taxes and charges, and
their allocation to roads. There has been no study of road user charges/costs
since 1988-89.

 In some cases, the primary sources are not held in a way that allows
analysis without making far-reaching assumptions. For example, most
road agencies do not record the division of expenditure between road
categories; many states do not report sales tax on motor spirit and
lubricants separately, only total sales tax revenue.
 In other cases, information is presented in such an opaque manner that
interpretation is almost impossible. The state budget in Karnataka, for
example, has dozens of budget heads/subheads covering expenditures by
the Public Works Department on different road categories. Many of the
budget head titles are not readily understood, outside a select few in
Government, and relate to project activities no longer active.

This lack of reliable and/or coherent information affects both policy makers and
the road user who pay the taxes and charges. It is difficult to see how policy
makers can make coherent policies and expenditure decisions without accurate
data on the level and distribution of taxation and expenditure. Even if a road
user charging policy existed, a sound information base would be necessary to
monitor its impact and provide the basis for corrective changes. The lack of
information also makes it difficult for road users to hold anyone accountable for

71
the more effective or efficient use of taxes collected from the road sector. The
consumer of publicly provided water and sewer services receives regular
detailed bills, and audited annual accounts are publicly available. With such
information, there can be accountability for both service standards and the level
of user charges. There is nothing comparable in the road sector and, while it may
not be possible to provide the same level of detail as for a water utility, there
should be accurate, comprehensible and timely information on the charges
raised from and the expenditures made to the sector. Indeed, this level of
disclosure is now mandated through the Right to Information Act.

Road Sector: Problems in Mobilising Resources

While the NHDP is the priority project and every effort is being made to meet
the resource requirements for meeting the targets, the problem in meeting the
physical targets for the non-NHDP component is the mobilisation of sufficient
resources.

1. The targets and the available sources of funds indicate a very big financing
gap and, given the need for fiscal prudence and the competing claims of other
sectors, it would not be possible to generate budgetary resources of the
magnitude indicated. The solution would lie in prioritising the projects
according to their importance in the national economy and emphasis on non-
budgetary sources like private sector participation and levy of user-charges for
transport services. The scope of increasing cess on petrol and diesel could also be
explored to supplement resources for financing high priority projects like
NHDP.
2. It is also important to understand that market borrowing has its limitations.
First, the market appetite for road projects may act as a constraint, especially
when a number of competing projects like PMGSY, NHDP etc. may target the

72
same investor kitty. The Government therefore, has to prioritise the borrowing
requirements in the context of claims from other infrastructural and transport
sectors as well as other socio-economic requirements.
3. Further, the borrowings from external agencies like the World Bank, ADB,
bilateral and commercial sources also contribute to the fiscal deficit. They also
add to the country’s external and public debt. The scope of such borrowing is
also limited as most institutions have country exposure limits and the available
resources have to be allocated among different sectors.
4. The argument also applies to extending Government guarantees on market
borrowings by public and private sector entities. Such guarantees are a
contingent liability and therefore, constitute fiscal risk for the Government.
Therefore, while the emphasis has to be on IEBR, market borrowings by the
public and private sector entities has to done on the basis of their own strength.
Here, financing schemes like asset-securitization, which provide a measure of
confidence to the investor, would be useful. These would include financing
mechanisms like borrowing against future toll receipts through their
collateralization.
5. While there is need to augment resources for the development of roads, it is
equally important to optimally utilize the existing infrastructure. In this context,
the possibility of developing canal banks as roads needs to be explored.

73
Potential Resources for National Highways and other Roads

Pradhan Mantri Gram Sadak Yojana (PMGSY)

The Pradhan Mantri Gram Sadak Yojana (PMGSY) was launched in December
2000 as a 100 per cent centrally sponsored scheme to provide rural connectivity
to unconnected habitation with population of 500 persons or more (250 in case of
hilly, desert and tribal areas) in the rural areas by the end of the Tenth plan
period. It is funded by the diesel cess in the central road fund, and through
borrowing from domestic financial institution and multilateral funding agencies.
Budget

The PMGSY programme is presently funded through the rural roads share (50%)
of Diesel Cess of Re. 2 per litre on HSD imposed under the Central Road Fund
Act. The following is the budget provided since the inception of the programme.

Year Amount (in Rs. Crore)

2000-01 2500
2001-02 2500
2002-03 2500
2003-04 2325
2004-05 2148 (+ Rs. 320 crore for ABD & World Bank Project over & above
cess).

