Issues in Infrastructure Finance

Some Fundamentals:

• Corporate Finance: Creditors have recourse to the borrower's

entire assets to meet their claim.
• Project Finance: Long term infrastructure finance of non-
recourse/ limited recourse nature-i.e. project debt and equity paid by the
cashflow generated by the project. In case of default, the lender has
no/limited claim over the assets other than the collateral. Pure Project
Finance is difficult to find as some recourse to the borrower is always
there.
• Takeout Finance: This is an arrangement in which one bank/FI
finances the project but after a specified period another bank/FI takes
over the loan from the book of the first bank/FI. Right from the day of
this formal arrangement the loan will be treated as a contingent liability
in the book of the second bank/FI. But when it actually takes over the
loan it will be a proper liability and it will bear the credit risk.
• Mezzanine Finance: This is an arrangement in which project debt
is converted into an equity stake in the project after some time. This is
generally a subordinate debt.
• Asset Securitization: Pooling of 'homogeneous', 'financial', 'cash-
flow producing' and 'illiquid' assets-issuing claims on those assets in the
form of marketable securities. This involves 'specific identification of risk'
and 'allocation of the same to various parties'. Assets are taken off the
bank's balance sheet once securitisation is done. Infrastructure project
loans are of heterogeneous nature and have varied risk and return
profiles. These loans are backed by securities which are indivisible,
immovable, takes a long time to construct and assume value only after
construction is complete. Infrastructure projects generate cash flows after
some time. Hence, securitization of infrastructure assets is not always
possible.
• Collateralised Debt Obligation: Collateralized debt obligations
(CDOs) are a type of asset-backed security or structured finance product.
At a high level, a CDO can be thought of as a mutual fund where the
owners (i.e. the equity class(es)) leverage their investment by borrowing
(by issuing debt) against the portfolio.Similar to Asset Securitization but
typically have fewer than 100 loans carefully selected to ensure
investment grade rating for the pool as a whole.
• Credit Derivatives: A credit derivative is a contract (derivative) to
transfer the risk of the total return on a credit asset falling below an
agreed level, without transfer of the underlying asset. This is usually
achieved by transferring risk on a credit reference asset. Early forms of
credit derivative were financial guarantees. Some common forms of credit
derivatives are credit default swap, total return swap and credit linked
note.
• Organised Market Syndication: Involvement of many lenders to
diversify credit risk.
 • Currency Swap: Important instrument used to attract foreign
currency loans. The instrument involves contract between two parties to
exchange periodic coupon payments in two different currencies over a
period of time. The notional principals are exchanged on the maturity of
the swap. The initial exchange of principal is optional. Coupon payments
are calculated based on notional principal amounts in two different
currencies. Notional principals are determined at inception using the spot
exchange rate. Coupon payments can be fixed versus fixed, fixed versus
floating or floating versus floating.
• Principal only Swap: Equivalent to a long dated forward contract
to buy dollar. It involves only principal exchange and on the maturity
date, one party receives the principal in currency 1 and pays the principal
in currency 2, the exchange rate being equal to the spot rate on the date of
transaction. Forward premium is amortised over the life of the swap.
• Coupon Only Swap/Interest Rate Swap: On the trade date both
sides of the transaction have equivalent NPVs. It redesignates the rupee
fixed coupon into a floating US $ coupon. The coupon swap gives an
'inception carry' which is equal to the difference in steepness between the
two yield curves. Foreign exchange risk is low in a coupon swap since the
principal is not at risk.
• DFIs-IFCI, IDBI, LIC, SIDBI-Rupee Loans, sometimes forex
loans(7-10 years)
• Multilateral Agencies-WB,IFC,ADB,JBIC-20-25 years-5-7%
interest rate
• Domestic Commercial Banks-Rupee Loans-3-5 years-6-8%
interest rate
• Foreign Commercial Banks-Small amounts of offshore loans-
Foreign Currency loan at LIBOR plus rates-7-10 years
• Export Credit Agencies-7-10 years
• Niche Institutions-IDFC, IIFCL, IL&FS, PFC, REC, HDFC, UDC

Type of Finance Use Comments

Project Finance Capital Intensive and Preferred Option
Long Gestation Project
Corporate Finance Financially viable low Few cases
risk Projects by reputed
Corporate Groups
Hybrid Finance-equity- At the construction phase Used by established
debt mix, quasi-equity- ventures.
debt mix, corporate
finance-project finance
mix
Bond Finance Projects of established Bond Market is
Infrastructure underdeveloped
Companies and
Companies with
Government backing
Long Tenor Bank/FI Difficult to find Asset-liability Mismatch
Loan
Takeout Finance Confined to 'lender One syndicate-
syndicates' construction period,
Another syndicate-
Operation and
Maintenance Stage
Securitisation Toll receivables of
several Road Projects
Pooled Finance based Municipal Finance Smaller utilities have
Instruments tapped the bond markets
through this.
Mezzanine Financing Limited use so far Higher return than
secured debt and share in
the 'up side' risk of the
project.

• A Project is called bankable if all the risks associated with the

project are clearly identified, equitably allocated to parties willing to
assume the risk.
• Equity-

1. Project Sponsors with operational interest to finance

preconstruction/ developmental costs
2. Developers (may be different from the sponsors)-
domestic/international, independently/in collaboration
3. Financial Investors-having only investment interest in the
project-private equity funds like venture capital funds,
institutional investors such as dedicated infrastructure funds,
Government sponsored funds, commercial banks, development
banks, private fund managers, equipment suppliers and other
privately held companies.
4. Public Utilities-minority holding
5. Multilateral Agencies

• In the infrastructure projects in India there is a predominance of

sponsors' equity. But sponsors' ability to raise equity from the primary
market is limited since:

1. There is no track record of performance at the development

stage.
2. Project sponsors have high gearing typically.
3. Projects are operationally complex in terms of contracts,
legal structures and right of first change on assets etc.
4. Difficult to understand for retail investors the true risks
involved
5. Infrastructure SPVs are normally not listed in the stock
exchanges

• Therefore, equity finance by financial investors is critical. But the

following problems discourage the financial investors:
 1. Limited exit options constrain equity participation
2. A Shallow Capital Market
3. Corporate Governance Issues and minority shareholders'
rights
4. Existing restrictions.

Issues for Discussion:

Constraints to Equity Participation in Infrastructure

• Financial Investors selling their stake to the project sponsors

through a 'put option' is not allowed in India. Approval to exercise 'put'
has to be obtained from the RBI at the time of the exercise and cannot be
obtained upfront. Such 'put option' agreement cannot guarantee a
minimum price on the sale of shares to the sponsors. Sale price in such
transactions is subject to pricing requirements of the RBI, which requires
an independent valuation to determine a 'fair' price for the shares at the
time the option, is exercised. Financial investors usually prefer to
determine the terms of exit on an upfront basis. In the absence of listing
of infrastructure equities, the exit options for the financial investors are
significantly restricted.
• Complex cross holdings across family or business groups leads to
lack of transparency in disclosures related to capital structures. This
dilutes minority shareholders' rights. Mandatory disclosure on
shareholder ownership is limited to only shareholder's name which is not
sufficiently unique.
• Port/Airport Management Companies, Construction Companies,
Equipment Suppliers and Infrastructure Service Companies can be
Infrastructure Project developers. For these companies the return from
the secondary business generated by the project may exceed from the
return generated from the project. A Project developer may act in a way
which maximises his return from the secondary activities at the cost of
project revenues. This discourages the financial investors whose only
return on equity is provided by the revenues generated by the project.
• Superannuation funds/insurance funds can invest in equities
subject to the trustees' assessment of the risk return prospects. EPF and
Miscellaneous Provisions Act, 1952 does not permit investment by PFs in
equities. The investment by insurance companies is reckoned as
'approved' only when the investee company has dividend track record for
at least five years. Unit linked insurance policies can invest upto 75% of
the funds earmarked for policy holders in government securities and
other approved instruments including equities subject to the prudential
norms on exposure and dividend track record and in adherence to the
investment policy laid down by the Board and monitored by investment
committees. These restrictions reduce contribution to equity by financial
investors.

