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TABLE OF CONTENTS

THE OVERVIEW OF THE INFRASTRUCTURE SECTOR IN INDIA

Infrastructure in India can be broadly classified into the following areas:

Electricity Railways Roads andbridges

Telecommunications Ports

Airports IrrigationUrban andrural watersupply

Storage and gasdistribution

Sanitation

However there is a dearth of proper infrastructure in the country and this is a cause forconcern since we are targetting an avergae of 9% growth rate of GDP.

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Table above shows the current plans and deficits in infrastructure as of 2011.

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FIGURE : THE GROSS CAPITAL FORMATION FOR VARIOUS PERIODS UNDER THE5 YEAR PLAN.

The total investments in infrastructure stand at 5% of Indias GDP

The government envisages that the Gross capital formation due to infrastructure

sector should rise from current 5% to 9% of GDP by end of plan period in order tomaintain the 9% growth rate target for the economy

On the above basis, the aggregate capital formation in infrastructure required to

achieve Indias targeted annual average growth in GDP of 9% over the Eleventh Planperiod, would have to rise from Rs 259839 crore in 200708 to Rs 574096 crore in

201112 at constant 200607 price. Over the Eleventh Plan period, as a whole, thisestimate aggregates to Rs 2011521 crore or US$ 502.88 billion (at an exchange rate ofRs 40/$).

THRUST AREAS FOR THE INFRASTRUCTURE SECTOR

The government envisages more public private partnership in infrastructure in order

to tide over the supply gap from the public sector in terms of resources.

Public sector would focus on disadvantaged areas such as irrigation and waterresource management, construction of rural roads, capital dredging at major ports, andsome economically or situational disadvantaged regions.

For other areas of Infrastructure, the GOI will look for public private partnership

projects.

Focus on building capacity of world class standards and providing public services at

reasonable prices.

Setup of various committees such as committee on infrastructure (COI),Cabinet

committee on infrastructure, PPP appraisal committee, and empowered committee tosimplify the procedure of facilitating fund flow from private sector.

Provision of a viability Gap funding of 20% to be provided by the government for

PPP projects undertaken in partnership with central ministry, state government or astatutory body or local body. The funding gap is the net present value of the gap

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between the projected costs of the project and estimated revenue generation over theconcession period based on user fees that was to be levied in a pre-determinedmanner.

FDI approval in the following sectors

SECTOR FDI LIMIT

1) Mining 100% FDI under automatic route2) Power 100% FDI under automatic route3) Civil Aviation 100% FDI under automatic route4) Construction and Development 100% FDI under automatic route5) Industrial parks 100% FDI under automatic route6) Petroleum and natural gas 100% FDI under automatic route7) Telecommunications 100% FDI under automatic route8) Special economic zones 100% FDI under automatic route9) Domestic Airlines 49% and above under GOI approval10) Existing Airports 74%-100% under GOI approval11) Infrastructure and services(except

telecom)49% to 74% under GOI approval

12) Petroleum and Natural Gas( refiningPSU companies)

49% to 74% under GOI approval

13) Telecom(basic and cellular services) 49% to 74% under GOI approval14) ISP with gateways, radio paging, end

to end bandwidth49% to 74% under GOI approval

15) ISP without gateways 49% and above under GOI approval16) Satellites Up-to 74% under GOI approval17) Mining and mineral separation of

Titanium bearing minerals and ores100% FDI under GOI approval

Various schemes are underway under the public sector, namely Bharat nirman for

Rural infrastructure, sectoral initiatives such as RGGVY, APDRP, Acceleratedirrigation benefit program( AIBP), NHDP, National maritime development program( NMDP) and JNNURM.

Setup of IIFCL( India infrastructure finance company limited) by the government of

India for providing long term loans, refinance of existing loans.

Relaxation of the Take out financing scheme of IIFCL as follows

1) Takeout finance schemes now based on project credit rating and will bedeclared upfront

2) For road projects, take out time is 1 year after COD( commercial operationdate)

3) For other sectors, take out time is 6 months after the commercial operationdate

4) Developers or banks can approach for takeout financing5) Lenders will not have to pay commission to IIFCl, rather they will be

compensated upto a certain percentage of interest gain accruing to theborrower under the takeout finance scheme

6) Interest rates charged by IIFCL will be non-discretionary and transparent

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Set up of Infrastructure Debt funds either as NBFCs or Mutual funds with scheduled

commercial banks acting as sponsors with prior approval of RBI. Also reduction inwithholding tax on interest payments of these funds from 20% to 5%, income taxexemption etc.

