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 nonrecourse/ 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', 'cashflow 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 loansForeign 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 Project Finance Corporate Finance Hybrid Finance-equitydebt mix, quasi-equitydebt mix, corporate finance-project finance mix Bond Finance Use Capital Intensive and Long Gestation Project Financially viable low risk Projects by reputed Corporate Groups At the construction phase Comments Preferred Option Few cases Used by established ventures.

Long Tenor Bank/FI Loan

Projects of established Infrastructure Companies and Companies with Government backing Difficult to find

Bond Market is underdeveloped

Asset-liability Mismatch

Takeout Finance

Confined to 'lender syndicates'

One syndicateconstruction period, Another syndicateOperation and Maintenance Stage Smaller utilities have tapped the bond markets through this. Higher return than secured debt and share in the 'up side' risk of the project.

Securitisation Pooled Finance based Instruments Mezzanine Financing

Toll receivables of several Road Projects Municipal Finance Limited use so far

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. Equity1. 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. 2. 3. rights 4.

Limited exit options constrain equity participation A Shallow Capital Market Corporate Governance Issues and minority shareholders' 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-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 etc1. 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 Indias 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 crossborder 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 Committees 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 RBIs 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 Borrower of % Additional with Limit General Board approval 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-tosell 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--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 postconstruction 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:

G-Sec/T Bills Corporate Debt Total

100% Debt Scheme 2.0 1.0 3.0

70:30 Scheme 0.6 0.5 1.1

Total 2.6 1.5 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 Indias 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 Indias 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 Indias 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

Indias 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 Indias 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 RBIs 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 interinstitutional 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 projects. and other tourism

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 longterm 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 companys 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.