Measures to increase Equity Participation:

• Dedicated international funds allow international investors to pool
risks by investing in a mix of projects. They also enable institutional
investors who are relatively risk averse to invest in infra projects after the
construction phase when project risks are much lower. The pool of global
capital these funds can tap is very large. Equity flow from international
funds will increase substantially if bankable projects become available
and the track record of implementation improves.
• There is also need to create infrastructure venture funds which
may provide necessary equity to SPVs and allow foreign funds to invest in
such venture funds in association with the local corporates/banks/FIs.
• To facilitate equity investment in infrastructure by insurance
companies, investment in equity of listed infrastructure companies
(including holding companies) and infrastructure schemes of equity
mutual funds, should qualify as approved investment under the category
of ‘Infrastructure and Social Sector’.
• An additional facilitating measure would be to relax requirements
of dividend payment history as a consideration for equity investment, as
several infrastructure companies, although stable in operations, may not
have a dividend payment track record.
• In many infrastructure projects, the buyback mechanism is used
indirectly to finance suppliers in the following manner. Equity is allotted
to the vendors, suppliers, etc at the initial stage as a consideration for the
supply of raw materials / machines received from them. When the project
becomes operational and the company has sufficient cash to pay for these
materials / machines, buyback of these equity shares becomes necessary
to help the developer regain control over the company. In buying back
share capital, companies face several restrictions including on a) the total
amount of outflow that can happen on account of buyback, and b) the
number of shares which can be bought back. It is therefore recommended
that in case of infrastructure companies, these buyback restrictions vis-à-
vis vendors be liberalized.
• Currently, in transportation, port and power sector, it is very
difficult to replace one or more initial bidders with new partners. This
jeopardizes the prospect of the project by reducing the flexibility in the
constitution of management. Hence, it is recommended that all the
bidding documents for infrastructure projects should provide a clause for
dropping the initial bidder(s) or replacing them by a new entity, if agreed
to by all the concerned parties through a deed of adherence. The deed of
adherence will bind the new entity to the terms of the original contract.
This provision should be included in model concession agreement.
• Currently, SEBI registered venture funds / private equity funds
cannot be taken as bidding partners, as these funds do not meet
conventional qualification criteria such as gross revenue, net worth or net
cash accruals. It is therefore recommended that the criteria to qualify as
bidding partners should be not the net worth of the private equity or
venture investment manager, but the uncommitted investible funds
managed by these entities and available for deployment.
 • Investment in unlisted equity capital of infrastructure companies--
operating or holding company--should get the same tax treatment as
listed equity investment.
• Pension funds should be allowed to invest in projects where a
multilateral agency or Central Government extends a guarantee on the
minimum rate of return. The multilateral agency in turn could charge the
project sponsor a commercial fee to extend this guarantee. Pension funds
should be permitted to deploy funds in projects appraised by the all India
FIs.

Limited Mezzanine Financing:

• Interest rate cap on ECBs constrain the use of mezzanine

financing by foreign investors.
• Pricing of quasi-equity instruments as per the risks associated
cannot be done.
• The norms for provisioning against NPA do not make a distinction
between senior debt and subordinate debt.
• For projects that are at the margin in terms of profitability
premium demanded for subordinated debt over senior debt by risk averse
lenders are far too excessive and that turn a potentially profitable project
unviable.

Measures to increase Mezzanine Financing:

• The current ceiling of LIBOR+350 basis points for ECBs makes it

difficult for the issuers to raise subordinated debt, mezzanine financing or
quasi equity as the maximum permissible return is not considered enough
to match the perceived risk. Keeping in view the long term nature of
infrastructure projects and the need for risk capital (in the form of quasi
equity), this all-in-price ceiling on ECBs should be removed for
subordinated and mezzanine foreign debt for infrastructure projects.
• There is also need to create specialised institutions for mezzanine
financing.

Limited Use of Takeout Financing:

In terms of RBI circular No.DBOD.No.BP.BC. 67 / 21.04.048 / 2002-2003 dated

February 4, 2003 on Guidelines on infrastructure Financing, banks may enter
into take-out financing arrangement with IDFC / other financial institutions or
avail of liquidity support from IDFC / other FIs. Under the arrangements, banks
financing the infrastructure projects will have an arrangement with IDFC or any
other financial institution for transferring to the latter the outstandings in their
books on a pre-determined basis. IDFC and SBI have devised different take-out
financing structures to suit the requirements of various banks, addressing issues
such as liquidity, asset-liability mismatches, limited availability of project
appraisal skills, etc. They have also developed a Model Agreement that can be
considered for use as a document for specific projects in conjunction with other
project loan documents. The agreement between SBI and IDFC could provide a
reference point for other banks to enter into somewhat similar arrangements
with IDFC or other financial institutions.

As it may be seen that the take out financing is intended to enable the banks to
avoid asset-liability maturity mismatches that may arise out of extending long
tenor loans to infrastructure projects. In view of this, banks may use this
facility, only if they have asset liability mismatch on account of their extending
long-term loan to infrastructure projects.

• Due to limited number of 'bankable' projects in the fray and no

liquidity crunch, banks have no inclination to sell out good assets from
their portfolio.
• High stamp duty reduces the attractiveness of takeout financing.
• Treatment of the assets in the loan books of both the financiers for
purposes of 'risk weighting' and 'standard loan loss provisioning' is a grey
area.
• Banks did not appreciate the fact that in a take out financing
arrangement, their exposure was on IDFC (not on the borrower) and they
should charge interest rate as per credit rating of IDFC, not the borrower
and leave some margin for IDFC. As the banks proposed to charge as per
borrower's rating, there was no margin left for IDFC.

Measures to increase Takeout Financing:

• At present take out financing is subject to 100 percent provision of

capital by both the entities involved simultaneously, which results in i)
maintenance of excess capital and ii) increase in the lending costs. This
can be rationalized by using a mechanism of credit conversion factor that
will allow the take-out financer to provide for much less capital than
currently required, until the take-out occurs.

