See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/276316925

Financing Infrastructure Projects Through Public-Private Partnerships in India

Article in Transportation Research Record Journal of the Transportation Research Board · December 2014
DOI: 10.3141/2450-15

CITATIONS READS
10 7,205

1 author:

Ramakrishnan T S

6 PUBLICATIONS 19 CITATIONS

SEE PROFILE

All content following this page was uploaded by Ramakrishnan T S on 28 July 2015.

The user has requested enhancement of the downloaded file.

Financing Infrastructure Projects Through
Public–Private Partnerships in India
T. S. Ramakrishnan
India has been suffering from a huge deficit in infrastructure facilities.
The Indian government perceives the public–private partnership (PPP)
model as the preferred mode to bridge this deficit and has initiated
several measures in that regard. This paper discusses the basic aspects
of PPP and how it works in India. Financing for infrastructure is one
of the major issues. This paper explains various issues such as over­
dependence on commercial banks for debts; inadequate financing
from infrastructure finance companies; issues in external commercial
borrowing; nonavailability of mezzanine financing; partial availability
of insurance, pension, and provident funds; and nonfinancing issues
that are plaguing infrastructure finance in India. The recent improve­
ments such as infrastructure debt bonds, relaxed norms for external
commercial borrowing, and reasonable exit options are also exam­
ined. The paper suggests various financial reforms that are needed for
PPP financing in India such as tapping into savings, allowing foreign
direct investment, increasing the cap on viability gap funding, allowing
balloon payments, giving impetus for corporation bonds, and building
infrastructure corpus.
India’s population is estimated to peak at 1,700 million in 2060
as per a United Nations study (1). With the liberalization of the
economy, India’s average growth rate was about 7% to 8% between
2003–2004 and 2008–2009. Goldman Sachs predicts the per capita
gross domestic product (GDP) growth rate to be in the 7.2% to 8.9%
range between 2005 and 2050 (2). But weak infrastructure has been
a key impediment to India’s growth. Poor infrastructure adds 3%
to 6% to the Indian manufacturer’s cost of doing business (3). The
World Economic Forum noted that India’s annual investments in
infrastructure between 1998 and 2005 averaged just 4% of GDP.
Although the country’s infrastructure investment doubled to 8% of
GDP between 2004–2005 and 2009–2010, it was much less than the
ambitious target of infrastructure forming 9% of GDP during the
11th Five Year Plan (FYP) period of 2007 to 2012 (4). Compara-
tively China spends about 20% of its GDP annually on infrastruc-
ture (5). Low levels of investment on infrastructure have rendered
India’s physical infrastructure incompatible with the anticipated
growth, adding to the production costs, denting productivity of capi-
tal, and eroding the competitiveness of its productive sectors (6). As a
result, India has been, and is likely to remain in the foreseeable future,
a supply-constrained economy.
Public Systems Group, MSH 101, Indian Institute of Management, Vastrapur,
Ahmedabad, Gujarat State, India. ramakrishnan@iimahd.ernet.in.
Transportation Research Record: Journal of the Transportation Research Board,
No. 2450, Transportation Research Board of the National Academies, Washington,
D.C., 2014, pp. 118–126.
DOI: 10.3141/2450-15
118
The 12th FYP spanning 2012 to 2017 has an ambitious infrastruc-
ture target of US$1 trillion, with the private sector contributing 50%
(4). India would like to augment its infrastructure spending between
5% and 8% of its GDP during the 11th FYP period to between 8%
and 11% of its GDP during the 12th FYP period (7). Achieving the
targeted investment as per the 12th FYP period plan presents many
challenges. The ability to finance infrastructure through the budget
is limited, given the many other demands on budgetary resources,
especially social sectors such as school education and primary and
preventive health care. The solution to this imbroglio lies in pri-
vate-sector participation, which not only provides the much needed
capital, but also helps to lower costs and improve efficiencies in a
competitive environment.
This paper discusses types and characteristics of infrastructure
finance; public–private partnership (PPP), its variants, and how it
works in the Indian context; emerging trends in PPP for infrastruc-
ture development; and the issues in financing PPP projects in India.
After highlighting the recent improvements that have occurred in
infrastructure financing in India, the paper concludes by listing various
financial reforms needed for PPP financing in India.
Infrastructure Finance
Types of Infrastructure Finance
There are three principal types of finance for infrastructure service
delivery: public finance, corporate finance, and project finance.
Public finance consists of equity financing (seed capital) provided
by the government through general budget reserves, earmarked
reserves, self-raised funds (such as licensing fees), intergovern-
mental grants, and fiscal transfers in addition to debt finance. Debt
financing is done through policy loans at concession rates, supplier
credits, and fixed income securities in the form of tax-secured bonds
and revenue bonds secured by project-related revenue streams. In
some cases, public debt financing is guaranteed by governments
either explicitly or implicitly (5).
Corporate finance consists of corporations providing equity
financing through retained earnings and shareholders’ equity. Debt
financing comprises commercial bank borrowing; subordinated
debt, which includes convertible debentures and preferred stocks;
privately placed borrowing; and the issuance of fixed income secu-
rities. These securities can be short term (such as commercial paper)
or of longer duration (such as corporate bonds) (5).
Project finance essentially comprises investments from corpora-
tions, public sectors, and finance institutions such as the Infrastructure
Development Finance Corporation (IDFC) and India Infrastruc-
ture Finance Company Limited (IIFCL) without sovereign guar-
antee. The revenue stream comes primarily from the tolling of
Ramakrishnan119
infrastructure projects. Project finance is made available mostly by
project-specific companies (otherwise called the “project company”)
with equity held by sponsors. Equity normally takes the form of spon-
sor investment in the share capital of the project company. Debt is
fully secured through the revenue stream of the infrastructure proj-
ect; this stream is assigned to lenders through security agreements
with trustees. Debt financing is usually a combination of bank loans,
sponsor loans, subordinated loans, suppliers’ credits, and bonds of the
project company (5).
Public finance projects cater to public goods, whereas the corporate
and project finance projects cater to private and club goods.
