Financing of Infrastructure Projects - An Overview

7/28/2019 Financing of Infrastructure Projects - An Overview

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Financing of Infrastructure Projects - An Overview

Abstract

Development of proper infrastructure is vital for economic growth of any country. Investors will like to put the capitalonly in those countries where there is developed infrastructure. Infrastructure consists of many things such as Road,Railway, Port and harbour, airport, electricity, telecommunication, water supply etc., Development of infrastructure is

capital intensive and gestation period is high. At the same time return on capital in case of infrastructure projects is smallas well as slow. Hence, investors are shy in investing capital in infrastructure projects unless some special incentives and

privileges are provided.

Rakesh Mohan committee report Central and state governments in India were solely responsible for development ofinfrastructure in India. Ministries used to do the planning and execution was done through contractors by Government

agencies and total money used to come from budget. Slowly the Government funding has shrunk whereas need fordevelopment of infrastructure has grown by leaps and bounds. Fund requirement is so huge for proper development ofinfrastructure that it is impossible task for Government. The expert group on commercialization of infrastructure projects

constituted by Government of India under the leadership of Rakesh Mohas has pointed out that during the period oftransition from 100% state investment in infrastructure towards increasing privatization of private sector; there will be

continued need for state support. To meet the present gap in the fund requirement of the infrastructure sector, it is

imperative to promote public and private partnership. The committee has advocated conscious use of availableGovernment Resources to take significant equity positions in infrastructure projects. This investment should be used as a

trigger to attract commercial equity funds as well as debt from different sources. The Government. Should essentially actas a catalyst and facilitates instead of a builder by providing seed-capital.

1. Introduction

Development of proper infrastructure is vital for economic growth of any country. Investors will like to put the capital

only in those countries where there is developed infrastructure. Infrastructure consists of many things such as Road,Railway, Port and harbour, airport, electricity, telecommunication, water supply etc., Development of infrastructure iscapital intensive and gestation period is high. At the same time return on capital in case of infrastructure projects is small

as well as slow. Hence, investors are shy in investing capital in infrastructure projects unless some special incentives and

privileges are provided.

2. Special features of infrastructure projects

(i) Large Capital requirement(ii) High sunk cost. A large proportion of the cost has to be irrevocably committed upfront before the project becomesoperative(iii) Long gestation periods

(iv) Returns are slow to pass in(v) Availability of foreign funds is poor(vi) Sector is sensitive to political environment and policy changes(vii) The services produced are non tradable. The excess services generated can not be stored or exported and deficiency

in service can not be met with by imports except for certain exceptions

No single solution applies to different projects as characteristics is different from sector to sector. What applies to roadsector does not apply to railways and what applies to railways can not apply to telecommunications sector as the capitalrequirements are different and so is the method of revenue collection.

Rakesh Mohan committee report Central and state governments in India were solely responsible for development of

infrastructure in India. Ministries used to do the planning and execution was done through contractors by Governmentagencies and total money used to come from budget. Slowly the Government funding has shrunk whereas need for

development of infrastructure has grown by leaps and bounds. Fund requirement is so huge for proper development ofinfrastructure that it is impossible task for Government. The expert group on commercialization of infrastructure projects


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constituted by Government of India under the leadership of Rakesh Mohas has pointed out that during the period of

transition from 100% state investment in infrastructure towards increasing privatization of private sector; there will becontinued need for state support. To meet the present gap in the fund requirement of the infrastructure sector, it isimperative to promote public and private partnership. The committee has advocated conscious use of availableGovernment. Resources to take significant equity positions in infrastructure projects. This investment should be used as a

trigger to attract commercial equity funds as well as debt from different sources. The Government. Should essentially actas a catalyst and facilitates instead of a builder by providing seed-capital.

2. Types of privatization

Following models for privatization of road infrastructure is available.

Sl

NoNAME Description

1Build operate transfer

(BOT)

Concession is given to private party to finance, build, operate and maintainthe facility. Investors collect the user fee during the concession to recover

the cost of construction, debt servicing and operation cost. At the end of theconcession, the facility reverts back to Govt. who has given the concession.

2 Build own operate (BOO) Similar to the BOT but without the transfer of ownership

3Build own operate transfer(BOOT)

Same as BOT but the project is transferred to the Govt. after a negotiatedperiod.

4Build transfer lease operate

(BTLO)

Govt. provides the right of way on which the highway is built. Private party

has to pay a nominal rent of payment for the use of the land

5Develop build operate

(DBO)

This is a new concept. Initially the company does not assume commercialrisk but is financially accountable for building and operating the system as

per specification. Later on the company assumes commercial risk as per theappropriate regulations laid by Govt.

4. Why Private projects like BOT are costly?

BOT projects are normally costlier if it is compared with the project report prepared by Govt. departments.