In the budget of 2003 – 04, the cess on High Speed Diesel has been hiked by Re.
0.50 per liter. 50% of the additional diesel cess is to become available for Rural
Roads in accordance with the Central Road Fund Act.

74
Resources For Rural Roads

The available sources of funds for the PMGSY is 50 per cent share of the cess on
HSD amounting to approximately Rs. 2,500 crore per annum, which is
inadequate to finance the programme of such magnitude in a definite time frame
(2002-07). For achieving the target, it would be imperative to generate additional
sources, which could involve borrowings from the external funding agencies.

The priority under the PMGSY would be to provide connectivity to unconnected

parts. Only after all unconnected habitations in a district have been covered, can
the upgradation of roads in already connected habitations be taken up. In these
cases also priority would be accorded to habitations connected by gravel roads.

For augmenting the availability of funds for rural roads, some states are
adopting the practice of levy of market fee on agriculture products. A similar
approach can be considered by states particularly to generate enough resources
for the maintenance of rural roads.

Resources for National Highways

In addition to the Central Road Fund, other existing and potential sources for
financing National Highways projects are:

(i) In the face of the huge requirements of funds for both development and
maintenance of all categories of roads, there is a need for setting up a Highway
Infrastructure Saving Scheme on the lines of National Saving Scheme to tap the
savings of the individuals and companies.

(ii) The Central Government and the State Government both collect substantial

75
revenue through the levy of different taxes on road user related activities. The
collection of these taxes is estimated 40,000 crore in the 2001-02. It is
necessary that the Government utilize such funds principally for the
development of roads.

(iii) Some parts of resources needed for roads link to industries, power plants,
colonies etc. could be raised from beneficiaries of such mega projects.

(iv) A special purchase tax of Rs. 5000 on two wheelers (excluding mopeds and
on passengers cars including multi-utility vehicles would generate revenue of
Rs. 2000 crore a year amount can be utilized for urban transportation Schemes
covering the thought of public transport traffic mgt. & safety Measures.

(v) The multilateral financing agencies like World Bank, (ADB) have been
providing loan assistance for high way would continue to come.

(vi) Toll Roads: Levy of tolls on road is another alternative for generating
additional resources for their upgrading the major attractions speedier
construction of roads otherwise be delayed due to budget constraints. Further
being implementing on a pay-as-you use principle, usually constructed and
operated on commercial principles implying efficiency in execution and better
level of service to users.

(vii) Private sector participating acting private invest in road development the
govt. approved the concept of private sector participating in the development,
maintenance and operation of National Highways, including expressways. To
provide the enabling legal framework the NH Act, 1956 was amended in June
1995. The private sector can now invest in National Highway projects, levy,

76
collect and retain fee from users and is empowered to regulate traffic on such
highways in terms of the provisions of the Motor Vehicles Act, 1998.

(viii) In addition, two model concession agreements for projects costing less than Rs. 100
crore has been finalized. Such standardization of terms and conditions is considered a
major step in encountering private sector participation.

Resources For State Roads

The following are the major sources of funds for the development of State
Highways and Major District Roads.

(i) The Central Government has already created Government has already created
a Central Road Fund and about Rs. 962 crore was available during 2001-02.
However, accrual to the Fund is quite low, keeping in view the requirement of
the road sector.

(ii) BOT projects have to be encouraged to meet financing requirements of State

Highways. For this purpose, it is necessary to ensure that a well thought out
legislation is passed in each State to prevent legal objections to the imposition of
toll on the users of the development facilities. At present, at many prices the
existing Motor Vehicles Act, 1988 is being used for the purpose. It would be
more appropriate to enact a special legislation keeping in view all the
requirements of the BOT projects. The Central Government has already extended
several fiscal and other facilities to the entrepreneurs undertaking infrastructure
projects and has also prepared model BOT agreements. States may also adopt
these agreements for road projects.

(iii) Since railway over-brides are constructed at level crossings where heavy
traffic crosses the railway line, toll funding of such works is a possibility. Such an

77
experiment is already underway in Maharashtra where a large number of such
ROBs have been taken up on toll basis.

(iv) External funding is also a source for financing. Institutions like the ADB,
World Bank, Japan Bank for International Cooperation (JBIC) etc should be
approached for funds to be used for the development of selected State
Highways.