Long term Infrastructure bonds for small investors can be issued by LIC,IFCI, IDFC

and Infrastructure finance companies that will provide a tax benefit of 20,000 in theyear of investment under the income tax act.

Use of foreign exchange reserves for infrastructure projects- IIFC( UK) a special

purpose vehicle was incorporated in London. This SPV will issue foreign currencydenominated bonds in which RBI will invest upto 5billion USD. The funds thus raised

by the SPV would be used to co-finance ECBs for infrastructure projects or for directlending to Indian companies

RBI has allowed banks for greater exposure limits to Infrastructure project borrowers,

In case of a single borrower, the banks can get an exposure of 20% as compared toearlier 15% and in case of a group of borrowers, banks can get exposure upto 50%

from existing 40% To manage ALM problem, banks can issue long term bonds with minimum maturity

of 5 years to the extent of their exposure of residual maturity of more than five years,and can take part in take out financing arrangements with IDFC and other financialinstitutions.

Bank guarantees can be provided to lending institutions for these infrastructure

projects in order to enhance their credit rating but on the condition that theparticipating bank will take a funded share in the project at least to the extent of 5% ofthe project cost and undertakes normal credit appraisal, monitoring and follow up ofthe project.

Banks can also participate in equity offering of promoters of an Infrastructure project

subject to some conditions

Banks which take up promoters share as pledge can exclude those shares from their

overall capital market exposure limits

Banks can invest in unrated bonds of companies engaged in infrastructure activity

subject to a ceiling of 10% for Unlisted non SLR securities

Other notable measures in this regard are relaxations related to asset classes,

Introduction of credit default swaps and securitization, liberalization of ECB policies.

The investment required by the Central and State Governments and the private sector

in each of the ten major physical infrastructure sectors for sustaining a growth rate of9% in GDP over the Eleventh Plan (200708 to 201112) and corresponding to the

quantitative targets for the Eleventh. The total investment amounts to Rs 2056150crore. This level of investment amounts to an average of 7.6% of GDP during theEleventh Plan as a whole.

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PROJECTED INVESTMENT NEEDS OF THE SECTOR AS OF 11T H PLAN PERIOD

The total investment requirements for the infrastructure sector as of 2011-2012 has

been anticipated based on below mentioned table of figures

Some of the observations are:

1. Total public investment in 2011-2012 period stands at 319904 crore and that ofprivate investment stands at 208413 crores.( Figure and Figure )

2. Major thrust areas for the government were , in order of decreasing investments,Electricity, Roads and bridges, Railways, Telecommunication, Irrigation, Watersupply and sanitation, ports, Airports, storage and lastly Gas. (Refer figure 4)

3. The overall breakup of investments required in each sector and via each source, publicor private, has been outlined in the figure 5.

FIGURE

FIGURE

FIGURE

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Figure

SOURCE OF INVESTMENTS FOR THE SECTOR

The government has led in the financing of infrastructure projects and during the first

3 years, the government sponsored 45% of the net investments in the projects.

The rest of the 55% came from debt financing( 41%) and equity financing (14%).

Within Debt financing, commercial banks gave around 21% of finance, 10% financed

by NBFCs, and less than 10% each was financed by External commercial borrowings,Equity, Foreign direct investments, and Insurance companies.

Table below gives the total financing needs of the infrastructure sector as of 11 th year

plan.

There is a debt funding requirement of 988035 crores and non debt requirement of

1068114 crores( Refer figure 6)

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FIGURE The likely sources of DEBT finance for the sector is as outlined in the Table 12.7

The total available debt finance for infrastructure sector stands at 825539 crore with a

funding gap of 162496 crores( USD 40.62 Billion) ( Refer figure7)

FIGURE

FINANCE ESTIMATES FOR THE 12T H PLAN PERIOD, BEGINNING 2012.

Projected Investments into infrastructure during the 12th Plan

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The overall planned expenditure on infrastructure based on revised estimates of 12th

year plan has increased from 41 lakh crore to 45 lakh crore.

This translates to an increase from 8% of GDP starting in 2012 to around 10% of GDP

as at the end of 12 th plan period.

CHALLENGES FOR INFRASTRUCTURE PROJECTS

As per the above figures, the sector has to close out the funding gap in order to meet

the targets

Infrastructure projects given their long pay-back period require long-term financing in

order to be sustainable and cost effective.

