Sources of Funding in Infrastructure Sector

Table of ContentsLiterature Review3Sources of Funding in Infrastructure Sector3Introduction3Infrastructure Spending Break-Up4Means of Infrastructure Funding5Commercial Lending6Bonds6External Commercial Borrowings6Foreign Investment Funding7Multilateral Agencies Lending7Insurance/pension funds7Grants8Visibility Gap Funding8Private Sector Capabilities8Why is Infrastructure funding different from other sectors?9Risk related to investment in Infrastructure Projects9Analysis of Infrastructure Development Finance Company12Introduction12IDFC Alternatives12Key Businesses12Corporate Finance13Investment Banking And Institutional Broking13Alternative Asset Management13Public Markets Asset Management14Higher Provisioning14Risk Management14Asset Liability Mangement15Conclusion and Recommendations15References16Exhibits16Exhibit 1: Standalone Balance Sheet of IDFC16Exhibit 2: Profit and Loss Statement of IDFC18

Literature ReviewWith the financing requirement in infrastructure sector, predictably, exceeding $1 trillion by 2016, the study of various sources that will contribute to this huge need and the analysis of various parameters associated with these sources become extremely important. In the near past, this sector was majorly financed by the public sector with a share of 5% of GDP as compared to China with a 14.4% of GDP [IDFC, Jan 2009]. To keep pace with the developed nations and to enter into the, so-called, big league, India needed severe investments in this sector. Private players, on the smell of massive opportunities, started to invest in this sector, cashing in on the major opportunities. Today, more than 50% of these investments come from the private sector, thereby actively participating in the growth & development of the country. A new model of investment started with a PPP i.e. Public private partnership where the public & private sector work together bringing in the respective strengths, improving productivity, efficiency & changed the way infrastructural projects were financed. Various sources & kinds of financing options began to roll out with major participating from commercial banks, institutional investors, long term investors & even foreign funds started to flow in [Vinod Kothari Consultants, July 2010]. This is a capital-intensive industry with high long-term initial investments & low subsequent operating expenses. Returns begin to flow only on a long-term period. Holding the investors for such a period, keeping their faith alive needs sufficient planning in designing various investment options with/without government support. We have tried to analyze the topic from the point of view of IDFC, an infrastructural finance company, where we looked into the business operations of infrastructural management companies, the risk management of investing in the sector, the asset liability management & the overall results achieved. Sources of Funding in Infrastructure SectorIntroductionA modern, well-organized and widespread infrastructure is essential for a countrys economic growth. The Government of India has been consistently increasing its spending on the development of infrastructure capabilities to achieve sustainable economic growth of the nation. The nations infrastructure spending is expected to grow to 9.9% of GDP during the 12th Five Year Plan from 7.5% during the 11th.

Source: Planning CommissionThe 12th plan gives stress on the need for expanding infrastructure and increasing investments by the Government and Private Players in the form of Public Private Partnerships (PPP). Active Participation of the private sector is important to support countrys infrastructure development. Total investment in infrastructure during the 12th Five Year Plan is expected to be around $747b out of which at least 50% would come from the private sector.

Infrastructure Spending Break-UpTelecom, electricity and roads account for about 70 percent of the total investments and are likely to rise at a CAGR of 26 percent, 14 percent and 12 percent respectively during the 12th Five Year Plan. Infrastructure Spending in Different Sectors (12th Plan)

SectorsAmount (in Rs. Crore)% of Total Investment

Electricity138942031%

Roads and Bridges53784012%

Telecom116532026%

Railways3585608%

Irrigation4033809%

Water Supply and Sanitation1792804%

Ports448201%

Airports896402%

Storage448201%

Oil and Gas Pipelines2689206%

Total4482000100%

Source: Planning Commission

The Government of India is encouraging private sector participation in infrastructure projects in many forms. They are being used increasingly for construction and operation of infrastructure projects. This model will improve efficiency, reduce time and cost overruns and augment resource availability as compared to public sector ventures.