Characteristics of Infrastructure Finance
Infrastructure projects differ significantly from manufacturing proj-
ects and the expansion and modernization of companies. Essentially,
infrastructure financing has the following characteristics:
1. The gestation period of infrastructure finance varies between
5 and 20 years depending on the type of project. The life cycle can
vary as well, between 10 to 50 years. Lending institutions do have
great difficulty in managing asset–liability mismatches, which are
essentially for a period of 5 to 10 years.
2. While there are exceptions, a mega-infrastructure project involv-
ing a PPP entails a huge investment. For example, the development
of Hyderabad Metro Rail with a PPP cost rupees (Rs) 118 billion and
had a concession period of 35 years.
3. The risks are high when large amounts are invested for long
periods of time. Risks arise from a variety of factors, including
demand uncertainty (as in transport projects), environmental trans-
formations (working from home enabled by better information and
communication technologies), technological obsolescence (in some
industries such as telecommunications), and political and policy-
related uncertainties (the state administration unwilling to help in
toll collection or cancelling toll charges altogether for political rea-
sons). Flyvbjerg studied 210 transportation infrastructure projects
across the globe (comprising 27 rail and 183 road projects) and
found that for rail projects, the actual traffic was on average 39.5%
lower than the forecast traffic. The average cost escalation for rail proj-
ects, bridges and tunnels, and roads was 44.7%, 33.8%, and 20.4%,
respectively (8).
4. High pricing could lead to less patronage from users and may
not contribute to the economy as much as was expected. Returns
here need to be measured in real terms because often the project’s
revenue streams are a function of the underlying rate of infla-
tion (5). For example, the financial internal rate of return of the
Thiruvananthapuram–Ernakulam High Speed Rail project was esti-
mated to be 2.21% (9). Moreover, a higher return from the project
in the initial years of operation reduced lenders’ risk.
Public–Private Partnership
Origin of PPP and Its Variants
Historically, the government has been developing the infrastructure,
but the large and widening gap between infrastructure needs and
the resources available created artificial scarcity in accessing good-
quality infrastructure facilities. This issue resulted in congested
roads and bridges, long waits for telephone connections, poor mass
transport systems, interrupted power supply, lack of hospitals and
educational institutions, inadequate waste treatment facilities, and
so on. These problems, in turn, impose huge costs on society, lower
productivity, reduced competitiveness, and more accidents. The
then–finance minister of India highlighted in his 2004–2005 bud-
get speech that the most glaring deficit in India was the infrastruc-
ture deficit. In the 11th FYP, the Planning Commission recognized
that the total resources required to meet the deficit in infrastructure
exceeded the capacity of the public sector. It was therefore neces-
sary to attract private investment to meet the overall investment
requirements. Although the PPP has gained ground since then, it is
still confined to a few sectors such as telecom, ports, airports, and
roads (10)
The United Kingdom pioneered the PPP model. Through its
Private Finance Initiative, the UK government used partnership
models to develop infrastructure facilities (11). Private Finance Ini-
tiative projects in 2004 represented between 10% and 13% of all
UK investment in public infrastructure, a sea change from a little
more than 10 years ago when PPPs were barely a blip on the radar
screen (12). The world emulated the United Kingdom. Private-
sector financing, design, construction, and operation of infrastructure
emerged as one of the most important models governments used to
close the infrastructure gap.
An umbrella definition of PPPs in India defines a PPP as an arrange-
ment between a government or statutory entity or government-owned
entity on one side and a private-sector entity on the other for the pro-
vision of public assets, related services, or both for the public benefit,
through investments being made by management or undertaken by
the private-sector entity or both for a specified time period; there is
substantial risk sharing with the private sector and the private sec-
tor receives performance-linked payments that conform to specified,
predetermined, and measurable performance standards (13). Com-
pared with traditional procurement models, a greater role is assumed
by the private sector in the planning, financing, design, construction,
operation, and maintenance of public facilities. Some of the most
common PPP models as evidenced in a Deloitte research study are
as follows (12):
1. Build–transfer or design–build. Under this model, the govern-
ment contracts with a private partner to design and build a facil-
ity in accordance with the requirements set by the government. On
completion, the government assumes responsibility for operating
and maintaining the facility.
2. Build–lease–transfer. The completed facility is leased to the
private-sector entity. The asset is transferred to the public-sector
entity at no additional cost after the lease period. The public-
sector entity retains responsibility for operations during the lease
period.
3. Build–transfer–operate or design–build–operate. Under this
model, the private partner designs and builds and operates the
facility for a specified period. However, once the facility is com-
pleted, the title for the new facility is transferred to the public-sector
entity.
4. Build–operate–transfer or design–build–operate–maintain.
This model combines the responsibilities of build–transfer with those
of facility operations and maintenance by a private-sector partner
only for a specified period. At the end of the period, the public-sector
entity assumes operating responsibility.
5. Build–own–operate–transfer. Here the government grants the
private partner a franchise to finance, design, build, and operate a
facility for a specific period of time. Ownership of the facility goes
back to the public-sector entity at the end of that period.
120
6. Build–own–operate. In this model, the government grants the
private-sector entity the right to finance, design, build, operate, and
maintain a project, as well as ownership of the project.
7. Design–build–finance–operate–maintain. Under this model,
the private-sector entity designs, builds, finances, operates, and/or
maintains a new facility under a long-term lease. At the end of the
lease term, the facility is transferred to the public-sector entity.
The same study indicated the following PPP models for existing
services and facilities (12):
1. Lease. The government grants a private entity a leasehold
interest in an asset. The private partner operates and maintains the
asset in accordance with the terms of the lease.
2. Concession. The government grants the private entity exclu-
sive rights to provide, operate, and maintain an asset over a long
period in accordance with performance requirements set out by the
government. The public-sector entity retains ownership of the asset,
but the private operator has ownership over any improvements made
during the concession period.
3. Divestiture. The government transfers all or part of an asset
to the private-sector entity. Generally, the government includes cer-
tain conditions on the sale to require that the asset be improved and
services provided.