Following are the causes:-

(i). Full funding is to be done by the private company and hence full project cost is required to be mobilised whereas the

Govt. department does not need to mobilise full money in one go.(ii). Burden of interest during the construction on loans is required which is absent in cash funded govt. projects.

(iii). Cash flow is a major problem for BOT project as whole investment is to be done upfront and investments areregulated by investors. Each and everything has to be fully insured and sometimes multilayer insurance which increases

the cost of financing. In case of Govt projects money comes as and when it is required as per budgeting allocation.(iv). Returns are not assured(v). All liabilities of debt service and equity return commence after physical completion of project, which is absent in case

of Govt. projects.(vi). Pre bid /post bid award expenses are high such as

(a). Expenditure on conducting feasibility study, engineering survey and preparation of conceptdesign & drawing

(b). Expenditure on financial viability analysis

(c ). Legal expenses on formation of companies(d). Travel cost of overseas partners and other bid documentation

(e). Negotiation cost, cost of bid bonds, performance and other costs


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(f). Detailed engineering cost such as design, drawing, survey legal & financial management cost.

(g). Higher staff cost as Indian and foreign specialists have to be hired(h). Cost of escalation(i). Higher operation maintenance and repair cost(j). Project management fee

(k). Rupee devaluation; inflation and interest rate fluctuation(l). cost of risk during construction stage such ascost and time over runs, drying up of finances during construction,

law & order Problem created by local influential people and political Uncertainty(vii) Cost all risk taken by entrepreneur(viii) Contingencies on legal, political & technical including business development cost

5. Financing and subsidy for BOT Projects

Normal source for financing of private infrastructure projects are debt and equity. Govt.of India has allowed debt-equityratio in such cases as 5:1 but financer always like to have bigger equity participation and it may go up to 2:1 or even 1:1.

As these projects are of unknown risk, financier always like to have higher equity participation. One specialty ofinfrastructure project is that it has a monopolistic market and hence much more assured future revenue stream. Thus risk

of equity is of much lower scale than that would be needed in case of industrial projects which are open to marketfluctuations. The rate of interest should be kept low almost equal to PLR.

Sources of Debt

(i) Sources of debt are as follow:-(ii) All India financial institution (AIFIS). They are the long term lending institution in India . They are IDBI, ICICI,

IL&FS, IDFC etc.,(iii) Scheduled Commercial banks They are traditional sources of working capital funding for Indian projects but nowGovernment is encouraging them to lend long term funds for infrastructure projects either singly or as consortium.However, appraisal for the project has to be done by special agencies as they do not possess such capabilities.(iv) Dedicated road fund: A dedicated central road fund has been created under the control road fund Oct 2000 by levying

a cess of petrol and diesel.(v) Cess on turn over

(vi) Betterment levy through venture capital mechanism(vii) Shops and establishment levy(viii) Tax on employment

(ix) Municipal bonds(x) Real estate development

Normally Govt of India allows "Real State development" in the project which is actually sub project of bigger project and

the debt equity ratio of such sub projects may be different. Real problem is to arrange equity for such projects which havelarge gestation period. Equity requirements for the project can be met from "Infrastructure funds" specially created byGovt. or other agencies. Venture capitalists do not like to have equity participation in case of such projects. Many

countries have created such " Infrastructure fund" and are useful for providing equity finances. Banks are normally notvery keen to finance such projects in the form of equity because these need long term financing and they are constrained

by the time profile of their deposits. Institutional financiers such as insurance companies, provident fund, gratuity fundand superannuation fund can be source of such financing if allowed so as to ensure that cash flow is comfortable in each

financial year.

As infrastructure projects are very costly, Govt has felt the need for giving some sort of subsidy in the form of "Real statedevelopment". Govt. of India has allowed to acquire extra land on the route of road and have also allowed to developthese land for making shopping mall,motels, garages etc., so that income from these development becomes another sourceof revenue for the project. However, the projected returns from real estate developed in the area may also be affected bymoney factors such as,


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(i). Land acquisition to be done by Govt or private project

(ii). Local permission for commercial and industrial activities(iii). FSI allowed by Govt.(iv). Provision of facilities like water, electricity, telephone etc.,(v). cost of construction

(vi). Proportion of land to be sold after development and their value(vii).Expected demand or sale price(viii).Change in Govt.rules and regulations

Other forms of subsidy may also be considered to make the infrastructure project viable such as

(i). Tax waiver for the import of construction equipment

(ii). Remission of sales tax for a limited period(iii).Incentive in the form of no tax on real Estate income for a limited period.(iv).Provision of low interest loan

(v).Tax holiday period for income should be available till loan has been repaid.