Means of Infrastructure FundingFormsDomestic SourcesExternal Sources

DebtDomestic Commercial BanksDomestic Term Lending InstitutionsDomestic Bond MarketsSpecialized Infrastructure Financing InstitutionsInternational Commercial BanksExport Credit AgenciesInternational Bond MarketsMultilateral Agencies

EquityDomestic DevelopersPublic UtilitiesOther Institutional InvestorsInternational DevelopersEquipment Suppliers FundsOther International Equity InvestorsMultilateral Agencies

The financial structure for a PPP project is usually 70-80% debt and 20-30% equity.Commercial LendingCommercial lenders are the largest financers of Infrastructure Projects in India. Infrastructure lending by commercial lenders rose over 36% through 2006 to 2011 (Rs. 1128 Billion to Rs. 5266 Billion). During this period the share of bank finance in the infrastructure sector as a percentage of gross bank credit increased from 2.2% to 13.4%. A huge amount of these funds was invested in the power sector (over 50%). The banks are now however on the verge of their maximum limits for lending towards the infrastructure sector. Another key problems faced by banks is the asset-liability mismatch problem, which arises due to the fact that longer duration loans required by the infrastructure projects need to be financed by shorter durations borrowings. The difference between liabilities and assets varies according to their maturity profile buckets. As the maturity time period increases, the liabilities surpass the assets and it results in asset liability mismatch for banks.As a solution to the asset liability mismatch, take-out financing has been developed. Such financing schemes involve three parties - Project Company, lending company and taking over institution (bank/consortium of banks/FI). The taking-over institution enters an agreement by which the lender transfers a part/whole of the outstanding to it on a pre-determined basis.

BondsBonds are issued in India by both Central and State governments, public sector undertakings, other government bodies, financial institutions, banks and corporates. Indian companies are allowed to issue bonds in Indian currency for trading on the corporate bond market in the country according to the existing regulations. Foreign institutional investors are permitted to invest in these bonds up to 995 billion rupees collectively, with 234 billion rupees in the infrastructure projects.

External Commercial BorrowingsExternal Commercial Borrowings (ECBs) are an important means of funding debt requirements of the infrastructure project. The number of ECBs extended depends on the interest rates in the country. They have been becoming cheaper over the years and developers are increasingly contemplating them as an alternate source.Firms in India raised about $637 million in December 2014. Companies such as L&T Finance are using the ECB route for its expansion. L&T infrastructure Finance raised over 4.2 billion through the ECB window last year.

Foreign Investment FundingForeign Direct Investment is permitted up to 100% in Greenfield infrastructure projects under the automatic route. The Cabinet had also cleared for FDI of 100% in Railways infrastructure and 49% in the defense sector last year. India needs an investment of about $1.7 trillion in infrastructure. Among the PPP projects, only he power sector is on track, achieving 100% of planned capacity, the airport sector is at 75% and road sector at 50%.Multilateral Agencies LendingPPP projects in India are, sometimes funded by institutions such as the World Bank and the Asian Development Bank. The Government of India started a PPP initiative called Mainstreaming PPPs in India in collaboration with ADB. It started in 2007 to enable PPPs by focusing on activities relating to various parameters such as process standardization, sector tools, development funds and projects development. ADB provides support by providing public sector loans to IIFCL, project companies, provision of guarantee to commercial lenders and public sector loans to states and municipalities for financing grants/equity support.The World Bank provides long-term financing for infrastructure projects in India. It helps IIFCL stimulate the development of a long-term local currency debt financing market infrastructure in India.

Insurance/pension fundsPension funds are an alternate source of finance for infrastructure projects as they provide long-term streams of income, predictable cash flows, diversification of project and societal benefits. The Government of India launched Infrastructure Debt Funds (IDFs) to allow infrastructure companies to raise finances from both domestic and foreign insurance and pension funds. IDFs can be set up as a trust or a company whose income would be exempt from income tax.