(v) Additional funds can be generated by the levy of surcharge on transport of

minerals by roads. Since substantial transport is done through roads,
considerable revenue could be generated through this source.

78
 Chapter 8

Recommendations

1. Create and Disseminate Better Information: The first step in strengthening the
decision-making process is improved information and information
dissemination. Many governments regularly re-assess the structure/level of road
user charges through Road Cost Allocation and Road Cost Recovery Studies76.
Such studies may cover:
 The road costs imposed by different vehicles on each road category in the
network;
 The total of taxes and fees paid by each vehicle type and for different
categories of roads; and
 The level of road user charges paid by each vehicle type on each road
category.

2. The nature and quality of the financial information collected and reported by
road agencies should be greatly improved, especially if the road agencies are
hoping to raise funding from the private sector. Globally, road agencies are
adopting a business oriented approach to managing the road network and
shifting from traditional government accounting to quasi-commercial accounts
in which:
 accrual rather than cash accounting is employed77;
 road/bridge assets are capitalized and depreciated; and
 the cost of maintenance is reported as an expense

79
3. Create a Coordinating Mechanism to Harmonize User Charges. While the
constitutional responsibilities for setting and collecting taxes and charges need
not be modified, there would be major advantages in a more coordinated
approach to setting road user charges. At present, there is little coherence in
either the methods or levels of charges and, in some instances, conflicting
incentives are being given. There are two broad options for establishing a
harmonized road user charge regime: a strategic road authority or a looser
affiliation of the center and state governments.

4. A Strategic Roads Authority (SRA) would be responsible for the planning,

coordinating and financing of the overall highways program. The Central Road
Fund already offers a source of finance for national and state highways, as well
as local roads; but it cannot influence the allocation of funds between activities
(set by statute), and has no powers over the road-user taxation policies adopted
by the individual states. The SRA could receive the cess, and all other designated
national road user charges and then channel this funding to develop a
coordinated approach to highway funding across all the states. It would be
charged with undertaking studies of road costs and revenues and developing,
with the relevant state agencies, an integrated approach to effective road user
charging.

5. The SRA should be given the responsibility for designing an approach to the
financing of capital investment, consistent with budget limitations and the
capacity to raise new sources of revenues, over the next two Five Year Plan
periods. It is perhaps inevitable that the present heavy financial burden of
developing a modern highway network will be spread more evenly over time.
The SRA would, therefore, need powers to raise medium term (5-10 years) debt,

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to be held on its balance sheet, to be repaid by a secure revenue flow from the
fuel cess and highway tolls.

6. Create and Maintain National and State Road Funds. Differentiating implicit
road user charges from general taxes always requires assumptions and
consequently the conclusions are speculative; there are no unambiguous criteria
for what constitutes a “normal” tax. However, if responsibility for setting road
user charges were separated from general revenue taxes, and the user charge
revenue accrued to a commercially managed Road Fund, then there would be
clearer lines of responsibility and accountability. Several such road funds have
now been established and are working satisfactorily. The main characteristics of
such a road fund include the following:
 A separate, quasi-autonomous Road Fund, should managed by a Roads
Board.
 The Roads Board includes representatives from private roadusers and
other stakeholders as well as the Government. Preferably, there should be
a majority of private sector members with a private sector chairperson.
 Road user charges are specific and separated from general taxation.
 Revenues are paid automatically and directly to the Road Fund, rather
than through the Consolidated Fund.
 Strict procedures are established for the allocation of funds between
activities and the approval of work programs submitted by the various
road agencies.
 Independent financial and technical audits are undertaken and all reports
are published.

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7. The levels and structure of road taxes have evolved without any underlying
economic rationale and/or specific objectives other than revenue generation. The
present tax structure provides neither economic efficiency nor equity. Any
efficiency or equity achieved has been incidental and not the result of deliberate
policy decisions. The absence of a well defined, rational and coherent road user
charge policy at the National and the State levels has contributed to the
multiplicity of taxes and the pricing distortions.
Therefore, it is strongly recommended that a national taxation policy be
developed, for the entire land transport sector, that would:
 promote efficient competition between alternative modes;
 encourage market oriented solutions that reduce subsidies;
 help develop optimal pricing policies for different land transport modes;
 acknowledge the desire to shift towards more direct charging for road
use; and
 differentiate road user charges from general taxes and define the shares
for road construction and road maintenance.