PPP—Preferred Mode of Financing
The private sector in the PPP model assumes a greater role in plan-
ning, financing, designing, constructing, operating, and maintaining
public facilities. Project risk is transferred to the party best positioned
to manage the same. PPP projects have been found to be sources of
various efficiencies. Some of them are listed below.
1. Reduced cost overrun. PPP projects are less expensive com-
pared with projects implemented under engineering procurement
and construction as there is an incentive for the concessionaire to
use cost-effective measures in implementation.
2. Reduced economic distortion. “User has to pay and polluter
also has to pay” has been gaining ground throughout the world. If
infrastructure services are retained as public goods (with nonrivalry
and nonexcludability clauses applicable), people who do not use the
services pay as much as those who use them. PPP enables the conces-
sionaire to collect charges only from the users, thereby eliminating
distortion.
3. Production and allocation efficiency. Resources for a spe-
cific application can be used more effectively. The construction
and operation of infrastructure may be completed in less time, with
lower overall cost, or both by using market-tested techniques and
incentives for innovation. Since users pay for the services they seek,
the most deserved infrastructure projects are allocated over other
projects.
4. Economic and social efficiency. Access to more capital allows
more projects to be funded on a fixed capital budget. Social benefits
accrue faster as infrastructure is built sooner (the concessionaire
has an incentive to finish the project well before the scheduled date
and commission it for revenue generation). Improved quality of life
results from increased access to infrastructure.
5. Fiscal prudence. With limited resources at their disposal,
governments have the tendency to ignore fiscal deficit concerns.
A larger share of PPPs in infrastructure development would help in
Transportation Research Record 2450
controlling fiscal deficit as enumerated in the Fiscal Responsibility
and Budget Management Act, 2003.
6. Unleashing of entrepreneurial energy. Countries in transition
have an enormous entrepreneurial energy that has been untapped
for a long time. The synergy between the user and provider of infra-
structure services would spur the economic development of the
country.
How PPPs Work in India
The Indian government has now endeavored to create a facilitat-
ing environment for large-scale involvement of the private sector
(either fully or in part) in developing infrastructure. PPP projects
are based on concession agreements between the developer and
the government as has been done for toll roads, ports, and airports.
Purely private-sector projects are market based such as in telephony
and merchant power stations.
The benefits of PPP do not accrue to the system unless govern-
ments enhance their capacity to execute and manage PPPs. Gov-
ernments need to develop the proper framework and instruments
and play a proactive role in addressing issues arising in the PPP
model. The transition from the traditional procurement model to
PPPs involves a change in procedural formalities, perceptions, and
also mind-set. PPPs would be more acceptable if they are seen as
a way of attracting private investment into public projects trans-
parently and fairly with the objective of enhancing the welfare of
all stakeholders concerned. In the past decade, the government of
India has taken a number of initiatives and measures in that regard.
Some of them are discussed below. The information on these ini-
tiatives has been sourced from the compendium of PPP projects in
infrastructure and the midterm appraisal of the 11th FYP (14, 15).
Constitution of the Committee on Infrastructure
The Committee on Infrastructure was constituted on August 31,
2004, under the chairmanship of the Prime Minister and renamed
the Cabinet Committee on Infrastructure (CCI) in 2009 (16). CCI’s
agenda is to initiate policies that ensure the time-bound creation of
world-class infrastructure, develop structures that would maximize
the role of PPPs and monitor the progress of key projects. CCI has
also initiated institutional, regulatory, and procedural reforms (14).
Constitution of Public–Private Partnership
Appraisal Committee
The Public–Private Partnership Appraisal Committee (PPPAC) was
constituted in 2005 to thoroughly scrutinize and perform due dili-
gence in the formulation, appraisal, and approval of PPP projects.
Only those PPP project proposals costing Rs 1,000 million and
above received from ministries and departments are considered for
approval by PPPAC (17).
Introducing Viability Gap Funding
The viability gap funding (VGF) scheme (announced in 2006) aimed
at improving the financial viability of competitively bid infrastructure
projects that were economically and otherwise justified but whose
Ramakrishnan121
financial returns were below the standard threshold. Under VGF,
the central government provides grant assistance of up to 20% of
capital costs to PPP projects undertaken by a government authority.
The sponsoring authority could provide an additional grant of up to
20% of project costs during the operation period. For national high-
way projects, the National Highways Authority of India provides
the entire VGF from the excess revenues transferred to it by the
central government. The VGF support for each project is deter-
mined through competitive bidding. The bidder with the lowest
VGF quote would be eligible to be awarded the project, provided
other requirements were satisfied.
Empowered Committee–Empowered Institution
An interministerial empowered committee–empowered institution
was established for appraising and approving projects for availing
the VGF grant for PPP projects. To ensure that the process of grant-
ing VGF is not vitiated and the fund is not misused by the conces-
sionaire, the VGF is released to the lead financial institution that
funds the concessionaire (18).
Setting Up of India Infrastructure
Finance Company Limited
Private players executing infrastructure projects through the PPP
mode had limited access to debt funds of longer maturity periods
because of the high cost of such debt and because benchmark rates
for raising long-term debt from the market were also absent (19).
IIFCL was therefore set up in 2006 as a nonbanking company to
provide long-term loans to finance infrastructure projects with long
gestation periods. IIFCL provides financial assistance of up to 20%
of the project costs by direct lending and also by refinance. Half of
this lending can be as subordinated debt (serving as quasi equity).
India Infrastructure Project Development Fund
Although the cost of a PPP project is borne by the concessionaire
(except in the case of VGF), the preliminary work in the form of
advisory services, such as preparation of project agreements, struc-
turing of projects, development expenses, and cost of engaging
consultants, requires funding. Ministry of Finance, Government of
India created an India Infrastructure Project Development Fund to
provide loans for such purposes (14).
Framework and Model Documents
In PPP projects, the government essentially transferred its authority
of providing public goods to the concessionaire for a specific period
called the concession period. This approach typically involved
the transfer or lease of public assets, delegation of governmental
authority for the recovery of user charges, operation or control or
both of public utilities and services in a monopolistic environment,
and the sharing of risk and contingent liability by the government.