GrantsInfrastructure projects can tend to be commercially not viable. In order to facilitate project sponsors to support such projects, the Government of India (project awarding authority) provides them with grants. Visibility Gap Fund was introduced to provide catalytic assistance and support difficult PPP projects.Visibility Gap FundingFinancing: Providing 20% of project cost Additional 20% can be allowed by the sponsoring authority, if requiredEligible Sectors: Transportation (rail, roadways, seaport, highways) Power/Energy Urban Infrastructure (water supply, sewage, solid waste management) Tourism (international convention centers) Special Economic Zones

Private Sector CapabilitiesThe private sector is expected to finance 50% of the investments (nearly $500 billion) in infrastructure projects in the country during the twelfth five-year plan. In India, project developers contribute majority of equity in infrastructure projects, with the next-largest contributor being the public sector. A private player in a PPP project can be a private company, a consortium of private interests or a Non Government Organization (NGO). Private players have limited amount of capital, tied up for long-term in infrastructure projects. They rely on private equity investors to decrease promoters risk.Prominent private players in Indian Infrastructure:

Source: Shodhganga

Why is Infrastructure funding different from other sectors?Sources of funding in Infrastructure sector differ from that of other sectors due to the risks involved in Infra sector. Therefore investors consider the following risks before making any investment in Infrastructure sector:1. Technical or quality risk: For example: employment of inexperienced or unqualified designers, technology changes in the industry standard and likewise. 2. Organizational risks: For example: time or cost objectives which could be internally inconsistent, inefficient prioritization of tasks, interruption of funding, and resource clashes with other projects in the organization.3. External risks: For example: shifting legal or regulatory environment, geological conditions, force majeure risks, etc.4. Project management risks: For example: poor allocation of time and resources, inadequate planning of project, inefficient use of project management disciplines.

Risk related to investment in Infrastructure ProjectsCountry risk: Such country risk consists of a politically motivated embargo or boycott of a project, debt repayments or shipment of product, which may reflect the foreign policy of the country. Country risk also considers circumstances where the host country cannot permit transfer of funds for debt service because of its own economic problems.Political risk: Political and regulatory risks are inherent in doing business. They affect all aspects of a project, right from site selection, construction, completion, operations and up to marketing. Where possible, these risks are assumed by promoter. Also, expatriation is one of the ultimate political risks.Sovereign risk: Lenders used to making credit judgments for loans to countries are in a position to make lending decisions where the project is owned entirely or in part by an agency of a country (This in terms of collateral or security and guarantee from Govt. of India. Being a build operate- transfer basis (BOT) projects it very essential to mitigate risk from lenders perspective hence this risk is very essential from lenders point of view).Foreign exchange risk: When capital expenditures, operating expenses, revenues and borrowings are not in the same exchange medium (currency), lenders may be asked to assume some of the risk through multicurrency loans which give the investee company an option of repaying in different currencies, based upon a fixed exchange rate.Currency risk: Much recent, privately financed infrastructure has drawn on foreign capital and therefore faces the risk of local currency devaluation. In the past, public enterprises or governments have borne the currency risk, but in the growing move to private finance, risk of currency depreciation falls on the promoter of the project, and ultimately on the consumers.Inflation risk: The lender must ultimately rely on projections of the cost of construction of the project, and the cost of operations. Use of correct inflation factors in figuring out these future costs is an area in which the lender usually has more expertise than the investee company or its promoters.Interest rate: Loans with floating interest rates may be used for construction loans and long term financing, as well as for working capital and short-term needs Forecasts of future interest rates used to or project capitalized construction costs and future debt service requirements are dependent upon realistic interest rate assumptions (Due to Global economic slowdown, it is advisable to have interest rate in floating condition till we get clear picture about complete recovery of economy from economic slowdown). Availability of permits/licenses: Where permits and licenses must be obtained and renewed before the project commences commercial operations, the lenders assume the risk that such permits and licenses will be obtained in a reasonable time in the absence of any provision by the promoters to pay these costs.Operating performance risk: As the completion guarantees drops, the lenders become dependent on the continued uninterrupted operation of the project and sale of its products or services to provide the revenues necessary to repay the project loans.Price of product: Lender must assess the future market for the commodity and make judgments as to whether such price projections are realistic.Enforceability of contracts for product: Even if a project is supported by take-or-pay contracts with adequate escalation clauses, there are still doubts about whether the contract is enforceable, and whether the contracting party is a reliable party who will live up to its contractual obligations. Possible force majeure defenses to performance must be considered.Price of raw materials: It can be assessed based on prevailing raw materials and other commodities price required for infrastructure projects.Enforceability of contracts for raw materials: If a project has long-term contracts for raw material at attractive prices, a question still arises as to their enforceability and as to whether the contracting party is reliable and will live up to the commitments. In case the raw material is imported, risk of import restriction or force majeure events in the exporting country must be considered. Lenders sometimes assume these risks by advancing additional loans.Refinancing risk: If the project is arranged on a basis whereby the construction financing and the long-term financing after completion of construction, are provided by different group of lenders, the construction lenders run the risk of not being taken out by the long-term lenders (This is due to various problems faced by BOT projects during its construction stage). Construction lenders prefer long-term financing to be arranged at the time of the construction loan. But its not always possible because of long lead-time. Project financing tends to have the same group of lenders for both construction lending and long-term lending.Completion Risk: The completion risk sometimes assumed by a lender arises in circumstances where for all practical purposes it is impossible to complete the project or facility so that it operates to the full capacity and/or specifications originally envisaged. Promoters do not want to be in a position of having to provide funds to attempt to complete a facility to specifications that require expenditures out of proportion to the benefit to be realized. Generally, these risks can be dealt with by giving little exposure to the lender, but the loan may have to be extended for a longer term due to lower production than anticipated in the financial projections.The risks may arise in any one of the following phases of the project life cycle:1) Engineering and construction phase2) Start-up phase3) Operations phase