Issues related to Corporate Bond Market:

• Size of India's Corporate Bond Market is very small, less than 1%

of GDP.
• Trading volume insignificant.
• Issuance takes place on a private placement basis-Private
placement market in India offers competitive rates and quick access to
the market as there is relatively less regulatory compliance. Hence the
segment which is less transparent accounts for over 90% of debt
placement in India.
• Cumbersome primary issuance guidelines for corporate issuers
• High costs of listing, rating, trusteeship, R&T agent, arranger fees,
stamp duty, intermediation costs to brokers and underwriters.
• Lengthy process-minimum timeframe for clearance of offer
documents by the regulator is 21 days.
• Shelf Registration (which facilitates frequent and quick issuance of
 debt securities) is available only to specially designated Public Financial
Institutions and not to all corporate issuers.
• Inefficient clearing and settlement mechanisms, poor and lengthy
enforcement laws relating to default proceedings-leading to illiquid
market
• AAA (Investment grade) rated bonds offer lower coupon rate than
sovereign instruments such as PPF/NSC. Individual investors have no
interest in the corporate coupon debts unless there is significant fiscal
concessions.
• Lack of innovative instruments viz. third party credit
enhancement and hedging tools for investors and traders to mitigate
credit risk and interest rate risk.
• RBI, SEBI and MoF all have regulatory and supervisory roles that
are not sufficiently delineated.
• Absence of long term investors
• No incentive for insurance companies,pension and provident funds
to earn above-market rate of return.
• Investments by banks in corporate bonds require a higher risk
weight than loans to corporates.
• Restriction on banks' investment in unlisted non-SLR securities to
10% and requirement of minimum investment grade rating.
• Restrictions on Superannuation Funds, insurance funds, provident
funds etc-

1. MoF permits investment by superannuation funds and

insurance funds upto 5% of incremental accretions in
shares/bonds of companies that have investment grade rating from
at least two credit rating agencies.
2. EPF & Miscellaneous Provisions Act,1952 permits
investment by PFs upto 10% of incremental accretions in private
sector bonds which have investment grade rating from at least two
credit rating agencies.
3. Insurance Companies cannot invest in any company, which
can result in the investment exceeding 10% of the capital of the
company or the capital of the investee company, whichever is less.

Measures to be taken to ensure an efficient Bond Market:

• Patil committee had recommended developing online order

matching platforms for corporate bonds which can be set up by the stock
exchanges or jointly by regulated institutions like banks, financial
institutions, mutual funds, insurance companies, etc. SEBI would frame
specific guidelines for setting up such trading platforms. The SEBI
working group which examines the recommendations suggested for
creation of a single unified exchange platform setup by BSE. By making
bond trading screen based and transparent an element of marketability
and price discovery can be introduced.
• The procedure for public issuance of debt needs to be streamlined
drawing on lessons from countries like Korea where regulatory approval
takes just 5 days against 21 days in India. A distinction between
regulatory requirements that apply to the wholesale market from those
that apply to the retail market could be made to enable listing to be a
straightforward exercise.
• RBI and SEBI should consider regulatory reforms that would help
develop hedging tools for investors and traders,e.g credit derivatives,
bond futures and options.
• RBI is of the view that the proposed system may be designed to
facilitate direct dealing between institutions while the smaller entities
could access the system through their principal members. The Committee
also noted that globally such trading platforms are owned by banks and
institutions as the markets are basically institutional in nature. It is,
therefore, felt that the platform could be managed by a separate company
registered under section 25 of The Companies act, 1956, jointly promoted
by banks and other financial institutions, Asset Management Companies,
insurance companies etc. This trading platform could be an electronic
order matching system on the lines of the order matching module of the
Negotiated Dealing System. It also needs to be ensured that as
participants currently trade in the OTC markets, the proposed trading
platform should be an additional choice coexisting with OTC market and
there should be no mandate as to the choice of platforms. While electronic
order matching systems for trading corporate bonds are required, it may
not be appropriate to mandate one trading system for all participants.
The choice of the actual usage would be determined by the relative ease
and efficiency of the competing platforms. Incidentally, SEBI had taken a
decision to permit multiple exchanges to develop trading platforms to
encourage competition.
• The suggestion of the Committee to introduce market repo in
corporate bonds can be considered after the establishment and
stabilization of the proposed trading platform as well as the clearing and
settlements systems on DvP basis. Trading of money market corporate
instruments like CPs and other short term instruments can also take
place on such trading platforms in due course. The trading of money
market instruments including repo will be within the regulatory
jurisdiction of the Reserve Bank.
• There is a need to expedite the implementation of Patil Committee
recommendations for the development of corporate bonds and
securitisation market. The key recommendations not yet implemented
that need priority in implementation are as follows:
1. Consolidation of all regulations pertaining to issuance of
corporate debt securities under the aegis of SEBI to
minimize multiplicity of regulations
2. Removal of TDS on corporate bonds in line with GOI
securities
3. Reduction and uniformity in stamp duty on issuance of debt
instruments and on securitisation transactions
4. Allowing repo transactions on corporate bonds through a
specialized clearing and settlement platform
• To increase the efficiency of the private placement market and
bring it in line with global best practices, the Deepak Parekh Committee
makes the following recommendations:
1. The global private placement market is restricted to
Qualified Institutional Buyers (QIBs). In India, however,
the company law puts a restriction of less than 50 investors
for an issue to qualify as a private placement. Hence, there
is a need to replace this requirement by the global practice.
2. Since large investors and QIBs generally drive corporate
bond markets, development of a trading infrastructure for
privately placed debt suited to the needs of such investors is
critical. Globally, the over the counter (OTC) market is
preferred over an anonymous trade matching system for
corporate bonds and a similar system could be adopted in
India. Further, to improve the transparency in the OTC
market, an electronic trade reporting system could be
devised.
• There is a regulatory asymmetry between loans and bonds with a
bias towards the former. The following measures would address this
issue:
1. Banks cannot invest in unrated debt instruments. Nor can
they invest in unlisted debt papers beyond a certain limit
(10% of their total non-SLR investments). No such
restrictions are applicable for loans. At a minimum, banks’
investments in infrastructure bonds should be exempt from
such restrictions.
2. Banks grant loans with no mark to market implications.
But their bond investments are subject to mark-to-market
regulations since banks are not allowed to classify any part
of their bond portfolio under the held to maturity (HTM)
category. This makes banks averse to holding corporate
bonds. Banks, therefore, need to be given an option to
classify their bond holdings under either the trading
category (with mark to market implication) or HTM
category (subject to only ALM norms). At a minimum, long
term infrastructure bonds (greater than 5 years maturity)
held by banks should be allowed to be classified under
HTM category.
• It has been the global experience that credit derivatives provide
depth to debt markets. With a narrow investor base in India for debt
instruments in India, it is imperative to introduce credit derivatives and
also allow foreign investors to trade in them. This will not only widen the
market but also enable efficient risk transfers.
• The current IRDA investment guidelines allow investment in
assets/instruments under the approved category only if they have a
minimum credit rating of AA (or A+ in exceptional cases with investment
committee approval). Since infrastructure companies typically do not
enjoy high credit rating at least in the initial years, it is recommended
that the minimum rating requirement for bonds, hybrid instruments
(such as convertible bonds) and securitized paper issued by infrastructure
 companies (including holding companies) be lowered to investment grade
(BBB-) to qualify as approved investments under the category of
‘Infrastructure and Social Sector’.
• Similarly investment guidelines for Pension Funds should be
modified to allow them to invest in infrastructure projects which have a
guarantee from the Central Government or multilateral agencies.
• Extending shelf registration to all types of corporate issuers would
facilitate quick, timely and cost effective access of issuers to the market.
• Government should encourage Financial Institutions to offer third
party credit enhancement and hedging tools like bond insurance that
enable sub investment grade corporates and municipalties to access
financing. This could be achieved through initial guarantee or funding
support to the FIs.
• Data on bond issues is not readily available. More effort needs to
be put into collecting and disseminating such data-a centralised agency
for this purpose is needed.
• Credit quality of the bond issuer should be clear and well
established. So, there has to be adequate disclosure of their financial
condition based on sound accounting principles and independent
auditing.
• Settlement of securities trades requires the support of a payment
system that assures delivery versus payment or at least short lags in
executing payment orders with certainty.
• An active money market can be very helpful in the development of
a bond market by providing liquidity to market participants and
establishing a yield benchmark the short end that helps in pricing issues.
Variable rate bonds require a market determined short term interest
rate. This is best established in a money market through the trading of
treasury bills. Failing that, a bank deposit rate can be used, but that is a
poor substitute. In general benchmark securities must have a stable and
predictable credit and be actively traded so that market quotes are
available at all times within a small bid/ask spread. Markets in
benchmark securities should have enough depth to sustain hedging
operations by brokers/dealers in both bonds and equity markets. To
facilitate the issuance of bonds of varying maturities it is helpful to have
benchmark securities traded at a wide spectrum of maturities.
• Structural inadequacies in market for government securities and
interbank money market have inhibited the emergence of a meaningful
yield curve in the nascent Indian debt market. The result is a relatively
flat yield curve. Even medium and long term instruments are not found to
be marketable without providing for returns that are similar to the short
term returns available in the market. This is of crucial significance for the
infrastructure sector where maturity has to be stretched.