8. Higher diesel cess: There is a strong economic case for a higher cess on diesel
as the variable costs imposed by heavy commercial vehicles are about 7-10 times
higher than those by passenger cars85. Heavy trucks are undercharged for their
road damage costs and raising the cess on diesel would be one way of recovering
these costs. The danger of a higher cess on diesel is that it would increase the
price differential with kerosene and encourage fuel adulteration.

9. Purchase and ownership taxes on vehicles (fixed taxes and charges) can and
often are used as part of a road user charge strategy. While it is generally

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preferable to relate charges to the use of the vehicles, this is not always
practicable. There are also good arguments for having a fixed charge to cover the
fixed costs of providing and maintaining the network. The annual fixed charge
should be structured to reflect not only the non-attributable costs of the network
but also those attributable costs which are not adequately recovered by use
related charges. For freight vehicles, this would suggest annual license fees based
on a combination of gross vehicle weight and the number of axles. The annual
license fee can thus provide incentives to road users to employ less damaging
vehicles.

10. Road tolls generate a small fraction of the total revenue from road users,
possibly around one percent. However, both in India and internationally, there is
growing interest in directly pricing for road use both to raise revenue and to
relate user charges more directly to user costs (including congestion).

11. It is also recommended that State governments implement a uniform tolling

system on their core highway networks, once individual links are improved to a
reasonable two lane standard with traffic levels sufficient to justify the cost of
tolling. The tolls should be set to recover, at least, the cost of operating and
maintaining the roads and should be commensurate with the national system. In
the longer term, the levels of tolls may be increased to cover the costs of
strengthening or rehabilitating further links on the core highway network.

12. The existing tax structure should be simplified first, by minimizing the
ambiguities in vehicle classification and the basis of charges. Certain taxes, which
are difficult to administer, like passenger tax and goods tax might be merged
with road tax (the principal tax levied by the State Governments) and a single

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consolidated charge levied. Rajasthan and Andhra Pradesh have already
amalgamated various taxes without loss of revenue. Another form of
simplification, now in use, is an one-time tax on private personal transport, i.e.
private cars and 2-wheelers. This would reduce administrative as well as
compliance costs. However, some form of annual registration may still be
desirable for vehicle control purposes, such as for vehicle road-worthiness.

13. Reform of sector institutions from old-fashioned PWD systems to a more

effective and efficient system is a key building block. Alternatively, establishing
a State Road Development Corporation with improved governance and more
nimble procedures may be given responsibility to act as a nodal agency for
induction of private investment in the sector by commissioning project
preparation and procurement activities on behalf of states.

14. Indian government agencies have accessed the retail equity market to a
limited extent. The development of a vibrant market in road equities could result
in two key benefits for the sector in India:
 possibility of accessing additional funding sources for the sector; and
 creation of investment exit possibilities for the existing investors, who are
primarily construction contractors, thereby enabling such strategic
investors to channel existing “locked” investments into new projects.

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 Chapter 9

Conclusion

Government inabilities to meet the current demand for capital infusion in the
Infrastructure (Road sector) due to other investment priorities have seriously
affected the social and economic growth of the country. Same conditions are
also being encountered worldwide, in countries like Malaysia, Italy, France,
Australia, etc. and hence resort to Private participation of entrepreneurs is
being encouraged. The success stories from abroad so far, can be replicated
in India. But what is really needed are not plans but implementation of these
plans? The government has to sit down and think how to involve the private
sector in their infrastructural development process, which is a necessity for
India’s sustained economic development. A proper risk mitigation approach,
risk sharing approach and clear job allocation is needed for this PFI to move
in new directions.

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 References

1. Road sector on Fast Track, Commitments and Achievements of UPA

Government,
2. Roads India, Investment Promotion and Infrastructure Development Cell,
Secretariat for Industrial Assistance. Ministry of Industry, GoI, Udyog
Bhawan.
3. Indian infrastructure, Nov 2004, Overview of Road sector.
4. Annual Report, MoRTH, 2004-05
5. Mr. Bovin Kumar, NHAI, DGM, BOT Projects.
6. Road Sector on a Fast Track, Commitments and Achievements of UPA Govt,
MoRTH, May 2005
7. Project Status Report, May 2005, NHAI.
8. Budget India 2005-06
9. India Financing Highways – World Bank Report 2004

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