Project Finance in Indi1 Intro

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project finance in India

SUPPLEMENT - INDIA - July 12, 2001

Introduction

Infrastructure development was a sector that received enthusiastic attention from the early daysof Indian liberalization. India was the promised land, with an abundance of large projects atvarious stages of conceptualisation a hundred or so power projects, scores of telecom projects,many infrastructure deals. A decade later, the enthusiasm has ebbed considerably and several

projects lie by the wayside, for want of debt or equity. Developers are tired, and seem to bewilling to give the promised land a pass for the time being. Some part of this exhaustion may be

well founded, but myth and exaggeration have contributed to some degree as well, in creating aninvestor-unfriendly image. This article attempts to provide an insider's perspective.

The truth is that India needs infrastructure and there are deals to be done. Foreign investment(whether debt or equity) is welcomed with open arms, and restrictions are reduced literally on adaily basis. More importantly, there are local resources available. The Indian institutions bothsource and provide long-term funds. Money for 10 or 12 years is available. The bond market for long-term infrastructure projects is developing, albeit slowly. Indian developers and financiersare developing sophistication in financing techniques. They understand risk. They understandlimited resource finance. Some can even match expertise with the best in the world. A

professional community of advisers legal, financial and sector experts has also emerged. The

legal system, albeit slow in resolving disputes, is as sophisticated as any in the world. There istruly a rule of law. The basics exist. As in the early and mid-nineties, one would have expectedthe streets to be lined with eager financiers and advisors. Why then, is the pace of infrastructuredevelopment so agonisingly slow?

Before an analysis of the causes, a quick snapshot of the status of a few key sectors isappropriate.

Power

'Fast track' projects (eight in number) they say is a misnomer. True. A few of them that had

Government of India counter guarantees did achieve financial close and even generate power. Nearly half fell by the wayside and are all but dead. Amongst the closed projects is one thatrenounced the counter guarantee (a lesson there perhaps). Several medium-sized projectsincluding Balaji, Samalpatti and PPN Power Projects in the State of Tamil Nadu, the power

project established by Jindal Tractabel Power Corporation in the State of Karnataka, and theKondapalli Power Project in the State of Andhra Pradesh, did close. There were no counter guarantees and substantially the funding was from long-term Indian lenders. A creditableachievement.


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This article has been written at a time when the power industry is suffering the negative imagesof the Cogentrix and Enron controversies. Recently, AES has announced its dispute with another state government. There is no denying that this incessant bad news has shaken investor confidence. However, it should also be noted that many other projects are generating power andare being paid. A lesson to learn from this may be for developers, their advisers and the

authorities, to be aware not just of project risk, but of the possibilities for the attainment of dealsthat are workable. This is where the emerging talent in India lies, in achieving workable projects.

That being said, projects ahead of their time and ahead of reforms in the distribution sector, inthe absence of strong payment security mechanisms, may need to live with a sense of insecurity,at least until sector reform is credibly done.

Considerable progress has been made in several states in this area, albeit mostly on paper. Tariff reform began in 1998 with the enactment of the Electricity Regulatory Commissions Act 1998,and many states either established Electricity Regulatory Commissions (ERCs) under thislegislation or under special legislation enacted for this purpose. The role of the Central

Electricity Regulatory Commission primarily is to regulate the tariffs of generating companies inrespect of inter-state generation and transmission, to promote competition, to frame guidelines inmatters relating to electricity tariffs, and to arbitrate or adjudicate on tariff disputes. The ERCs insome states, including Maharashtra, Orissa, and Andhra Pradesh, have been active and passedtariff orders. The recent order by MERC mandating "merit order despatch" has invited criticismsince it implicitly overlooks the take or pay regime, and has been used to excuse the utility fromdespatching power. It was a hot summer and probably the older plants must have run at peak load, if the utility did not despatch Dabhol power for long periods, based on this order. Theairconditioners certainly worked!

States such as Andhra Pradesh, Haryana, Orissa, Uttar Pradesh etc have introduced special

legislation to unbundle the sector, with the establishment of separate generation or transmissionentities and one or more distribution vehicles. Orissa moved ahead more rapidly than others andestablished four Distribution Circles with a view to privatizing each of them. Though completed,the privatization of distribution in Orissa has not been the success originally envisaged. This areaof power sector reform requires urgent attention and lies at the heart of the reform in the entireelectricity sector.

A key area of reform relates to the new proposals on payment security. The mega power project policy was announced a few years ago. The Hirma, Pipavav and Ennore power projects werelisted for this purpose. The mega project status conferred special benefits including tax benefitsand preferred payment security through escrow or other arrangements. Like the 'D' Project, theseare also monster-sized projects and are moving in a stop-start fashion. In the absence of credible

payment structures, these mega projects are not bankable. True that with the intervention of thePower Trading Corporation (PTC), the ability to sell the power to more than one state should, intheory, spread the risk. But neither the credit standing of PTC nor the states in question haveinspired the requisite confidence. The crux will be the innovation of a payment security structure.Amongst the options explored include the creation of a charge on the Consolidated Fund of India, or of the state government, direct payment instructions to the Reserve Bank (to debit staterevenues), creating an overriding legislative charge on state revenues from particular sources of


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tax. The constitutional efficiency of these is a matter of debate and there is little precedent.Clearly these are long-haul projects and will undergo several fits of activity before they reachtheir final outcome.