Participation of Banks, institutions and NBFCs in Infrastrucure Financing:

• Commercial Banks are typically not in favour of long-term finance

due to asset-liability mismatch. Also prudential management could be the
pretext on which banks would not increase their exposure to
 infrastructure sectors. Another major issue related to bank finance is the
market risk which may arise due to several factors like tariff fixation,
payment security mechanism, offtake risk, toll fixation, realised traffic
volume, lack of market intelligence.
• Inflationary expectations discourage long term savings in
particular.
• High fiscal deficit has not only crowded out funds but also has
resulted in a higher interest rate regime which discourages investment.
• Nevertheless, banks, institutions and large NBFCs play a vital role
in infrastructure financing through originating, underwriting and
distributing infrastructure financing risk.
• RBI has allowed FIs and banks to issue infrastructure bonds. But
other than IDBI and ICICI Bank no banks/FIs have issued these bonds. It
seems that they are not interested to increase their exposure to
infrastructure.
• IDFC and SBI have joined hands to form a scheme to provide
liquidity support to banks. IDFC commits at the point of sanction to
refinance the entire outstanding loan(principal+uncovered interest) or
part of the loan to the bank after a specified time period say five years.
The bank would repay the amount to IDFC with interest as per the terms
agreed upon. The refinance support would particularly benefit the banks
which have the requisite appraisal skills and the initial liquidity to fund
the project.
• Banks, FIs and NBFCs can securitize their portfolio of
infrastructure loans as per the guidelines issued by RBI which enables the
banks to sell the loans to different investors by issuing securities against
these loans.
• RBI has not imposed any restrictions on flow of credit to
infrastructure sectors. Certain regulatory concessions have been granted
to infrastructure by RBI. Definition of infrastructure has been widened
during last three years. Indirectly, banks and FIs have been given the
facility to lend for infrastructure through additional credit exposure limit
of 10%.
• There is no need for infrastructure to be granted priority sector
status as the financial requirement for infrastructure projects is very
large and if it is allowed to compete with smaller borrowers in
agriculture, SSI and weaker sections it would crowd out flow of credit to
these sectors.
• DFIs were set up soon after India’s Independence and it was actively
pursued during the planning era as the then existing markets and
institutions, i.e., banks were thought unsuitable to meet the capital
requirements of industry, particularly its demand for long-term funds.
Establishment of DFIs was thus a stage in the development of the
financial system. The logic of creating DFIs was to provide term capital at
rates of interest that were in line with the return on capital. All the core
industries including infrastructure industries could avail of such credit
with confidence since they would not be starved of inventory financing as
commercial banks were already there to provide working capital. Thus,
the DFIs played a crucial role in fostering economic growth.
 • As a consequence of financial sector reforms and calibrated
globalisation measures initiated since 1991, the financial services industry
became intensely competitive. On the lending side, there has been a
progressive blurring in the traditional divide in the operational domain of
banks and DFIs. Further, the withdrawal of concessional finance and
SLR status of bonds issued by the DFIs, led to a strain on their borrowing
capacity in a cost effective manner as they had to borrow directly from
the market at market related rates. Consequently, commercial banks,
with their wide retail reach and access to current and savings bank
deposits, are able to offer finer rates to their clients, which DFIs, without
similar access to low-cost funds, have not able to match. The
development of the domestic capital market and freer access to cross-
border funding exerted greater pressure on FIs through acceleration of
the disintermediation process. As a result, blue-chip companies are now
able to raise funds directly from the market/banks and, aided by the
softening interest rate regime, such companies are also pre-paying
institutional dues. On account of these developments, the development
financial institutions (DFI) model became increasingly unsustainable and
the AIFIs are fast adopting the business model of a bank to remain viable
in the long run.
• In this backdrop, the focus of the policy initiatives by the Reserve Bank
and the Government of India has been to facilitate the process of
transition of the DFIs opting for conversion into banks through a series of
measures aimed at financial restructuring, provision of regulatory
relaxation for restructured investments of creditor banks or providing
government support, transfer of stressed assets of FIs to asset
reconstruction companies/asset management trusts for managing the
NPA level and course, and in the light of evolution of the financial
system, Narasimham Committee’s recommendation that, ultimately
there should be only banks and restructured NBFCs can be
operationalised.

• Thus, with the transformation of two major DFIs, viz., ICICI Ltd
and IDBI into commercial banks along with shifting of IDFC Ltd.,
towards non-bank financial sector, there are only seven DFIs, viz., Exim
Bank, IFCI Ltd., IIBI Ltd., NABARD, NHB, SIDBI and TFCI Ltd. Of
these, IFCI Ltd., is under restructuring package of GOI whereas IIBI
Ltd., is in the process of winding up and viability study has been
recommended in the case of TFCI Ltd. Thus, only the remaining four
DFI, which are statutory bodies are functioning with better financials.
Further, these are also exploring the possibility of venturing into newer
areas such as, SME financing, micro financing, venture capital financing,
advisory services etc., so as to realign their core operations by broad
basing them and venturing into activities aimed at generating non-interest
revenues.

Suggestions to improve participation of banks, institutions and large NBFCs in

infrastructure financing:

• Pension funds should be permitted to deposit part of their funds

with banks for long periods and ensure that the banks use them
exclusively for infrastructure financing.
• Liabilities of the banks created by the sale of long term
infrastructure bonds may be kept outside the purview of SLR and CRR.
• RBI should not treat investments by banks in close ended
infrastructure debt funds as capital market exposure.
• Resetting of interest rate should not be done during the
construction/take off period as it entails to distort the project cost and
thereby profitability.
• In order to have a comfort for the banks/FIs, it is desirable to
create a guarantee organisation on the pattern of European Investment
Fund which would guarantee the loans sanctioned by banks/FIs to the
extent of 50%.
• In case the account goes bad, the guarantee organisation would
reimburse the claim to the FIs which would not only give the comfort but
would also help banks/FIs to increase their asset base with the same
capital besides charging interest at a lower rate, as compared to the
situation where no such guarantee is available.
• Hedge funds may be considered for providing credit enhancement
to the lenders.
• All large projects may be rated by external agencies.
• Banks may be permitted to provide bridge financing against
budgetary support.
• Securitisation: Securitization helps transform loans to tradable
debt securities, and thereby facilitates financial institutions to not only
address the exposure norm constraints, but also distribute risks more
efficiently even among those who do not have the skills to appraise
infrastructure risk. To further develop the market for securitisation of
existing infrastructure assets by banks, financial institutions and NBFCs
to domestic and overseas investors, the following key steps needs to be
taken:
1. Inclusion of Pass Through Certificates (PTCs) under the
definition of ‘security’ as per SCRA, which will enable PTCs to get
listed.
2. Rationalization of RBI’s guidelines on securitization in line
with international best practices. (Notably, in contrast to the global
practice, originators in India have to amortize the profits made
from securitization over the asset maturity, but book all expenses
in relation to the asset sale upfront. This acts as a disincentive for
banks.)
3. To increase investor base, the IIFCL should be allowed to
invest in senior tranches of securitized papers.
• Aligning NBFCs’ exposure norms with banks: The current
exposure norms for infrastructure sector lending by banks and NBFCs is
as follows:
Single Borrower Limit Group
• Additional with Borrower of %
General Board approval Limit
Banks 20% 5% 50% Tier I & II
 NBFCs 20% 0% 35% Only Tier I