The project agreement terms and the bidding process for award-
ing concessions were usually complex because many stakeholders
were involved. Standard documents streamline and expedite deci-
sion making and ensure that the entire process is conducted fairly
and transparently and in a nonarbitrary manner. The model conces-
sion agreements published by the planning commission for various
sectors provide this framework (14).
Emerging Trends in PPP for
Infrastructure Development
PPPs are increasingly becoming the preferred mode for construc-
tion and operation of commercially viable infrastructure proj-
ects. But there are many areas in which the PPP model has not
been ventured so far in India, sectors such as schooling, health
care, irrigation schemes, and upgrading and maintenance of water
bodies.
Countries and states within countries remain at different stages
of understanding and deployment of the PPP. Despite having estab-
lished a comprehensive framework for PPPs and 15 years of expe-
rience, India remains in the first stage of the PPP market maturity
curve (12). Governments that have not gone for large-scale PPP
projects for schools, hospitals, and defense facilities can learn from
countries such as the United Kingdom. Some of the mistakes often
made in the earlier stages of the maturity curve, such as the ten-
dency to apply a standard model for all infrastructure projects, can
be avoided.
Through the development of a strong, broad-based framework in
regard to establishments (such as CCI, PPPAC, and an empowered
committee–empowered institution), clear-cut procedures and docu-
ments (such as model concession agreements), and financial institu-
tions and funds (such as India Infrastructure Project Development
Fund and IIFCL), India is about to enter the second stage of the PPP
maturity curve. Countries in Stage 2 of the PPP market maturity
curve establish dedicated PPP units in agencies and begin develop-
ing new hybrid delivery models. In this stage, the PPP market gains
depth and expands to multiple projects and sectors. Countries also
leverage new sources of funds from capital markets.
Countries in Stage 3 of the PPP market maturity curve refine,
innovate, and use more sophisticated risk models with increased
focus on the life cycle of the projects. An advanced infrastructure
market is developed with the participation of pension funds, provi-
dent funds, insurance funds, and private equity funds (12). India has
yet to see those advances take place.
Issues in Financing for PPP Projects
in India
Inadequate Funding from Infrastructure
Finance Companies
There are still many unresolved issues in financing private play-
ers in the PPP model. Nearly 70% of the resource requirements of
the private sector are funded by borrowing. But the debt compo-
nent of the total investment during the 11th FYP was about 48.1%.
To bridge that gap, it is necessary to enhance the availability of
bank credit (5). Although the IDFC and the IIFCL are meant to
provide long-term debt for the infrastructure development, they are
deemed insufficient to meet the growing debt needs of the sector.
For instance, the lending from IIFCL is restricted to 30% of the total
project debt, leaving the concessionaire to seek 70% of the total
project debt from commercial banks (20).
122
Asset–Liability Mismatch and Overdependence
on Commercial Banking
Credit to the infrastructure sector by the commercial banks increased
from 13% of their total credit in 2000 to 33% in 2009 (5). The
essential issue in debt finance for infrastructure is the asset–liability
mismatch as infrastructure debt funds are given primarily for long-
gestation projects. This issue affects the private developer too. Faced
with the short payback period and long gestation period of the project,
the developer passes on the burden to the end user.
Some regulatory issues in borrowing from banks and financial
institutions also need to be looked at. Banks cannot provide long-
term finance funding, given the fact that their funding is through
short-term deposits. This mismatch poses in part liquidity risk, as
well as interest rate risk. Lending on a floating rate basis can miti-
gate the interest rate risk for the bank, but the concessionaire would
not be in a position to gauge the financial viability of the project in
the long run. Further, the expertise of banks and financial institu-
tions in the credit appraisal of such projects is limited. It is also not
advisable to rely on commercial banks for the entire debt compo-
nent. The solution lies in tapping diverse sources of debt funding.
Also the banks’ debt schemes need to be attuned to the requirements
of the infrastructure sector as much as the agriculture and manufac-
turing sector. Moreover, it is an accepted practice throughout the
world that long-term liabilities are to be used to finance long-term
assets, thereby eliminating the asset–liability mismatch. To hedge risks
effectively, which is inherent in long-gestation infrastructure projects,
derivative markets are essential. But derivative markets are yet to grow
in India.
Issues in External Commercial Borrowing
The existing guidelines do not permit domestic financial inter-
mediaries to refinance existing rupee loans from external sources
although the demand for the same exists. The refinancing of exist-
ing rupee loans through external commercial borrowing, if permit-
ted for infrastructure projects, could benefit foreign investors who
might invest during the postconstruction (less risky) period of the
project. This approach would help lenders who would prefer to have
their loans refinanced to enhance their assets portfolio, and it gives
scope for the concessionaires to generate funding from a greater
diversity of sources (5). But, there is a flip side. Exchange rate dif-
ferentials are crucial to external commercial borrowing and are to
be accounted for in the total interest rate (21). If exchange rate dif-
ferentials are unhedged, refinancing through external commercial
borrowing may even result in the interest rates being higher than the
expected return on equity. For instance, the exchange rate of Indian
rupee (INR) per 1US$ remained stable at about Rs 45 between
2004 and 2007 and between 2009 and 2011. But, the exchange rate
increased to Rs 62 per 1US$ in 2013. Foreign exchange hedging is
available only for a period of 8 years. Investments through exter-
nal commercial borrowing cannot be hedged effectively for foreign
exchange fluctuations beyond 8 years (22).
Lack of Mezzanine Financing
for Infrastructure Projects
Mezzanine financing (quasi-equity funding) is still in the nascent
stage in India. Mezzanine financing allows the financing company
Transportation Research Record 2450
to convert the loan into equity in the case of delays in loan repay-
ment. The interest rate of a mezzanine loan is somewhat higher than
the loans of a senior lender. Given the debt–equity ratio of 70:30
across PPP projects, the concessionaire may be accused of imple-
menting the project by leveraging loans. Mezzanine financing may
check this trend and make the concessionaire more accountable.
Some private equity firms in India have forayed into mezzanine
financing. Long-term lending financial institutions such as IDFC
and IIFCL may provide mezzanine financing.