Telecom

Quite like the power sector, major initiatives have been taken to develop telecom infrastructure.However, unlike the situation with power, as any India watcher will tell you, there has been atelecom revolution of sorts with fast-moving technology, the provision of world-classtelephony has been a reality in many parts of India. The process, which began in the earlynineties, had its share of hiccups.

The liberalization of telecommunications started with the invitation for bids for the introductionof private CMTS operators in 1992 and the issue of the New Telecom Policy of 1994. A biddingwar ensued, and so did litigation over the manner of the award of the tenders. Eventually the

process was straightened out and licences were awarded, with the government earning

unprecedented revenue therefrom. The provision of CMTS services began in 1996 and quicklythereafter the operators realized that they had made their bids on the basis of overly optimistic business projections. The high cost of network roll-out, coupled with abysmally low penetrationlevels, rendered the operators unable to meet their licence fee obligations. Faced with a sinkingindustry, the government announced its revised telecom policy statement, the National TelecomPolicy 1999, better known as the NTP 99.

The NTP 99 introduced the bedrock of today's industry, with the 'revenue-sharing' formulasubstituting the fixed tariff licence fee regime of the previous policy. This policy, in addition torestating the basic tenets of the old regime, also resulted in (a) recognition of technologicaladvancements, (b) introduction of new categories of licences, (c) state-run operators obtaining

licences on the same terms and conditions as private players, thus creating a more level playingfield, and (d) rationalization of the rules regarding foreign direct investment. The NTP 99 alsoenvisaged the end of state-run monopolies in international and national long-distance telephony,and the corporatization of the DOT. This last item has already occurred, and the DOT's operatingdivision was hived off into a distinct corporate entity, the BSNL.

In the meantime, the TRAI the telecom watch dog was created under its parent statute of 1997. For the first time, private players had a forum that was inexpensive and made relativelyquick decisions to air their grievances. At inception, the euphoria of its existence cloaked its lack of powers over the combined policy maker, regulator, and dominant player in the market, ie theDOT. Time and litigation delineated the scope of the functions and powers of TRAI. Thereenactment of the TRAI Act in 2000 brought a fresh lease of life, albeit with greater restrictionson its essential powers, to the TRAI. The main amendments related to the process of disputeresolution between stakeholders in the industry.

More recently, the industry has seen the introduction of new licence categories, including inrelation to the provision of optic fibre backbone and national long-distance services. Essentially,the backbone providers have been licensed in two categories, one to provide ducts and dark fibre,and the other to provide capacity. The former permits 100% FDI and requires only registration,


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and the government expects to see a main chunk of the investments enter this sector. Thegovernment has also liberalized the rules regarding the establishment of private internationalgateways, vide submarine cable and satellite uplinking. Restrictions on the use of the Ku bandare expected to be lifted shortly.

The huge initial outlays that were required have resulted in a phase of consolidation, both of markets and of players. The major players have acquired interests in circles so as to create larger base footprints along the vital north-south corridors, and especially to link the two cities of Delhiand Mumbai. Hutchison and BPL two of the largest operators have begun to consolidate their holdings in each of their respective circles, whilst the merger of Birla AT&T and Tata Cellular has created a telecom behemoth. In the non-voice areas also, investments by players such asSatyam and Dishnet, have tended to concentrate on the creation of retail and connectivityinfrastructure, a move surely influenced by the entry of PCC into the ISP and gateway markets.

The financing of the industry was, until recently, achieved by working capital and intercorporateloans, in addition to the regular equity and vendor funding routes. However, with the anticipated

closing of the Shyam and Hughes fixed telephony projects, project financing appears to havefinally come into play. This should once again contribute to the further development of vitalinfrastructure facilities, playing to the governments NLDO and backbone imperatives. Alreadysome of the early effects of this policy are being felt in the spurt in the establishment of data andcall centres, making India, literally, the land of the back office.

The key issues in relation to telecom projects and investments in India continue to be the highcosts of network roll-out, especially the acquisition of rights of way, allocation of spectrum andthe continuously changing policy, as typified most recently by the controversy over permittingthe use of WiLL technology by fixed line operators and the allocation of vital spectrum to suchuse. A final decision is expected in this regard towards the end of this month. Other issues that

would affect players include the lack of a definitive interconnection regime, by law or bycontract, caused largely by the existence of a captive monopoly in the hands of the BSNL andMTNL.