As the funding requirements of reputed infrastructure companies are

growing rapidly, the exposure norms for NBFCs need to be relaxed and
brought in line with those for banks.
• Rationalizing exposure norms
• Underwriting: Currently financial intermediaries are
constrained by exposure norms in underwriting and originate-to-
sell transactions. The exposure norms should not be applicable to
such transactions where the intention is to sell off the exposure
within a short period of time, say 6 months. This will help these
financial intermediaries in maintaining confidentiality, managing
timing mismatches and accelerating deal closure. Should the
intermediaries fail to sell the exposure within the stipulated
period, they may be asked to raise additional capital or write off
the excess exposure from their capital or prohibited from taking
further exposures.
• Step-down subsidiary: The current regulatory policies treat
lending to step-down project SPVs floated by infrastructure
companies under the group borrower limits even if the lending is
without recourse to the parent company. This severely restricts
bank lending and hence such lending could be exempt from the
group exposure limit.
• Take out financing: At present take out financing is subject to
100 percent provision of capital by both the entities involved
simultaneously, which results in i) maintenance of excess capital
and ii) increase in the lending costs. This can be rationalized by
using a mechanism of credit conversion factor that will allow the
take-out financer to provide for much less capital than currently
required, until the take-out occurs.

• To enable banks/NBFCs to mobilize sufficient resources of suitable

tenor and nature for infrastructure financing, the following
recommendations are made:
• Foreign borrowing for on-lending to infrastructure sector: The existing
guidelines do not allow financial intermediaries such as banks,
financial institutions and NBFCs to raise foreign currency
borrowings for on-lending to infrastructure sector. Given the
significant requirement of attracting foreign funds, these
intermediaries should be allowed to raise long term resources (say
minimum 10 years) from overseas market.
• Removal of SLR requirements: The resources, whether domestic or
foreign, raised by banks for a period of say 10 years by way of
bonds/term deposits for investment in infrastructure assets should
have no SLR requirement. This will enable banks to lend more
and also help in offering competitive rates on such bonds and
deposits.
• Given the present state of DFI in the country, only DFIs with sound
financials and having strong risk bearing ability to manage volatility in
 financial markets and interest rates, need to be encouraged and provided
with certain facilities to finance infrastructure. These could be in the form
of:
1. increase in capital base,
2. consolidation through organisational and financial restructuring
3. Ability to address NPA related issues
4. Ensuring good coprorate governance for the benefit of all
stakeholders-not just in case of the DFIs, but also in case of the
corporates assisted by the DFIs.
5. Explore newer business areas to improve profitability and utilize
its loan origination capabilities to increase business through the
securitisation route and by exploring potential tie-ups with other
banks/financial institutions which have large funds and who may
need loan origination and project evaluation expertise. Essentially,
this would involve less risk than holding long-term loans up to full
maturity and lesser requirement of financial resources, while
facilitating higher turnover and a faster churning of the portfolio.
• Only institution specific support and debt restructuring to viable DFIs
need to be permitted which is purely based on strong fundamentals,
coupled with development of capital market, particularly the corporate
debt market through introduction of financial instruments, for trading
and creating liquidity in the primary and secondary corporate debt
market. Introduction of an infrastructure fund and infrastructure bonds
to tap the institutional segment could be considered.

Raising Rupee Resources by domestic entities:

• Some special purpose instrument such as 'infrastructure bonds' need to

be evolved with appropriate fiscal incentives. But the question arises who
should issue these bonds. One is not sure of banks' ability to raise
resources of the magnitude of $60 bn a year and more importantly lend it
to infrastructure projects. The cost of raising resources through such
bonds becomes too high to be viable. The SPV implementing the projects
can issue these bonds but the credit risk and liquidity risk inherent to
such bonds would either not elicit appropriate response or will have to be
priced high enough to render the projects viable. For banks only term
risk is involved but for corporates credit risk is also there.
• Therefore appropriate tax incentives and some kind of liquidity and
repayment insurance would be necessary to make private sector bond
financing of infrastructure projects viable. Involvement of Government/
Government sponsored institution is necessary in the provision of
liquidity and repayment insurance.

External Debt Financing:

• Export Credit Agencies have traditionally funded public sector projects

backed by sovereign guarantees. In recent times they are willing to lend
against guarantees of commercial banks. So far they have had a limited
role.
• The number of international banks involved is small, subject to exposure
limits for projects and countries, involved in syndication involving
cumbersome procedures, willing to accept 7-10 years tenor vis-à-vis
requirement of 15-20 years tenor, can be a part of a mix involving other
long term lending-must be accompanied by suitable refinancing
arrangements.
• International Bond Markets are difficult to access and are replete with
various rules and regulations. Costs are higher than for syndicated loans.
Maturities of 10 to 30 years are typical-even longer maturities are
available for creditworthy issuers. Possible to access them in the post-
construction stage when risk perceptions have diminished and projects
begin to generate steady revenue streams. International bond markets
could be used to refinance shorter term loans taken initially to finance the
construction stage. Pricing depends on corporate financial characteristics
and country characteristics. Efficiency of pricing can be enhanced by the
existence of sovereign debt actively traded in the international market as
this increases country visibility and provides a benchmark against which
corporate debt can be efficiently priced.
• Active involvement of multilateral institutions can help reduce the risk
perception on the part of other investors. At present the procedures of
these institutions are too cumbersome to be acceptable to private sector
investors. It is important to use their guaranteeing capacity to extend the
maturities of commercial loans to private sector infrastructure projects.
In fact IFC syndication has been able to romp in non-bank FIs and
international insurance companies.
• There are restrictions on cross currency swap involving multilateral
agencies. There were restrictions on multilateral institutions to issue
rupee bonds whereby they would raise rupees from domestic investors
and lend them to domestic banks/FIs who have bankable projects in
hand.
• Banks in India do have products like currency swap but such swaps are
mostly confined to short tenors. Furthermore it is doubtful whether the
Indian banking sector as a whole can offer hedging instruments of the
scale required.
• India also lacks a sufficiently deep forward market in foreign exchange.
Long tenor loans if financed through forex borrowings, these need to be
adequately hedged against currency risks since few infrastructure
projects have forex earnings to serve as a natural hedge.
• Since forex-rupee swap are akin to ECB, they are subjected to the limits
fixed by Government/RBI on ECB every year.
• To avoid forex exposure and consequent forex risks, fixed rate rupee
financing is important as local banks are not able to lend long term at
fixed interest rates and the municipal bond market is nascent and long
term investors are not comfortable taking municipal risks. International
MFIs can play a vital role by providing a range of products for direct
financing of municipal bodies. They can bring high quality project
appraisal and long tenor money and market based financial and project
discipline to ULBs.
 • The Government of India has permitted ADB to raise Rs.2975 crore
either through rupee bond issues or through swap route to be used for
infrastructure projects subject to certain conditions such as:
a. Swap route can be taken only when ADB has lending facilities
lined up.
b. The Rupee Bond must have maturity in excess of 10 years.
c. Upto 25% of the funds raised may be used for lending to
intermediary FIs involved in infrastructure financing e.g.
IIFCL,IDFC, PFC, REC and IRFC etc.
d. When the funds are raised through swap route, the borrowing by
these FIs,although in the nature of ECBs, would be outside the
ECB window available to them.
e. FIIs may invest in Rupee bonds within the overall ceiling of FII
investments in Corporate Debt Instruments.
f. SBI would be the Swap counterparty for ADB.
g. The prevailing regulatory risk weights as prescribed by RBI,
presently at 20% would apply to the bonds issued by ADB.
• External Commercial Borrowings(ECBs) are commercial loans availed
from non-resident lenders with a minimum average maturity of three
years. They can be raised from international banks, international capital
markets, multilateral financial institutions, export credit agencies,
equipment suppliers, foreign collaborators and foreign equity holders.
There is an automatic route and an approval route. But FIs dealing
exclusively with infrastructure are allowed only under the approval route
on case by case basis.
• RBI has been refusing ECB proposals of public sector FIs like IIFCL,
IRFC, PFC, REC etc. engaged in infra finance on the ground that it
would amount to surrogate sovereign borrowing.
• There are interest rate caps on ECBs (LIBOR+200 bps for average
maturity of 3-5 years, LIBOR+350 bps for loans with average maturity of
more than 5 years). Caps are too low to attract funds for riskier
infrastructure projects.