Analysis of Infrastructure Development Finance CompanyIntroductionInfrastructure Development Finance Company Ltd (IDFC) is India's leading integrated infrastructure finance player providing end-to-end infrastructure financing and project implementation services. In the year 1998, the company registered with theReserve Bank of India as a Non Banking Financial Company (NBFC). Highlights about business Provide finance for infrastructure projects including through ownership of infrastructure assets. Operate a full range of business lines, from project and corporate finance to asset management (mutual funds and alternatives) and investment banking. Provide finance and advisory services for infrastructure projects, asset management and investment banking.IDFC AlternativesIDFC Alternatives is IDFC's alternative asset management vertical. The Infrastructure team of IDFC Alternatives comprises India Infrastructure Fund (IIF), and India Infrastructure Fund II (IIF 2) with a fund size of about $900 Million.Key BusinessesIDFC comprises a portfolio of businesses that attempts to meet various needs of infrastructure finance in India. Strategic Business units of IDFC are: Corporate Finance Investment Banking and Broking Alternative Asset Management Public Markets Asset ManagementThough each individual business has its own financial targets and deliverables, these have worked together to position IDFC as an end-to-end solutions provider for infrastructure finance in India.

Corporate Finance This SBU is further divided into two sectors:

1. Project FinanceIt is the core of IDFCs business as of date. It has two main functions;Evaluate infrastructure projects of varying complexities and offers alternative financing structures using a portfolio of different instruments. This business has met the debt requirements of almost all major private sector infrastructure projects across India.

2. Fixed Income and TreasuryIt focuses on the fixed income market and comprises the treasury business, relating to the management of liquidity and investment and trading in debt instruments; and the debt capital markets business, which advises clients on raising debt funds and helps them gather debt capital from the market.

Investment Banking And Institutional Broking It comprises of advisory, capital raising services and institutional broking. It provides a range of services like private equity syndication, IPOs, QIPs, as well as international offerings such as GDRs, ADRs, FCCBs, project advisory and M&A services. During FY14, IDFC Capital Limited was merged with IDFC Securities Limited as per the Order of the Honble High Court of judicature at Bombay dated March 28, 2014.

Alternative Asset Management IDFC Alternatives Limited involves fund management across three asset classes Private Equity, which provides equity capital to infrastructure developers with the objective of creating value through capital appreciation Project Equity, which offers equity capital to brown field and operational core infrastructure projects to create value through regular yields and capital appreciation Real Estate, which is a relatively recent addition, is focused on residential real estate across top 6 cities. It generates returns through three streams of revenue: Asset Management fees; Investment Returns on the Companys Funds; Companys share of the carry income

Public Markets Asset ManagementIt is IDFCs mutual funds business, operated through the IDFC Asset Management Company Limited (IDFC AMC). IDFC holds 75% stake and Natixis Global Asset Management holds rest 25%. It manages different mutual fund products for institutional and retail investors. Income is generated through asset management fees. It focuses on growing the AUM by offering suitable products and channeling retail and corporate savings into Indias debt and equity markets.

