Innovations and Constraints in Financing Infrastructure Projects

Ashok Wadhwa Ambit Corporate Finance Pte Ltd January 7, 2005

Overview
Financing infrastructure Constraints Select Indian experience Potential solutions International experience

Financing infrastructure

Infrastructure to impact growth plan

Sustainable growth depends upon availability of efficient infrastructure Economic Survey 2004 Government recognises need for significant investments Governments focus shifting from direct involvement to regulatory and policy framework UPA gives major push by announcing significant investments in specific projects As on March 04, government has 568 projects with estimated cost of Rs 2,470 bn Private-public partnership key thrust area to generate adequate financing

Key implications
Rising economic activity Outlook for infrastructure has improved Further liberalization in key sectors Reduce reliance on government funding

Drivers Future Strategies Effects

Increased FDI inflows in infrastructure Pressures on Government to reduce fiscal deficit / subsidies Higher liquidity and portfolio investments Higher private sector participation

Global players to invest in India Government to play role of facilitator Private participation has boosted confidence Innovative financing to attract investments

Financing needs are significant

FDI and Private flows in infrastructure constituted only 5%

Historical experience not satisfactory

Projects relied entirely on subsidies / government funding Investment in infrastructure decreased to 3.7% of GDP in 2002-03 from 5.4% in 1993-94 No regulatory framework or inter-government coordination (TRAI, TAMP active only recently) Disparities in regional growth leading to imbalance Concepts like securitization / CDO a recent phenomenon Select sectors (ports and telecom) experience much awaited success Fragmented tax decision making structure leading to multiple layers of tax Lack of timely information or industry data

Shapers of Future Industry

Private sector participation to drive growth
Tap local liquidity to create attractive investment opportunities Attract and retain potentially large foreign investors

Financial viability of projects to be ensured

Cost and productivity improvements lead to lower cost overrun and timely completion Flexibility in innovatively financing projects

Shift in responsibility

Government key facilitator in providing amicable regulatory and business environment Corporatisation of projects to encourage private investors

Constraints

Private finance avenues are limited

Private financial flows to developing countries infrastructure

Infrastructure financing and total bank lending

Source: Dealogic / World Bank

FDI and allocation discouraging

FDI Approvals / Inflow
Aug 1991 / Oct 2002
Infrastructure 5%

FDI Allocation

Source: CRISIL / NCEAR

Multitude of issues to be addressed

Sources Uses Revenues Debt service Operating expense Opportunity cost Accelerated net benefits

Operating efficiencies Credit rating Debt service coverage User fees Dedicated fees Government subsidies Public grants

Disentangling financial drivers and impacts is key to discern the net gain

Regulatory and policy is evolving

Key policy framework slowly falling in place
Banking sector reforms being implemented Telecom sector liberalised with Unified Access Service License regime since Oct 2003 Electricity Act notified in June 2003 and SEBs revamped financially Private participation in ports made attractive

Government agenda is to take proactive action

Schemes with different names brought under single umbrella

Overriding priority for last mile projects Setting up of investment commission and Inter-Institutional group

Need for national policy on pricing and levy of taxes Deepening of the domestic capital markets

Tax structure is being harmonised

Government relies heavily on tax revenues
Road related tax revenues accounted for 18% of GDP Only one third used for maintenance or reinvestment of roads, as against 90% in US or 60% in Australia

Multiplicity of taxes and levies at various administrative levels Substantial variation in levies across states Rationalisation of exemptions under Income-tax Act could hamper investment in infrastructure
Interest exemption on ECBs not available Tax holiday for telecom

Select Indian Experience

Recent Indian experience

Cochin International Airport
First private airport in India; commenced in 1993 and operational since 1999 Kerala Govt holds 37% and rest by banks, institutions and public Fee of Rs 500 levied per passenger Profitable since 2002-03 and profit of Rs 211 mn in 2003-04 8% maiden dividend in 2004

National Highway Authority of India

AAA Credit rating and raised over Rs 70 bn in debt through bonds Line of credit from LIC for Rs 6 bn; interest at 1% over 18 year Govt treasury with duration of over 25 years Investment in NHAI Bonds exempt from capital gains Backed by Govt at fee of 0.25% pa

Recent Indian experience

Rajiv Gandhi Container Terminal
Operation of terminal with revenue sharing of 33.3% Build International Transshipment Terminal at cost of Rs 211 bn Payment of Rs 350 mn over 5 years Govt budgetary support for rail / road connectivity / dredging at Rs 93 bn Operate terminal for 8 years and new terminal for 30 years

CES Onyx Pvt Ltd

Part of Vivendi Group Contract for collection of 1,100 tonnes garbage in Chennai covering two million people per day 7 year contract worth Rs 270 mn per annum Also managing water distribution and industrial toxic management

Considerations

Gives strategic hold to Dubai Ports International Connectivity with Far East ports - Hong Kong Attract transshipment business from Sri Lanka

Potential solutions

Financing needs to get innovative

Key Objectives

Use existing financial resources more effectively Specify and quantify the benefits and revenues to stakeholders Detailed risk assessment and allocation of risk amongst stakeholders Supplement, not replace, traditional financing
Benefits

Public benefits realised sooner Inflation of costs can be curbed Matches payment to useful life of projects Large projects relatively cheaper due to economies of scale lower unit material and start-up costs

Create a climate for financing

Effective policy framework communicated adequately

Stable and sustainable to reflect financing horizons

Legal establishment with binding targets

Possible option - variations

Multilateral Agencies
(World Bank / IFC / ADB) Subsidies / Grants

Government

Guarantees / Risk insurance / funding

Project

Equity

Project Sponsor

Export Credit Agencies

Syndicated funding

Guarantees / credit enhancement

Commercial Banks

Financing considerations
Average maturity
Average tenure of 7-10 years; lesser maturity puts pressure on price charged / levies

Bank lending rate

Bank lending rate higher for infrastructure 200 basis points Spreads typically lower than sovereign bonds

Type of instrument
Bond issuance provides flexibility project types issue size seniority tradability back-weighted repayment structure US$ 4 bn of bond issuance in 2002-03 by emerging markets Credit rating investment grade

International experience

US Federal Highway Administration

Initiative from 1994 to introduce flexibility in financial characteristics of Federal-aid highway program Overriding objectives:
Increase investment Accelerate projects Improve utility of existing financing opportunities Lay the groundwork for long-term programmatic changes

Characteristics of initiative:
Accomplish through a State-driven process Not seeking commitment of new Federal funds

Various models evaluated and tested:

Flexible match - Value of private contribution offsets state share Reimbursement of bond financing costs Tapered match - State funding higher during initial period Partial conversion of advance construction - States may obligate funds for advance construction n a phased fashion

Green Financing - Netherlands

Environment friendly instruments issued by Dutch Govt Ensures sustainable housing, wind turbines and organic farms Lower interest rates for the company; but reasonable return for the investors Dutch Govt promoting the program in developing countries Major project requirements:
Provide significant and immediate environmental benefit Provide a financial return

Variations include, providing subsidies and fiscal incentives

Conclusion

A Look to the Future

We need the courage of innovation from the stakeholders, and we must find in ourselves the willingness to trust the new course long enough to harvest the benefits.