Suggestions to Improve External Debt Financing:

• If MFIs lend in rupee to municipal corporations they should be treated as

non-recourse domestic borrowing.
• Foreign banks/FIs with credible experience in development finance
should be permitted to raise funds in the Indian markets for lending to
infrastructure. However, their individual schemes will have to be
scrutinized and then permitted to ensure that there is no undue profit
mongering.
• ECB for infrastructure finance by FIs/NBFCs may be considered to be
put in the automatic route upto $500mn and in the approval route beyond
that limit.
• NBFCs should be allowed to access ECB for funding both equipment and
projects and not to restrict ECB for just imported equipment.
• NBFCs financing import of infrastructure equipment should be subjected
to ECB with the minimum average maturity of 3 years (from the present
 5 years) and should be allowed to access through automatic routes also(at
present this is covered under approval route.)
• At present utilization of ECB proceeds for working capital requirement is
not permitted. However, there is need to permit this for companies in
infrastructure projects.
• Tarapore Committee Report on ECBs:
o ECBs of over 10 years maturity should be outside the overall limit
without call/put options upto 10 years.
o ECB denominated in Rupees should be outside the overall ECB
limit.
o The end use restrictions on ECBs should be removed.

• Suggestions by RBI on Rupee lending by MFIs:

• we may permit select entities (Foreign banks/MFIs to
borrow rupee resources to onlend domestically. However, to limit
such activity, the quantum of rupee funds permitted to be raised
may be capped at, say, 25% of the foreign funds brought in by that
entity. The limits may be revised in due course.

• such foreign entities/MFIs could also have tie ups with

select domestic FIs which have long experience in raising Long
Term funds and also having specialised skills in project evaluation
& monitoring.

• we may consider allowing these entities to raise resources in

India through innovative design of instruments to incentives the
domestic retail investors.

• the current stipulation that the rupee funds raised

domestically should be directly lent to infrastructural projects may
be relaxed to encourage lending activity. Lending to entities
directly associated with infrastructural projects (SPVs like IIFCL)
may also be considered. It may however be noted that there is no
particular advantage in indirect lending through intermediaries
like banks.

• However, resources are already scarce in the domestic

rupee market. If foreign banks are allowed to access rupee funds it
could put pressure on interest rates

• Domestic entities-banks, FIs, NBFCs, Corporates should be

able to borrow from abroad-borrowing process to be appropriately
liberalized making the borrowing rate economical and protecting the
exchange rate risk. The Government may step in with appropriate
guarantee or set up an SPV to do the same for the purposes of
transparency.

• Swaps could be allowed to specific institutions with sound

financials/track record and such borrowings need to be capped.
 • Forex rupee swaps may be made more flexible for MFIs. It
may be appropriate for MFIs like ADB to enter into swaps directly with
banks/FIs operating in India which may consider such arrangements
advantageous on commercial consideration and on a voluntary basis.
However, such an approach also should not involve any implicit or
explicit GoI guarantee. Presently, IFC has been permitted to swap the
rupee proceeds into foreign currency. The stipulations laid on end-use of
the funds generated out of foreign currency are required to be lent within
ECB framework.

• There are suggestions for making available moderately

priced hedging instruments for MFIs so that currency mismatch of the
revenues and the liabilities can be hedged. RBI may consider extending
hedging facilities to MFIs on the similar lines as extended to FIIs.
Currency swaps as mentioned above suffers from non-availability of
supplier of long term rupee resources and users of long term foreign
resources.

• Current guidelines permit only forward cover with tenor

restrictions for FDI related exposures. Though there are other types of
instruments available in the domestic foreign exchange markets, only
authorized persons resident in India are permitted to use the same. In
any case, any hedging activity in the domestic foreign exchange markets
must be undertaken using only permitted instruments and benchmarks.
Specific cases may be examined subject to Government of India
recommendations and also likely market impact.

• Some form of liquidity and/or prepayment insurance

should be provided by Government or Government sponsored agency
with insurance cost borne by the Government. This may be replaced by
sophisticated hedging instruments after the market develops and gains
some depth and liquidity.

• Internationally there are specialised companies that

provide insurance against defaults in part or in whole.Loan/bonds that
are insured are said to be credit wrapped and the insurers who provide a
single layer of insurance are called monocline bond insurers. These are
international 'AAA' rated agencies that are not keen to credit wrap
Indian loan exposures as India has a 'sub investment' grade rating. Credit
derivatives can help manage the credit risk of banks as they provide an
efficient mechanism for the transfer of risk. Internationally the presence
of credit default swaps and credit linked notes helps in transferring credit
risk from the banks and FIs to the financial markets. A conducive
environment for such instruments should be created.

• Deepak Parekh Committee Suggestions:

i) Steps for improving FII participation

The existing debt FII/sub account limits (in USD billion) is as follows:
 100% Debt Scheme 70:30 Scheme Total
G-Sec/T Bills 2.0 0.6 2.6
Corporate Debt 1.0 0.5 1.5
Total 3.0 1.1 4.1

Currently these limits are allocated to FIIs by a bidding process which

results in low absolute limits for each FII, weakening their incentive to
actively utilize their allocated limits. What little trading that takes place
under these limits is largely motivated by arbitrage. Hence, to ensure that
the limits get better utilized and attract genuine long term investors as
opposed to arbitrage traders, the following recommendations are made:
a. Replace the existing allocation process with a first come first serve
rule for both the schemes.
b. Provide withholding tax exemption to FIIs / sub accounts investing
through these schemes.
c. Once the limits start getting sufficiently utilized, an additional
limit for investment in long term debt instruments issued by
infrastructure companies should be considered.

ii) Separate treatment for infrastructure holding companies

At present, most developers such as L&T, Gammon, GMR Infrastructure,
etc., house all their infrastructure investments in a holding company as a
separate business from that of the parent company. These holding
companies get classified as NBFCs under RBI guidelines due to their
income and asset patterns being largely financial in nature. This puts
several restrictions on the holding companies as enumerated below:
a. Compliance with stringent regulatory requirements applicable to
regular lending NBFCs.
b. Limits on bank borrowing by these companies
c. ECBs not allowed under the automatic route
d. FDI investment in these companies not allowed without RBI
approval
e. Investment in these companies by registered venture capital funds
is subject to regulatory approval

Since the holding company corporate structure (such as L&T

Infrastructure Development Project Limited) facilitates infrastructure
development, they need to be treated as a separate class of NBFCs (say
infrastructure NBFCs) exempt from these restrictions. Specifically, the
infrastructure holding companies should be allowed to raise FDI under the
automatic route.

iii) Refinancing through ECBs

The existing guidelines do not permit raising ECBs for refinancing existing
rupee loans. Foreign financers may not be keen to participate in projects in
early, risky stage but may be willing to do so after certain period when the
risks subside. To facilitate foreign financers’ entry at that stage and thereby
enable Indian lenders to fund other projects, refinancing should be allowed.
 iv) Relaxing the all-in-price ceiling for subordinated and mezzanine
debt
The current ceiling of LIBOR+350 basis points for ECBs makes it difficult
for the issuers to raise subordinated debt, mezzanine financing or quasi
equity as the maximum permissible return is not considered enough to
match the perceived risk. Keeping in view the long term nature of
infrastructure projects and the need for risk capital (in the form of quasi
equity), this all-in-price ceiling on ECBs should be removed for
subordinated and mezzanine foreign debt for infrastructure projects.