Higher Provisioning Given the difficult state of almost all infrastructure projects across the country, both the executive and the Board believe that asset deterioration and non-payment risks have increased. Therefore, it was felt that IDFC should increase its provisioning to mitigate future risks and create a stronger balance sheet. IDFCs provisioning is well in excess of the regulatory minimum prescribed by the RBI for NBFCs.

Risk ManagementIDFC deploys a comprehensive Enterprise Risk Management (ERM) framework that tracks the extent of risks in the aggregate credit portfolio on a regular basis. It adopts an integrated approach to manage all the three types of risks; Loan portfolio management, asset liability management (ALM) and loan pricing. It ensures a strong risk management framework for market and credit risks.

Asset Liability MangementRisk Group focuses on ALM to enhance the effectiveness of the current process of regular monitoring of liquidity and interest rate risks. The software-based ALM system captures data from various disparate platforms and allows for more detailed and comprehensive analysis.Features of ALM-based risk management system: Allows real-time tracking and monitoring of all types of risks Provides precise information on activities, risks and controls to all Has the capability to track, understand and manage information across the organization Generates risk heat maps at all levels of the business Shows the list of open issues at any point of time Enables setting up central repository for all policy and procedures Enables standardizing of all group policies and procedures Provides trend analysis on risk history to take proactive measures

Conclusion and RecommendationsBanks can at best be expected to provide short term financing during the construction period. Pension and insurance funds do not have their own due diligence capabilities for infrastructure projects; Infrastructure Finance Companies (IFC) and Infrastructure Debt Funds (IDF) can provide such services.The bank dominated financial system has been able to step up and meet the needs of the first wave of private investment in infrastructure in a fast growing credit environment. There is a lack of a sufficiently sophisticated system of financial intermediation capable of channeling domestic savings into infrastructure.It is important to create mechanisms to addressa) The problem of mismatched assets and liabilities in banks and NBFCs lending to infrastructureb) The challenge of distributing risks more widely across the domestic financial systemTo make this work securitization could be done to allow originators to lay off risk to the other investors. In addition, a deep and liquid domestic bond market with a wide variety of participants can be formed.

References Sidharth Sinha, Long Term Financing of Infrastructure, W.P. No.2014-03-23 (2014, March), Indian Institute Of Management Ahmedabad Ernst and Young, Accelerating public private partnerships in India. Retrieved from http://www.ey.com/ Price Waterhouse Coopers, Infrastructure in India, A vast land of construction opportunity, (2008, Nov). Retrieved from https://www.pwc.in/en_IN/in/assets/pdfs/ Geethanjali Nataraj, Infrastructure Challenges in India: The Role of Public-Private Partnerships, Observer Research Foundation Paper #49(2014, Feb). Retrieved from http://orfonline.org/cms/export/orfonline/modules/occasionalpaper Nidhi Bothra, Sources of Infrastructure Funding, Vinod Kothari Consultants Pvt. Ltd. (2013, April 26). Retrieved from https://www.india-financing.com/ Rajiv B. Lall, Ritu Anand, Financing Infrastructure, IDFC Occasional Paper Series (2009, Jan). Retrieved from http://www.idfc.com/pdf/white_papers/Financing_Infrastructure.pdf IIFCL Mutual Fund Infrastructure Debt Fund (2013, Dec 18). Retrieved from http://www.bseindia.com/ http://www.moneycontrol.com/news-topic/india-infrastructure-fund/ http://en.wikipedia.org/wiki/Economy_of_IndiaExhibits

Exhibit 1: Standalone Balance Sheet of IDFCIDFC

Standalone Balance Sheetin Rs. Cr.