External commercial borrowings may become scarce in light of recent Euro zone

crisis, and depreciation of the rupee.

The government funding may have to come down in order to focus on other areas of

investments and to manage the fiscal deficits.

The banking sector faces problems in terms of exposure limits to the Infrastructure

sector being reached and also to manage the Asset liability mismatch; these bankscannot possibly lend long term to infrastructure projects.

Takeout financing has not really kicked in for the banking sector.

Pension and Insurance companies have an obligation to invest substantially in the

government securities in order to help government tide over fiscal deficits, howeverthis leads to non- direct participation by these funds in the sector

Under developed corporate bond market in view of absence of bankruptcy laws,

limited investor base and limited number of issuers.

Absence of a urban municipal bond market on account of absence of secondary

market in these bonds, bond ratings, sufficient user charges, absence of robustaccountancy practises by these municipalities

Insufficiency of user charges that are collected from projects such as roads, irrigation

and water supply etc are sometimes impacted due to regulatory, legal and other issues.Thus cash flows from these projects, which are meant to service the loans, getsimpacted dearly

Various legal and procedural issues impacts the riskiness of these projects and hence

the readiness of possible investors in this sector. Possible problems include those ofland acquisitions, environment clearances, and other procedural delays.

Thus in light of the above points it becomes imperative that the infrastructure industry gets a

new avenue of raising cost effective funds in the form of Infrastructure debt funds.

REQUIREMENTS FOR SETTING UP AN IDF

The RBI guidelines on the setup of the Infra-structure debt funds either as a Mutual fund or anon-banking financial company has been reproduced below (Refer attachment 1)For finalizing the structure of the proposed IDFs wide-scale consultations wereheld with potential investors, infra co. and regulators and experts. Followingbroad structure has emerged based on these consultations:

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I. An IDF may be set up either as a Trust or as a company. A trust based IDFwould normally be a Mutual Fund (MF) that would issue units while acompany based IDF would normally be a form of NBFC that would issuebonds;

II. An IDF would have to be registered in India and regulated by one of the

financial regulators. A trust based IDF (MF) would be regulated by SEBI;and an IDF set up as a company (NBFC) would be regulated by RBI.

III.The investors would primarily be domestic and off-shore institutionalinvestors, especially Insurance and Pension Funds who have long termresources. Banks and FIs would only be allowed to invest as sponsors of anIDF.

IV. Can raise capital through rupee denominated or dollar denominated bondsof minimum 5 years maturity to tap the on-shore and offshore institutionalinvestors.

V. IDF-NBFC would need to have Net Owned Fund of Rs 300 crores or more and has toinvest only in Public Private Partnerships (PPP) and post commencement operationsdate (COD) infrastructure projects which have completed at least one year ofsatisfactory commercial operation and has to become a party to a TripartiteAgreement.

VI. There will be a Tripartite agreement between the IDF-NBFC, Project authority, andthe concessionaire ( read private party) which will allow concessionaire to issue bondsthat will be taken up by the IDFC and in case of any default on part of theconcessionaire, the bonds will be redeemed by the Project authority

VII. In case of an IDF that issues bonds, credit enhancement inherent in PublicPrivate Partnership (PPP) projects would be available. Such IDFs would refinancePPP projects after their construction is completed and they have successfully operated

for atleast one year. Such projects would involve a lower level of risk andconsequently a higher credit rating. Such a structure would enable flow of Insuranceand Pensions Funds at competitive costs in order to channelize low cost long termdebt in PPP projects in infrastructure sectors such as roads, ports, airports, railways,metro rail etc.

VIII. In case of IDFs that issue units, greater credit risk would be borne bythe investors who will be free to seek correspondingly higher returns. MFswould be especially useful for non PPP projects.

IX. The minimum credit rating of the IDF-NBFC has to be A from CRISIL or anequivalent rating from FITCH, ICRA or CARE

X. The NBFC will have to have a minimum CRAR of 15% and tier2 capital cannotexceed tier1 capitalXI. Credit Concentration Norms- The maximum exposure on Individual projects will be

at 50% of its total capital funds( Tier 1+ Tier 2) capital.XII. An additional exposure of upto 10% may be taken in the project based on the

discretion of the IDF board.XIII. To attract off-shore funds into IDFs Finance Minister had also announced that

withholding tax on interest payments on the borrowings by the IDFs would bereduced from 20% to 5%. Income of the IDFs has also been exempt from income tax.