Use of Insurance Funds and Pension and
Provident Funds for Infrastructure Projects
It is mandatory for life insurance companies to invest at least 15%
of their life fund in infrastructure and housing. Only 10% of assets
under management were invested to fund infrastructure develop-
ment in 2011–2012 (22). This percentage shows that insurance
companies have not contributed as much as they should in the infra-
structure financing domain. At present because of the conservative
outlook on pension fund usage, it has not been used in infrastructure
financing. But efforts are on to bring pension and provident funds
into infrastructure financing.
Other Issues Affecting Infrastructure Financing
A project’s failure to be completed as scheduled poses serious
problems to all other stakeholders, the concessionaire, financial
institutions, the project authority, and the government. The delay
in land acquisitions and environment clearance, aberrations and
delay in policy making resulting in policy paralysis, and the lack
of quick redress mechanisms make the financial calculations go
awry as a result of the delayed project planning and execution. It
does not benefit the stakeholders and results in high cost of services
for end users. Construction cost increases with delay, jeopardizing
the return on investment. Delay in the commercial operations date
(COD) would delay revenues from the user for the concessionaire,
thereby affecting the cash flow and the ability of the concessionaire
to repay the loan, thereby rendering the originally financially viable
project unviable.
Recent Improvements in Infrastructure
Financing in India
Some measures introduced by the government in the recent past for
better infrastructure financing are discussed in the following.
Takeout Financing and Infrastructure Debt Fund
Commercial banks are not in a position to finance PPP infrastructure
projects whose repayment period extends between 15 and 20 years
because of the asset–liability mismatch. If commercial banks are
allowed to transfer the loan after a period of 5 to 6 years, which
normally coincides with the construction period of the project, to
another financial institution, the asset–liability mismatch could be
overcome. This approach is called takeout financing. The loan is
transferred from the books of the financing bank within the pre-
determined period (say, 1 year from the COD) to another financial
Ramakrishnan123
institution (second lender), ensuring that the project receives long-
term financing by more than one lender. The first lender receives the
payment from the second lender.
To make takeout financing possible, the Deepak Parekh Com-
mittee proposed the Infrastructure Debt Fund (IDF) to raise funds
amounting to Rs 500 billion (US$11 billion), and subsequently in
2011 the government of India announced the IDF (20). The frame-
work allowed the IDF to be set up by one or more sponsors; they
could be commercial banks, nonbanking financial companies,
investment banks, or multilateral agencies. The sponsors have to
invest at least 10% of the total fund. To facilitate offshore investors,
the withholding tax was reduced to 5% from 20% on interest pay-
ments on IDF borrowing. For domestic investors, an investment of
up to Rs 20,000 in these bonds was eligible for an income tax deduc-
tion, for which they would obtain about a 7.5% to 8.25% interest
rate, either annually or cumulatively. The tenure of IDF bonds was
10 years with a minimum lock-in period of 5 years (23). In general,
IDF earns about 10% more than the interest rate paid by IDF to its
investors. After operating costs are deducted, the balance is kept as
a corpus to meet any liabilities arising out of nonperforming assets.
IDF bonds are not project specific, and IDF pools all the bonds
while lending to project companies. IDF was restricted to PPP proj-
ects that have completed 1 year of commercial operations. Given
the fact that it takes about 4 to 6 years for a PPP project (such as a
road) to begin its commercial operation, the funding by IDF 1 year
after the COD would save commercial banks from the asset–liability
mismatch problem as the debt can be moved to IDF from commercial
banks 1 year after the COD (20).
Many financial institutions have introduced IDF bonds from 2011.
In 2011–2012, the first year of rollout, Rs 30,000 was raised; in
2012–2013 it was about Rs 25,000 and is targeted at Rs 500 billion
for 2013–2014 (24). But, Rs 500 billion is too little for India when
compared with the total infrastructure investment of US$1 trillion that
is the goal for the 12th FYP.
Funding from Multilateral Agencies
and Foreign Banks
Among the 322 projects that were executed in the first phase
(Golden Quadrilateral) of the National Highway Development Pro-
gramme, 82 were executed under the Engineering, Procurement
and Construction mode with the aid of the World Bank, the Asian
Development Bank, and the Japan Bank for International Coopera-
tion, which contributed about 60% of the total project cost in the
first two phases of the Delhi Metro Rail Corporation project. Many
other metro rail projects such as Bangalore, Chennai, and Jaipur are
also modeled after the Delhi Metro Rail Corporation project with
financial aid from the Japan Bank for International Cooperation.
Relaxation of Norms for External
Commercial Borrowing
The Reserve Bank of India relaxed external commercial borrow-
ing norms for infrastructure finance firms in January 2013. Infra-
structure finance companies can now avail themselves of overseas
borrowing up to 75% of their net worth without approval from the
Reserve Bank of India, as against 50% earlier. The hedging require-
ment for currency risk was also reduced from 100% of their expo-
sure to 75% (23). But, the exchange rate increase in INR versus US$
between March 2013 and October 2013 would have nullified the
benefit arising out of the hedging requirement relaxation.
Secured Loan for Infrastructure Development
The Reserve Bank of India in March 2013 announced that in certain
conditions, the debt due to lenders in PPP projects may be treated
as secured, with some riders (25). The conditions are that the user
charges, toll payments, are to be kept in an escrow account in which
senior lenders have priority over withdrawals by the concessionaire,
predetermined increase in user charges or an increase in the conces-
sion period if project revenues are lower than anticipated, and the
right of substitution by the senior lender in the case of concessionaire
default (26).
Reasonable Exit Options
In 2009 the B K Chaturvedi Committee recommended reasonable
exit options for the concessionaire in PPP road projects. It was on
the expectation that if developer companies are allowed to divest
their equity holding without any lower limit at the end of the con-
struction phase to operation and maintenance companies, faster
rotation of capital for construction companies would result, which
would invite more investment for infrastructure projects under the
PPP. The B K Chaturvedi Committee redefined the change of own-
ership as the bidders’ share in equity dropping below 51% anytime
until 2 years after COD. Further, it said each member of the consor-
tium evaluated for the purposes of prequalification and short listing
in response to the request for qualification should hold at least 26%
of such equity until 2 years after COD. While requiring the bidder
to hold 51% until 2 years after COD, the B K Chaturvedi Com-
mittee relaxed the need to hold any equity after that. It was finally
accepted that the bidder was to hold at least 26% from 2 years after
COD for the rest of the concession period (27). In June 2013 the
Indian government announced that the bidder could relinquish its
equity completely for completed and ongoing projects (28).