Mar '14Mar '13Mar '12Mar '11Mar '10

12 mths12 mths12 mths12 mths12 mths

Sources Of Funds

Total Share Capital1,516.291,514.731,512.362,300.951,300.61

Equity Share Capital1,516.291,514.731,512.361,460.951,300.61

Share Application Money0.120.30.64.140.26

Preference Share Capital0008400

Reserves13,192.6611,942.5810,627.618,765.065,522.24

Networth14,709.0713,457.6112,140.5711,070.156,823.11

Secured Loans42,867.4938,597.2333,535.9835,435.010

Unsecured Loans3,385.131,478.243,645.56862.2626,522.88

Total Debt46,252.6240,075.4737,181.5436,297.2726,522.88

Total Liabilities60,961.6953,533.0849,322.1147,367.4233,345.99

Mar '14Mar '13Mar '12Mar '11Mar '10

12 mths12 mths12 mths12 mths12 mths

Application Of Funds

Gross Block438.05435.38436.05441.67433.26

Less: Revaluation Reserves00000

Less: Accum. Depreciation160.38143.72121.8699.7175.44

Net Block277.67291.66314.19341.96357.82

Capital Work in Progress0.900.160.644.63

Investments11,198.8811,272.408,485.718,107.425,778.84

Inventories00000

Sundry Debtors643.150.76371.4615.4545.93

Cash and Bank Balance217.46127.5217.82225.5532.03

Total Current Assets860.56178.28389.2824177.96

Loans and Advances61,426.3258,251.9150,966.6039,558.8228,121.22

Fixed Deposits005727430

Total CA, Loans & Advances62,286.8858,430.1951,927.8840,542.8228,199.18

Deferred Credit00000

Current Liabilities12,185.2315,776.8410,840.251,158.41774.23

Provisions617.41684.33565.58467220.25

Total CL & Provisions12,802.6416,461.1711,405.831,625.41994.48

Net Current Assets49,484.2441,969.0240,522.0538,917.4127,204.70

Miscellaneous Expenses00000

Total Assets

60,961.6953,533.0849,322.1147,367.4333,345.99

Contingent Liabilities3,499.043,042.742,645.742,183.55914.84

Book Value (Rs)

97.0188.8480.277052.46

Source :Dion Global Solutions Limited

Exhibit 2: Profit and Loss Statement of IDFCProfit & Loss account of IDFC

------------------- in Rs. Cr. -------------------

Mar '14Mar '13Mar '12Mar '11Mar '10

12 mths12 mths12 mths12 mths12 mths

Income

Sales Turnover8,214.217,765.306,094.324,271.823,144.71

Excise Duty00000

Net Sales8,214.217,765.306,094.324,271.823,144.71

Other Income17.7211.19-33.49177.08423.41

Stock Adjustments00000

Total Income8,231.937,776.496,060.834,448.903,568.12

Expenditure

Raw Materials00000

Power & Fuel Cost00000

Employee Cost129136.99149.12107.63104.43

Other Manufacturing Expenses00000

Selling and Admin Expenses00226.9164.3747.52

Miscellaneous Expenses713.49478.8829.68170.06121.99

Preoperative Exp Capitalised000-11.380

Total Expenses842.49615.87405.71330.68273.94

Mar '14Mar '13Mar '12Mar '11Mar '10

12 mths12 mths12 mths12 mths12 mths

Operating Profit7,371.727,149.435,688.613,941.142,870.77

PBDIT7,389.447,160.625,655.124,118.223,294.18

Interest5,006.964,665.193,422.482,354.941,944.10

PBDT2,382.482,495.432,232.641,763.281,350.08

Depreciation24.2927.4531.2832.732.84

Other Written Off00000

Profit Before Tax2,358.192,467.982,201.361,730.581,317.24

Extra-ordinary items000.0200

PBT (Post Extra-ord Items)2,358.192,467.982,201.381,730.581,317.24

Tax657.07703598.7453.44304.4

Reported Net Profit1,701.121,764.981,602.961,277.151,012.84

Total Value Addition842.49615.87405.71330.68273.95

Preference Dividend0043.6332.170

Equity Dividend394.24393.84347.87292.51195.13

Corporate Dividend Tax676352.2745.0722.21

Per share data (annualised)

Shares in issue (lakhs)15,162.8615,147.2815,123.6314,609.4813,006.12

Earning Per Share (Rs)11.2211.6510.318.527.79

Equity Dividend (%)2626232015

Book Value (Rs)97.0188.8480.277052.46

Source : Dion Global Solutions Limited