6. Encouragement to entrepreneurs by Government

Road infrastructure projects are highly capital intensive with long gestation period. Risk factor is also very high and hencevery few entrepreneur (either Indian or foreign) come up for taking up such projects. This is a totally new concept in India

and hence Government must treat these projects in a new way and not like any conventional PWD project. The attitude ofgovernment must be different. It should be based on the concept of partners for development and not as contractor. In fact

is should be a win-win situation for all three involved parties ie., government, entrepreneur and user. If the project is notcost effective from user'' point of view then the project will not be successful. Therefore, their interests should also beseen. At the same time entrepreneur must be assured a minimum return on his investment. Government should consider

following points to encourage entrepreneurs:-

(i). Land acquisition for the project is one of the most important part of the project. Government should acquire the land

for the whole project at a time along with the land for "Real estate development", In fact in case of new alignment 250meters of land on both sides should be earmarked for future expansion of road and real state development. In course oftime these land will generate good revenue. One of the major causes for time over run and cost over run of the project isdelay in land acquisition and removal of encroachments. This will decrease the initial investment in land.

(ii). Government should consider BTLO mode i..e, build, transfer, lease and operate so that Govt. also gets revenue duringthe operation.

(iii). Government may think of giving special laws for financing, tax incentives and resource mobilization(iv). Various alternate sources of fund generation should be searched

(v). Real Estate Development site should be carefully monitored by Govt. They should allow liberae FSI and shouldprovide facilities like water, electricity, telecon upto the boundary of site. They should allow the entrepreneur a mix ofresidential, commercial and industrial activities on both sides of alignment of road.(vi). Timely environmental clearance should be given so that project is not delayed.

(vii). Rehabilitation of displaced persons should be taken care by the Govt.(viii). Development site on both sides of road should be considered as backward area for industrial development.(ix). Tax concessions should be given(x). Proper security during the construction should be provided by Govt.(xi). There should be "single window clearance" system for all statutory clearance(xii). Agreements should be drawn in a balanced manner where risks are duly shared which needs attitudinal change in

Govt. thinking.(xiii). Govt. should allow advertisement right to entrepreneur and the lease of land should be for 90 years.


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Types of i nf rastructure project

i) Construction of Roads, bridges, highways etc. Large number of roads, by pass, bridges etc. have been constructed bygovernment agencies as well as private agencies specially in Gujarat & Maharashtra. Some of them are pretty successful

but many have difficulties in achieving the goal.

ii) Construction of Railways Konkan Railway is an example in railway construction in India although most of the

funding came only through government agencies. If the project would not have been delayed unduly, it should havestarted paying back by this time.

The concept of private funding has been introduced in railways basically in two areas wagons and railway track. Ownyour wagon scheme is one such area where private parties are encouraged to buy wagons and handed over to railways.

Indian railways pay lease charges to the party. Already 14000 wagons are running under this scheme.

iii) Urban transport sectorUrban population is growing rapidly in India. The number of cities having population morethan a million is about 50. Mass transport demand is estimated to grow rapidly. To meet this enormous demand, apartfrom other modes of Public transport; urban transport projects whether rail based or bus based has to be implemented.

Metro rail, Mass transit system etc. will have to be executed in a big way. Delhi Metro rail has already been executed withthe help of international agencies. Bangalore and Chennai is also going to have metro or mass transit system. This needsinvestment and financing can be done even through municipal bonds.

iv) Waterways India has large river system besides it is surrounded on three sides by waterways. Inland shipping and

coastal shipping is a big area where large-scale transportation can be accomplished by encouraging private participants.Infrastructure for Jetty construction, ship repair facility etc has to be developed in a big way.

v) Airport Air traffic is playing an important role in both passenger as well as cargo improvement inside the country aswell as outside the country. Large numbers of airports have to be developed, improved and maintained in a professional

way. A number of project with private international participation has already been started.

vi) Sea port

There are a large number of major as well as minor ports in India which need improvement in port facilities,emerging ship technology, deeper draughts, container handling system, large cargo movement. Private participation onsea port is going to improve the export potential of this country. Privatization of port development is comparatively easier.

vii) Pipeline transportationTransportation of gas through pipeline has been started in India and GAIL has already done

good jobs. Gas pipeline transportation in Russia, Germany, France etc. has been done in big way as this is the cheapestand most energy efficient and risk free transportation system. Even coal can be transported in slurry form through thissystem.

viii) Power generationThere is shortage of power generation in each and every state of India. Hence, power is a big

necessity. A large number of private power producers were invited. Enron was one of the first power producer who startedpower production in Dabhol. Other power producers in Orissa, Karnataka and other places have also started production.

Unfortunately the experiments with private power producers have not been very good because of inherent shortcomingswith State Electricity Boards. Fortunately now Electricity Boards have separated power generation and transmission.Some of the States are improving the system and new model for power production / distribution has to be developed

which will prove to be more successful. Politicization of power subsidy has to be done away with.

At the end it can be said very boldly that private participation in infrastructure projects can be fully successful andfinancier will also come forward. In Tokyo more than five private companies are running metro rail and is being run very

successfully.

Documents

Financing of Infrastructure Projects - An Overview