Financial Reforms Needed
for PPP Financing in India
Using Domestic Savings
Gross domestic savings are about 30% of the GDP in India. Low-risk,
low-return savings of India are targeted primarily toward bank depos-
its. Medium-risk, medium-return savings are moved toward mutual
funds. High-risk, high-return savings are moved toward the stock mar-
kets. By providing inflation indexed government bonds (which have
an inherent sovereign guarantee), the government may move sizable
low-risk, low-return savings and medium-risk, medium-return savings
of India toward infrastructure funding.
The household savings account for 7.7% of GDP in 2012–2013
was about Rs 10.9 trillion. At present, the retail investor receives an
income tax exemption up to Rs 20,000 for investing in IDF bonds.
To tap domestic savings for infrastructure financing, the Working
Sub-Group on Infrastructure Funding Requirements and Its Sources
for the implementation of the 12th FYP (2012 to 2017) recom-
mended that the income tax exemption for IDF bonds may be raised to
Rs 100,000 (29). When mutual funds, which are moderate in risk and
124
return, are expected to generate a return of 15% per annum and when
investment in real estate is expected to give a substantial return, it is
difficult to attract voluntary investments for the IDF bonds. When
equity investors in infrastructure projects expect a return of 20%
to 25% on their equity, it is to be accepted that household inves-
tors expect a return of 8% plus inflation. To make IDF bonds more
attractive, the interest rates for IDF bonds may be indexed to infla-
tion with a maturity period of 15 years or so. Doing so would give
an option for domestic savings to become invested in long-tenure
infrastructure financing.
Allowing Foreign Direct Investment
Foreign direct investment (FDI) is permitted up to 100% in green-
field projects under the automatic route. In the case of existing proj-
ects, however, FDI under the automatic route is permitted up to
74%. Further, 100% FDI is allowed under the automatic route for
coal and lignite mining; construction development projects; min-
ing of diamonds, precious stones, gold, silver, and minerals; the
petroleum and natural gas sector; power generation; transmission;
distribution; power trading; and manufacture of telecom equipment.
In telecommunication services FDI up to 74% subject to certain
conditions is permitted. In the case of air transport services, FDI
up to 49% is permitted (5). With 100% FDI for infrastructure proj-
ects, especially for those with long maturity periods, the ambitious
targets of infrastructure development as envisaged in the 12th FYP
may be achieved.
Increasing the VGF Cap
The current policy allows VGF of up to 40% of the total project
cost. In the case of road projects, the first two phases of the National
Highways Development Project involving high-density corridors
are almost complete. The remaining phases of the National High-
ways Development Project are not as financially remunerative as
the projects of the first two phases. Out of about 35,000 km of road
network, only 20,000 km were awarded (30). In 2012–2013, only
787 km were awarded, and not a single kilometer was awarded
between April 2013 and October 2013 (31, 32). In the case of rail and
power projects, the construction periods are much longer, the invest-
ments are gargantuan, and the return on investment is to be obtained
over a long period of time (say, 30 to 40 years). For instance, the
Hyderabad Metro Rail PPP costs Rs 118 billion, with a concession
period of 35 years and an entitlement of a further 25 years, which
includes the 5-year construction period. With that backdrop, it is
better for the project authority to increase the VGF limit to 49%
of the total project cost from the extant 40% with increased equity
on the part of the concessionaire. In fact the VGF should be linked to
the equity of the concessionaire. When the equity component is less,
there is little skin in the game. For projects accessing VGF that are
expected to yield windfall profits, provisions should be made in the
concession agreement so that such windfall profits are appropriately
shared between the authority and the concessionaire.
Allowing Balloon Payment and Delayed Payment
Since the tenure of commercial bank loans is about 7 years, the
concessionaire has to pay the principal and interest within 7 years of
Transportation Research Record 2450
the beginning of the project. Rather than going for takeout financing
at the end of the tenure of commercial bank loans, project financ-
ing institutions may make a loan at the beginning of the project but
may allow a moratorium of payback for the concessionaire until the
repayment of commercial loans is exhausted. Moreover, the payback
may also be delayed by the adoption of a balloon payment.
Impetus for Corporation Bonds
According to the 2011 census, 30% of the Indian population lives in
urban areas, and by 2030 that figure is expected to increase to 40%.
But, the existing infrastructure facilities in regard to roads, drink-
ing water, power, sanitation, and so forth remain a far cry from the
growing demand. With the current revenues, the urban local bodies
are able to meet less than a third of the total fund requirements of
infrastructure development (33). The impetus to corporation bonds
would provide the necessary source for VGF while awarding PPP
projects on urban infrastructure.
Building Government Capacity with Funds—
Need for a Transport Infrastructure Corpus
In India, the tax component, which is almost equally shared by the
union government and the state governments, makes up about 50%
of the retail price of petroleum (gasoline) and diesel. The union gov-
ernment collected Rs 748 billion during 2012–2013 from the central
excise tax on petroleum products (34). Ideally, the heavy taxation on
petroleum products needs to be channeled toward the development
of a fuel-efficient, environment friendly, and sustainable transport
infrastructure; environment mitigation programs; transport safety;
and so on. There is a need to create a transport corpus at the union and
states level sourced primarily from tax revenues of petroleum products
that would provide the needed resources for VGF of megatransport
projects.
Holistic Outlook Toward PPP and Its Financing
The policy changes to promote PPPs for bridging the gap in the infra-
structure deficit undertaken at the union government level until now
have not percolated uniformly across all union government minis-
tries. For instance, the total costs of PPP projects completed and under
implementation by 2010 in the Ministry of Road Transport and High-
ways and Ministry of Civil Aviation were Rs 556.09 billion and Rs
246.6 billion, respectively. For the same period, it was Rs 47.17 billion
for the Ministry of Railways (14).