Suggestions to create specialised long term debt funds:

• There is strong case for creation of specialised long term debt
funds to cater to the needs of the infrastructure sector. There is need to
enable registration of rupee debt funds within the SEBI venture capital
framework. RBI should not treat investments by banks in such close
ended debt funds as capital market exposure. Similarly, IRDA may
consider including investment in SEBI registered debt funds as approved
investments for insurance companies. These debt funds may also be
required to invest a maximum of 33.33%of the investment funds in listed
debt securities. Rupee debt funds should be given the option to list
themselves on stock exchanges after a period of one year from financial
closure. These debt funds should receive the same treatment as VC funds.
Investments in these debt funds should not be subjected to 'capital
market' exposure limits that the RBI applies to equity investments for
banks. Rather they should be treated in the same manner as bank
investments n bonds and/or debentures and should be accorded the same
risk weightage as applicable to normal infrastructure credit. IRDA, the
Central Board of Trustees of the EPFO and the proposed pension fund
regulator should modify their respective investment guidelines to permit
insurance companies, PFs and gratuity funds, pension funds to
invest/commit contributions to SEBI registered infra debt funds. At a
stage considered appropriate by RBI, FIIs may also be allowed to
participate in SEBI registered infra debt funds.
• RBI's suggestion on specialised debt funds:
o RBI agrees with the recommendation that investment in
units of 100% Debt Funds should not be reckoned as capital
market exposure. As regards capital requirement, it is felt that
there is no concessional risk weight applicable to normal
infrastructure credit although banks are allowed a risk weight of
50% on their investment in securitized paper (with AAA rating)
pertaining to infrastructure facility if the infrastructure facility
generates income/cash flows which would ensure
servicing/repayment of the securitized paper. While Debt Funds
meeting these requirements will become eligible for the risk weight
of 50%, the same treatment may not be accorded to all SEBI
registered debt funds. FIs could create “Infrastructure Debt
Funds”, wherein MFIs like ADB, DEPFA and DEG could invest.

Use of Foreign Exchange Reserve in financing Infrastructure

A number of suggestions have been made regarding effective utilization of
India’s forex reserves for various productive purposes. On every occasion in the
past, RBI had expressed its inability to accept the suggestion on the grounds that
such a move would not be consistent with the objectives of reserve management,
which requires reserves to be maintained in extremely liquid and safe external
assets to serve their purpose. Besides, the arrangement would contradict
international norms for reserve management. It is evident that making available
India’s forex reserves to fund infrastructure would result in a depletion of
reserves as the portion of reserves lent to domestic entities, either directly or
through SPV, would lose the character of reserves and could no longer be
counted as part of India’s forex reserves. Besides, there is a possibility that a
portion of amount lent to domestic entities will flow back to RBI as reserves with
attendant problem of sterilising such inflows and implicit costs associated with
such sterilization operations. It may be mentioned in this context that the Union
Finance Minister in his Budget Speech for 2005-06 announced the setting up of a
financial Special Purpose Vehicle (SPV) for financing infrastructure projects in
specified sectors. The Budget Speech stated that in case of implementation of
large infrastructure projects, the foreign exchange resources could be drawn for
financing necessary imports. The proposed SPV has since been set up.

♦ If infrastructure needs are financed through foreign exchange resources,

then the issue of exchange risk, as to who will be bearing the exchange rate
risk, is also to be addressed.
♦ If the foreign funds received by domestic entity are not used for import,
they may result in excess domestic money supply and there will be
sterilization cost for the same.

This has to be consistent with prevailing monetary and exchange rate policy. If
reserves are used to fund infrastructure, it is no longer available as 'reserve' and
the primary purpose for which it is created, i.e., the monetary and exchange rate
management, is defeated. As long as there is no dearth of liquidity in the
market, releasing reserves for infrastructure projects would not lead to the
desired results and they would simply come back to the RBI as future accretion
of foreign exchange. Further, to the extent they act as a cushion against
prevailing liquidity risks, investing reserve in infrastructure projects involving
gestation lags would create maturity mismatches.

Deepak Parekh Committee on use of Forex reserves:

The committee believes that there is a need to find out suitable structures that
can effectively help in channeling these reserves for investments in infrastructure
projects without the risk of monetary expansion. The following structures
provide starting points for exploring such a mechanism:

v) Externally focused investment arm

A company will be set up in a foreign country with the Government of
India (through say IIFCL) being the sole contributor of funds to this
company. The mandate of this company will be to invest in creation of
infrastructure outside India, only of the kind that would either supplement
 India’s infrastructure needs or help in sourcing raw materials for domestic
development. For example, the company can invest in power projects in
Bhutan/Nepal with an understanding that they will supply part of the
power generated to India, or invest in gas pipelines construction up to the
Indian border. Also, the company can provide support to Indian oil and gas
companies to acquire assets overseas which would facilitate India’s
infrastructure development.

vi) Monoline credit insurance company backed by foreign exchange reserves

Monoline credit insurance companies are basically credit enhancement
agencies that offer “credit wraps” for a one-time upfront fee. The monoline
insurance company can be set up by IIFCL with a thin capital in a foreign
country. The company can then raise long term foreign currency bonds
which would be subscribed by RBI out of its foreign exchange reserves. The
funds so raised will be deployed in highly rated collateral securities (e.g. US
Government bonds). Backed by such collateral, the insurance company
will provide credit wrap--for an appropriate market-determined fee--to
infrastructure projects in India for raising resources from international
markets. The provision of credit wrap will improve the credit rating of such
projects which in turn will help the issuers in lowering their borrowing
cost, issuing longer tenor instruments, raising higher amount of debts or
expanding the investor base for the instruments being issued.