THE WORKING OF THE IDFS

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REFERENCE PAP ER: IIDF CONCEPT BY GAGENDER HALDEA

1) IDF is set up

2) IDF lends to the infrastructure company like take out financing from IIFCL3

SAMPLE WORKING OF AN IDF

Sponsors Participation

Value(Crs)

%age

Participatio

n

A 1000 11%

B 1500 17%

C 1500 17%

D 2000 22%

E 3000 33%

Total FundValue

9000

This is an IDF-NBFC

Sponsor Banks and Financial institutions such as ADB, IFC, ICICI etc set up the IDF-

NBFC with a total fund value of 9000 croresA Hypothetical situation for showcasing the working of an IDF can be shown as follows.

Company X needs funds of 2000 crore for Initially starting up an infrastructureproject

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The company avails of the finance initially through commercial bank Y

The company sets up the project and starts repaying the interest to the bank

The repayment needs to be done of the principal according to the schedule as

provided in Tables below.

Terms of IDF finance

Lenders Name IDF-NBFC

Lending amount 2000 crs

Tenure 10Yrs

Interest Rate 8.25%1) redemption of bond principal at end of8 years

The company has two options, either roll over refinancing through Banks or use an

IDF to be able to pay off the Debt to the bank.

TERMS OF FINANCING

Terms of Bank Finance

LendingBank name X

Lending amount 2000 crs

Tenure 5 Years

Interest rate 9.50%

1) Interest to be paid semiannually

2) Prepayment penalty 2% on amountoutstanding

3) Repayment of principal after 3 years

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SAMPLE SHEET OF BANK FINANCING VS IDF REFINANCING

Bank Financing IDF Funding at 8.25%

Semiannual

Periods upto 15years

Principalpaid

Interest tobe Paid

Total

cashflow

Principal paid Interest paid

Total

cashflow

0 -2000 -2000

1 95 95 95 95

2 95 95 95 95

3 95 95 95 95

4 95 95 95 95

5 95 95 95 95

6 95 95 95 95

7 95 95 95 95

8 95 95 95 959 95 95 95 95

10 95 95 95 95

11 95 95 40 82.5 122.5

12 95 95 82.5 82.5

13 95 95 82.5 82.5

14 95 95 82.5 82.5

15 95 95 82.5 82.5

16 95 95 82.5 82.5

17 95 95 82.5 82.5

18 95 95 82.5 82.519 95 95 82.5 82.5

20 95 95 82.5 82.5

21 95 95 82.5 82.5

22 95 95 82.5 82.5

23 95 95 82.5 82.5

24 95 95 82.5 82.5

25 95 95 82.5 82.5

26 95 95 82.5 82.5

27 500 95 595 500 82.5 582.5

28 500 71.25 571.25 500 61.875 561.875

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29 500 47.5 547.5 500 41.25541.2

5

30 500 23.75 523.75 500 20.625520.6

25

Semiannua

l rate 4.75%

Semiannual

rate

4.51

%

Annualrate 9.50% Annual rate

9.03%

Observations1) The bank finance comes out to be at 9.50% over the 15 year period2) The IDF financing would come out to be close to 9.03%3) The advantage with the IDF, apart from saving in the interest rate would be the easy

availability of the funds for a period of 10-15 years at a lower cost of debt.

Assumptions:1) The bank will initially give a loan for 5 years that can be refinanced by another bank

for another 5 years and thus there are 3 rollovers until final payment of the entire loanin the last 2 years

2) Tax impacts on cash flow have not been considered.3) The IDF has been assumed to be able to refinance the entire 2000 crs at the end of 3

years in 4 equal tranches4) The IDF is repaid at the end of period 27 up-to period 30.5) Current rates on AAA or AA+ rated Infra bonds have been assumed at 9% and used as

reference rate for deciding the IDF finance interest rate

CURRENT DEVELOPMENTS

Companies such as Reliance, L&T, SBI and ICICI have put up their offer document

of Mutual fund IDFs for review on SEBI website.

Four banking and financial services giants ICICI Group, Life Insurance

Corporation, Citicorp Finance India and Bank of Baroda on Monday joined handsto launch India's first infrastructure debt fund (IDF) to be structured as a non-bankingfinance company (NBFC).