Most of the infrastructure ministries and departments are on the
concurrent list of union and state governments; the union govern-
ment and the state governments could pitch in simultaneously. But
even now, only some state governments have implemented infra-
structure development through PPPs, although the framework for
PPP projects is readily available for emulation by all state gov-
ernments in scaling up investments in various physical and social
infrastructure sectors. The total cost of PPP projects completed and
under implementation by the union government and state govern-
ments was Rs 1012.57 billion and Rs 2064.81 billion, respectively,
by 2010. Of the total value of state government PPP projects, five
states, Uttar Pradesh, Gujarat, Maharashtra, Karnataka, and Andhra
Pradesh, alone accounted for 58.3% (14).
Ramakrishnan125
The issues pertaining to PPP financing have subtle linkages with
a host of other issues afflicting PPPs and the general administra-
tive system. Investment in long-tenured PPP projects poses a great
risk for developers unless there is consistency in policy and fairness
toward developers by successive elected governments. When the
government falters from the mutually accepted concession agree-
ments with no rationale, the developers must obtain a quick redress
through arbitration or litigation.
Conclusion
PPPs have definitely been accelerated in India. The PPP Data
Update Note 68A from the World Bank highlighted that India
was a top recipient of private participation in infrastructure since
2006. India’s 43 new projects with private participation in infra-
structure in the first semester of 2011 were almost half of the
investment for new private participation in infrastructure projects
for developing countries (35). But the acceleration is not enough
to meet India’s goals set forth by the planning commission for
the 12th FYP spanning 2012 to 2017. It has been estimated that
the total fund requirement for the 12th FYP is about Rs 65 tril-
lion (US$1 trillion), and the funding gap is about Rs 14.6 trillion
(US$231 billion) (29).
The framework for the PPP model is reasonably well developed
but requires fine-tuning on various aspects. Apart from the general
slowdown of the economy, the vital issue has been infrastructure
financing. The trend in the recent past is to award larger projects
under a PPP. For instance, the conversion of existing four-lane
roads of the Golden Quadrilateral stretches to six-lane roads done
with PPP amounts to a few hundred kilometers, unlike the road
stretches awarded previously. The PPP reforms have to encompass
railways, which hitherto missed out on huge developmental plans.
When railways adopt PPPs, invariably the total project cost of rail-
way projects will be much higher than for road projects. Therefore,
it is necessary to have better infrastructure financing mechanisms
in place. Moreover, as India is about to enter the second stage of
the PPP maturity curve, PPPs have to encompass hitherto unat-
tended sectors such as irrigation, development and maintenance
of water bodies, rainwater harvesting, education (especially pri-
mary and secondary education), power, linking of rivers, creation
of new channels and inland waterways, primary and preventive
health care, and specialty hospitals. It is necessary to have a wide
range of financial instruments to provide the mammoth financ-
ing requirements, and the suggestions in this paper would help in
achieving that goal.
References
1. Shrinivasan, R. India’s Population Will Peak at 1.7bn in 2060: UN
Study. The Times of India, May 5, 2011. http://articles.timesofindia.
indiatimes.com/2011-05-05/india/29512357_1_population-projections-
billionth-person-peak. Accessed March 25, 2011.
2. Wilson, D., and R. Purushothaman. Dreaming with BRICs: The Path to
2050. Global Economics Paper No. 99. Goldman Sachs, Oct. 1, 2003.
http://www.goldmansachs.com/our-thinking/brics/brics-reports-pdfs/
brics-dream.pdf. Accessed Feb. 15, 2012.
3. Swati, S. The 10% Growth Story and India’s GDP. http://www.chilli
breeze.com/articles_various/India-growth.asp. Accessed Aug. 15,
2010.
4. Research and Markets. Brochure on India Infrastructure Report Q3
2010. http://www.researchandmarkets.com/reports/1246314/. Accessed
Mar. 25, 2011.
5. Kaur, G., L. Lakshmanan, R. Rajesh, and N. Kumar. Infrastructure
Financing—Global Pattern and the India Experience. RBI Staff Stud-
ies, July 2010. http://www.rbi.org.in. Accessed Aug. 17, 2010.
6. Subbarao, D. Should Banking Be Made Boring—An Indian Perspec-
tive. RBI Bulletin, Dec. 2009. http://www.rbi.org.in. Accessed Aug. 16,
2010.
7. India Infradebt Limited. Overview: Background. http://infradebt.in/
overview/background.html. Accessed Nov. 10, 2013.
8. Flyvbjerg, B. Cost Overruns and Demand Shortfalls in Urban Rail and
Other Infrastructure. Transportation Planning and Technology, Vol. 30,
No. 1, 2007, pp. 9–30.
9. Kerala, L. Poised To Enter the High Speed Era! 2013. http://www.master
builder.co.in/kerala-poised-to-enter-the-high-speed-era/2/. Accessed
July 15, 2013.
10. Haldea, G. Doubling Investment in Infrastructure to Rs 41 lakh cr. ($1
tr.) for India’s 12th Five-Year Plan (2012–2017). 2011 IIF Spring Mem-
bership Meeting, New Delhi, March 2–4, 2011. http://www.iif.com/
download.php?id=JrnwriL5wzU=. Accessed March 10, 2012.
11. Allen, G. The Private Finance Initiative (PFI). Research paper. Eco-
nomic Policy and Statistics Section, House of Commons Library, Dec.
2001. http://www.parliament.uk/commons/lib/research/rp2001/rp01-
117.pdf. Accessed Aug. 16, 2010.
12. Deloitte. Closing the Infrastructure Gap: The Role of Public–Private
Partnerships. Deloitte research study. 2007. http://www.deloitte.com/
view/. Accessed Aug. 15, 2010.
13. Department of Economic Affairs. Approach Paper on Defining Public–
Private Partnerships. Ministry of Finance, Government of India, Feb.
2010. http://www.pppinindia.com/pdf/ppp_definition_approach_paper.
pdf. Accessed Aug. 15, 2010.