Miscellaneous Suggestions:

• Allow private sector to issue zero-coupon bonds by changing the

present guidelines which are too restrictive.
• Allow insurance and pension funds to participate in a bigger way.
Now insurance companies cannot lend more than Rs.150 cr per single
projects.
• To bring clarity as to what constitutes infrastructure, the
definition of infrastructure under various regulation (such as those
relating to banks and insurance) and Acts (such as Income tax Act) needs
to be harmonized. It is suggested that the RBI’s definition provided in
Annexure I of Circular dated October 10, 2006 be adopted as the
definition under IRDA (Registration of Indian Insurance Companies,
2000) as well as under the Income Tax Act, with the only exception that
the definition should explicitly include pipelines.
• Re-examine partial credit guarantee of ECBs by domestic banks as
these funds are virtually ruled out in infrastructure sector due to long
gestation period, inadequate credit rating in the early stages etc. Since
domestic banks will be short on resources, partial credit guarantee by
domestic banks may be re-examined.
• Relax cap on debt FIIs and give freedom to them to invest in the
long end of debt market: This liquidity needs to be fuelled by satisfying
pension funds demand for long term assets to match their long term
liabilities. Infrastructure project bonds backed by monocline-AAA credit
enhancement will appeal to such investors and globally such assets have
yielded 3-5% higher average returns than similarly rated fixed income
 bonds of the same tenor. Currently there is a cap of $1.5 bn on debt FIIs
to invest in the debt market and most of this is invested in the short end of
the market. The cap should be relaxed and the investors such as
international pension funds must be given the opportunity and freedom to
invest in the long end of the market.
• Government should consider allowing some highly credible
infrastructure developers (net worth > Rs.500 crore, infrastructure
assets/investment base > Rs.5000 crore on a consolidated or group basis)
to raise tax free bonds or partial tax credit bonds.
• Set up a 'guarantee corporation' institution that is purely in the
business of providing financial guarantees to enhance the credit rating of
projects. These institutions can be government or quasi-government
bodies or specialised financial institutions set up by the Government.

Appraisal of PPP Projects:

• Very few institutions like SBI Caps, ICICI, IDFC, UTI Bank and
IL&FS are appraising the projects and thereafter take steps for
syndication of such loans.
• The lead bank having the maximum share is selected in the inter-
institutional meeting.
• Some of the institutions who participate in the meeting do not
participate in funding of projects and earn fee based income for
appraising as well as loan syndication of these projects.
• The lead bank normally goes by the appraisal done by the
appraising institution.
• 80% of these projects are funded by public sector banks.
• There is need for proper appraisal cells at least in the large public
sector banks-it will not only enable them to earn a substantial fee based
income but also create confidence amongst the banks/FIs that such
projects have been appraised by institutions having taken a larger share
of funding.
• It is very difficult to rate the SPV at its initial stage. The rating is
done on the basis of financial and non-financial parameters but
infrastructure SPV's financials are not available at a nascent stage. The
only comfort could be that SPVs are being created by established group.

Initiatives already taken or proposed to be taken:

Viability-Gap support

The salient features of the scheme are:

a) In order to be eligible for funding under this scheme, the PPP

project must be implemented, i.e. developed, financed, constructed,
maintained and operated for the project term, by an entity with at
least 51 per cent private equity.

The eligible sectors include:

 i) Transportation: Roads and bridges, railways, seaports,
airports, inland waterways;

ii) Power;

iii) Urban Development: Urban transport, water supply,

sewage, solid waste management and other physical
infrastructure in urban areas;

iv) Infrastructure projects in Special Economic Zones; and

v) International convention centers and other tourism

projects.

vi) Any other sector can be added by the Empowered

Committee with the approval of the Finance Ministry.

b) The total Viability Gap Funding under this scheme shall not
exceed twenty per cent of the total project cost. The government or
statutory entity that owns the project may provide an additional 20%
grants out of its budget.

c) The implementing agency must be selected through a transparent

and open competitive process.

d) The bidding criteria would be the amount of VGF sought.

e) Viability gap funding under this scheme will normally be in the

form of a capital grant at the stage of project construction. Proposals
for any other form of assistance may be considered by the Empowered
Committee and sanctioned with the approval of Finance Minister on a
case-by-case basis.

f) While 38 projects have been received under VGF, sixteen projects

have been given ‘in principle’ approval. Steps are being taken for the
preparation of a PPP manual giving details of PPP procedures.

Special Purpose Vehicle (SPV)

• Government have approved the setting up of a SPV for the

purpose of providing long-term debt to infrastructure projects. The SPV
will borrow money against Government Guarantee and on-lend these
funds to the infrastructure projects. This is expected to ease the asset
liability mismatch of the financial institutions and lower the cost of long-
term debt.

• Pursuant to this, a scheme has been drawn up and a Non-Banking

Finance Company (NBFC) called India Infrastructure Finance Company
Ltd. (IIFCL) is being set up. The IIFCL office opened for business on
March 13, 2006. It is presently trying to build a network within the
financial community. It started working with a capital of Rs.10 crores.
The equity contribution of Rs.90 crore, as provided in the Union Budget
 2006-07 has been received. With this, the paid up capital of the company
has gone up from Rs.10 crore to Rs.100 crore as against the authorized
Capital of Rs.1000 crore.Approval of the Government guaranteeing the
first part of the company’s borrowing programme for the year 2006-07,
amounting to Rs.5,000 crore, has been received. The guarantee is subject
to payment of guarantee fee payable at the rate of 0.25 percent per
annum, in advance. IIFCL proposes an ECB of $1 billion and is seeking
Government approval for a domestic bond issuance of Rs.12000 crore in 4
tranches of Rs.3000 crores each. A number of proposals for financing
have been received by IIFCL. The Board of Directors of IIFCL has
approved 47 credit proposals involving assistance from IIFCL amounting
to Rs.8810 crore. The salient features of this scheme are:

a) The IIFCL will borrow money from the markets on the strength of
Government guaranteed bonds. These will be long duration bonds
(more than 10 year maturity). The IIFCL can also raise money from
organizations such as the World Bank, Asian Development Bank etc.
and international debt markets, i.e., External Commercial Borrowing
etc.

b) It will then lend this money to viable infrastructure projects. The

projects may be sponsored by any entity, whether in the public or
private sector or by a joint venture. Preference will be given to Public
projects and Public Private Partnership Projects.

c) The IIFCL will fund projects on the strength of appraisal done by

the lead Financial Institution. Disbursements and recoveries will be
‘pari-passu’ with senior debt and will be done through the lead
financial institution.

d) Lending may be in the form of direct loans or through Financial

Institutions (Refinancing). The extent of loans will be 20 per cent of
the cost of projects or less. Cost of land provided by Government will
not be funded.

Infrastructure Finance Initiative:

• There will be a $ 5 bn fund with three distinct parts of $1 bn, $1 bn

and $3 bn. The plan is to deploy about $2 bn in equity capital and $3 bn
in long term debt financing with maturities exceeding ten years.

• IDFC, Citigroup and Blackstone would contribute USD 75-100

million each (together around $ 250 mn) to the first equity fund of 1
billion with the remainder to be raised from the market over a period of
4-6 months from the date the agreement is finalized. The second equity
fund of USD 1 billion would be raised in the subsequent twelve months
from reputable international investors as well as selected domestic
institutional investors including IIFCL.
 • An additional USD 3 billion would be raised in foreign currency
debt financing to be included as part of the overall initiative as ECB
funding on account of IIFCL on a pre-approved basis in the context of
ongoing discussions between the Ministry of Finance and the RBI. This
amount would be raised in several tranches as a concrete pipeline of
projects becomes visible.

• A tripartite agreement was signed between IIFCL, IDFC,

Blackstone and Citigroup on February 15, 2007 for the deployment of
these funds into infrastructure projects, including those for which equity
is provided by the IDFC/Citigroup managed equity fund. The IIFCL
would contribute USD 25 million to the Equity Fund as part of this
tripartite agreement.

Revolving Fund for Project Development:

• FM announced the setting up of such a fund in the 2007-08 Budget

Speech.
• It is intended to set up a revolving fund of Rs. 100 cr to quicken
project preparation. The fund will contribute up to 75% of the
preparatory expenditure in the form of interest free loan that will
eventually be recovered from the successful bidder.
• The framework for the fund is being prepared in consultation with
the stakeholders.
• Although a small initiative, thisis expected to be very useful and
help the smaller States and municipal bodies to prepare projects.