The continuing disinvestment process, the announced early dismantling of VSNL's monopolyover international voice telephony and the introduction of internet telephony, coupled with thedecision to pass both the Communications Convergence Bill and the proposals to lift restrictionson the use of the Ku band during the next parliamentary session, should see a continued inflowof investment to this industry.

Other sectors

There has not been much activity in the other infrastructure sectors, such as roads, ports, water and urban infrastructure. A few ports have been successfully privatised, mostly in the state of Gujarat, such as Pipavav and Mundra. All of these have been completely funded by domesticlenders.

In the roads sector, there has only been one project that closed on a project finance basis theDelhi-Noida highway. In the short run, it has been easier to develop these projects


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may incur debt of up to $50 million and developers of infrastructure projects may access foreignexchange funds of up to $200 million for the purpose of equity investments in downstreaminfrastructure projects, without any approvals being required for the same. Procedurally, it hasnever been easier for Indian corporates to borrow foreign funds.

Independent regulators and dispute resolution

Each sector needs special regulation. Independent regulators have been and continue to beestablished for each sector, to provide the industry and technical expertise. Teething troubleshave obviously arisen, and turf wars are not uncommon. However, as with some of the earlier experiments with tribunalization, the system should mature with time and familiarity.

Different litigation forums for foreign and Indian lenders, coupled with the lack of clarity of theDebt Recovery Tribunal's powers, and the delays associated with the civil judiciary, appear tohave been overcome through inter-creditor arrangements, which now form the cornerstone of multi-lender financing.

Key causes for slow development and outlook for the future

The past decade has taught India many lessons in improving its ability to attract and retainserious investment in the infrastructure sector.

The lack of a policy framework and the sometimes poorly conceived policy initiatives seem tolie at the heart of the difficulties of the infrastructure sector. These added not merely legal risk,

but also significant commercial risk. Obviously the lack of regulatory clarity on certainty of revenue streams, as well as competitive forces, did undermine the viability of projects. Some of the above problems have been exacerbated by the lack of an independent regulator, though in

certain sectors, one is not sure if this has been a blessing in disguise.Other factors for the perceived failure include the lack of well-laid bidding and procurement

procedures, which earlier did lead to time consuming litigation. The initial phases of opening upa sector had necessarily to be a negotiated process, and experiments with internationalcompetitive bidding procedures were not always warranted. A few experiments in the auctioningof licences, such as in the telecom sector, had the advantage of induced competition, but the lack of clarity in the policy framework, the licensing conditions and a perceived lack of transparencywere the causes of excessive initial delays.

The fear of the uncontrollable judicial process and its expansive view of locus standi, resulting in

multifarious public interest litigation and the consequent inevitable delay to the project, alsocontributed to increased levels of anxiety for both developer and lender.

The list does not end there. The lack of coordination between the central and state governments,coupled with the lack of quality governmental agencies/advisers that were acquainted with thecomplexities of financing models, and the inevitable fears of a large and uneducated labour forcecaused a lot of hesitation towards and unnecessary suspicion of foreign investors. In fact, manyutilities and agencies did believe that private financing, particularly with foreign investment,


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were essentially western conspiracies to exercise economic hegemony. Experienced advice andconfidence building have made the difference in recent years.

The government and the players have realized that it takes a lot more than desperation and publicneed to achieve the financial closure and successful operation of infrastructure projects. A

number of policy measures have been announced to overcome the earlier shortcomings, andfurther such announcements are in the offing. A major development in this regard is theconsolidation of the many earlier, sometimes conflicting, notifications on foreign investment.

The government has also realized the need for, and obtained expert advice on the method andmanner of developing the various sectors. An offshoot of this is the disinvestment process,whereby the government has started to off-load its stake in key industries to private participants.The silver lining of this process is not just that the units are already entrenched, but are alsolargely profit making and suitable for expansion.

The judiciary has now clarified many issues relating to the procurement process, and had

strengthened the hands of the government in determining the scope and manner of private participation in public utilities. Certain basic concepts relating to locus standi have been clarifiedand vexatious litigants have been curtailed, by measures including the imposition of penalties.

Industry associations and other non-governmental bodies have also started many initiatives toeducate both the public and the regulatory authorities on public-private partnerships in keysectors. Seminars, conferences and other discussion fora, on topics and issues related toinfrastructure development and financing, are now a commonplace feature on literally anyIndian's calendar. Editorials and opinions are also more focused on the need for an elimination of

political posturing from infrastructure development.

Increased industrialization, the growth of GDP and control over inflation should, in conjunctionwith the above, contribute to make India a more investor-friendly location that ever before.

In conclusion, there is no gain saying that developers and financiers will continue to require agreat deal of understanding, patience and perhaps an enduring belief in karma. However, there isa large viable infrastructure market waiting to be developed on a project finance basis in India,

probably one of the largest in the world and real gold at the end of the rainbow for those willingto go the distance.

Project Finance in Indi1 Intro

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