14. Secretariat for Infrastructure (a). Compendium of PPP Projects in
Infrastructure. Secretariat for Infrastructure, Planning Commission,
Government of India, 2010. http://infrastructure.gov.in/pdf/compendium-
of-ppp-infrastructure.pdf. Accessed Aug. 15, 2010.
15. Planning Commission, Government of India. Chap. 14 Investment in
Infrastructure, Mid Term Appraisal for Eleventh Five Year Plan 2007–
12. http://planningcommission.nic.in/plans/mta/11th_mta/chapterwise/
chap14_invest.pdf. Accessed Jul. 15, 2013.
16. Secretariat for PPP and Infrastructure, Planning Commission, Government
of India. http://infrastructure.gov.in/. Accessed July 15, 2013.
17. Secretariat for Infrastructure (b). Formulation, Appraisal and Approval
of Public Private Partnership Projects. Secretariat for the Committee
on Infrastructure Planning Commission, Government of India, 2009.
http://infrastructure.gov.in/pdf/compendium-of-ppp-infrastructure.pdf.
Accessed Aug. 13, 2010.
18. Secretariat for Infrastructure, Planning Commission, Government of
India. Financial Support to Public Private Partnerships in Infrastruc-
ture. 2010. http://pppinindia.com/pdf/Finance.pdf. Accessed Aug. 15,
2012.
19. India Infrastructure Finance Company Limited. Scheme for Financing
Viable Infrastructure Projects through a Special Purpose Vehicle Called
the India Infrastructure Finance Company Limited (IIFCL) (revised).
http://www.iifcl.org/Content/sifty.aspx. Accessed Aug. 15, 2012.
20. Deepak Parekh Committee Report on India Infrastructure Debt Fund,
Government of India. June 1, 2010. http://infrastructure.gov.in/pdf/
INDIA%20INFRASTRUCTURE%20DEBT%20FUND%20010610
%20CLEAN.pdf. Accessed Nov. 10, 2013.
21. Chakrabarty, K. C. Infrastructure Financing by Banks in India:
Myths and Realities. Annual Infrastructure Finance Conclave Orga­
nised by SBI Capital Markets Limited, Aug. 2013. http://rbidocs.rbi.
org.in/rdocs/Speeches/PDFs/MATEDG200813.pdf. Accessed Nov. 10,
2013.
22. Deloitte Touche Tohmatsu India Private Limited. Funding the Infra-
structure Investment Gap, March 2013. http://www.deloitte.com/assets/
Dcom-India/Local%20Assets/Documents/Thoughtware/Funding_the_
InfrastructureInvestment_Gap.pdf. Accessed Nov. 10, 2013.
23. Mondal, D. May Not Always Bond. Business Today, Feb. 2011. http://
businesstoday.intoday.in/story/infra-bonds-may-not-be-good-choice-
of-investment-for-all/1/12660.html. Accessed Nov. 10, 2013.
24. India Today Online New Delhi. Union Budget 2013–14: Full text of
Chidambaram’s budget speech, Feb. 2013. http://indiatoday.intoday.
in/story/union-budget-2013-14-full-text-of-chidambaram-budget-
speech/1/252048.html. Accessed Nov. 10, 2013.
25. Press Information Bureau, Government of India. Debts of Infrastruc-
ture Projects Being Implemented Under PPP Mode and Having Model
 126
Concession Agreements Treated as Secured Lending, March 2013.
http://www.finmin.nic.in/press_room/2013/debt_infra_PPPModel.pdf.
Accessed Nov. 10, 2013.
26. PPP in National Highways: Model Concession Agreement 2009. Secre-
tariat for the Committee on Infrastructure, Planning Commission, New
Delhi, India.
27. B K Chaturvedi Committee. Revised Strategy for Implementation of
the Total Project Cost (TPC)–Framework and Financing, 2009. http://
planningcommission.nic.in/reports/genrep/rep_nhdp_1.pdf. Accessed
March 15, 2011.
28. InfraPPP. India Allows Sale of Equity of Road PPP Projects to Reactivate
Sector. Business Today, June 25, 2013. http://businesstoday.intoday.in/
story/global-pe-firms-corporate-lending-activities-in-india/1/189230.
html. Accessed Nov. 10, 2013.
29. Planning Commission. Working Sub-Group on Infrastructure—
Infrastructure Funding Requirements and Its Sources over the Imple-
mentation Period of the Twelfth Five Year Plan (2012 to 2017). http://
planningcommission.gov.in/aboutus/committee/wg_sub_infrastructure.
pdf. Accessed Nov. 10, 2013.
30. National Highway Authority of India. NHDP and Other NHAI Projects
as on 30th September 2013. http://www.nhai.org/whatitis.asp. Accessed
Nov. 10, 2013.
View publication stats
Transportation Research Record 2450
31. Mishra, M. NHAI Project Award Touches New Low of 787 km in FY 13.
Indian Express, March 25, 2013. http://www.indianexpress.com/news/
nhai-project-award-touches-new-low-of-787-km-in-fy13/1092821/.
Accessed Nov. 10, 2013.
32. Mihir. Despite EPC Switch, No Road Project Awarded Since May.
Indian Express, Oct. 3, 2013. http://m.indianexpress.com/news/despite-
epc-switch-no-road-project-awarded-since-may/1177538/. Accessed
Nov. 10, 2013.
33. Sheik, S., and M. G. Asher. A Case for Developing the Municipal Bond
Market in India. ASCI Journal of Management, Vol. 42, No. 1, 2012,
pp. 1–19.
34. Comptroller and Audit General of India. Report No. 17 of 2013, Chap-
ter 1 Central Excise and Service Tax Revenues. http://saiindia.gov.
in/english/home/Our_Products/Audit_Report/Government_Wise/
union_audit/recent_reports/union_compliance/2013/INDT/Report_17/
chap_1.pdf. Accessed Nov. 10, 2013.
35. Izaguirre, A. K. PPI Data Update Note 68. Private Participation in Infra-
structure Database. Public Private Infrastructure Advisory Facility,
World Bank Group, 2012. http://ppi.worldbank.org/features/December-
2011/2011-Global-update-note.pdf. Accessed Nov. 10, 2012.
The Revenue and Finance Committee peer-reviewed this paper.