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ATTACHMENTS 1- RBI GUIDELINE ON IDF SETUP

RBI/2011-12/268 DNBS.PD.CC.No.249 /03.02.089/2011-12 November 21, 2011

To All NBFCs excluding RNBCs

Infrastructure Debt Funds (IDFs)

The Finance Minister had in his budget speech for the year 2011-2012 announced the settingup of Infrastructure Debt Funds (IDFs), to facilitate the flow of long-term debt intoinfrastructure projects. The IDF will be set up either as a trust or as a company. A trust basedIDF would normally be a Mutual Fund (MF) while a company based IDF would normally bea NBFC. IDF- NBFC would raise resources through issue of either Rupee or Dollardenominated bonds of minimum 5 year maturity. The investors would be primarily domesticand off-shore institutional investors, especially insurance and pension funds which would

have long term resources. IDF-MF would be regulated by SEBI while IDF-NBFC would beregulated by the Reserve Bank.

2. The Reserve Bank had vide its Press Release dated September 23, 2011, issued broadparameters for banks and NBFCs to set up IDFs. Detailed guidelines are set out in thefollowing paragraphs prescribing the regulatory framework for Non Banking FinancialCompanies (NBFCs) to sponsor IDFs which are to be set up as Mutual Funds (MFs) and

NBFCs. Such entities would be designated as Infrastructure Debt Fund Mutual Funds(IDF-MF) and Infrastructure Debt Fund Non-Banking Financial Company (IDF-NBFC).All NBFCs, including Infrastructure Finance Companies (IFCs) registered with the Bank maysponsor IDFs to be set up as Mutual Funds. However, only IFCs can sponsor IDF-NBFCs.

Eligibility Parameters for NBFCs as Sponsors of IDF-MFs3. All NBFCs would be eligible to sponsor (sponsorship as defined by SEBI Regulations forMutual Funds) IDFs as Mutual Funds with prior approval of RBI subject to the followingconditions, in addition to those prescribed by SEBI, in the newly inserted Chapter VI B to theMF Regulations :

i. The NBFC should have a minimum Net Owned Funds (NOF) of Rs. 300 crore and Capitalto Risk Weighted Assets (CRAR) of 15%;

ii. Its net NPAs should be less than 3% of net advances;

iii. It should have been in existence for at least 5 years.

iv. It should be earning profits for the last three years and its performance should besatisfactory;

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v. The CRAR of the NBFC post investment in the IDF-MF should not be less than theregulatory minimum prescribed for it;

vi. The NBFC should continue to maintain the required level of NOF after accounting forinvestment in the proposed IDF and

vii. There should be no supervisory concerns with respect to the NBFC.

Eligibility Parameters for IFCs setting up IDF-NBFCs

4. Only NBFC-IFCs can sponsor IDF-NBFC with prior approval of the Reserve Bank andsubject to the following conditions.

i. Sponsor IFCs would be allowed to contribute a maximum of 49 percent to the equity of theIDF-NBFCs with a minimum equity holding of 30 percent of the equity of IDF-

NBFCs,:

ii. Post investment in the IDF-NBFC, the sponsor NBFC-IFC must maintain minimum

CRAR and NOF prescribed for IFCsiii. There are no supervisory concerns with respect to the IFC.

Tripartite Agreement

5. IDF-NBFCs will enter into Tripartite Agreements to which, the Concessionaire, the ProjectAuthority and IDF-NBFC shall be parties. Tripartite Agreement binds all the parties thereto tothe terms and conditions of the other Agreements referred to therein also and whichcollectively provide, inter alia, for the following:-

i. take over a portion of the debt of the Concessionaire availed from Senior Lenders,ii. a default by the Concessionaire, shall trigger the process for termination of theagreement between Project Authority and Concessionaire,

iii. the Project Authority shall redeem the bonds issued by the Concessionaire which havebeen purchased by IDF-NBFC, from out of the termination payment as per theTripartite Agreement and other Agreements referred to therein (compulsory buyout),

iv. the fee payable by IDF-NBFC to the Project Authority as mutually agreed upon betweenthe two.

6. NBFC and IFCs that fulfill the eligibility criteria as above may approach the Central Officeof the Department of Non-Banking Supervision, Reserve Bank of India, Centre I,World Trade Centre, Cuffe Parade, Mumbai 400 005 for sponsoring IDFs as MFsand NBFCs, as applicable.

Investment by NBFCs and IFCs in IDFs

7. The exposure of sponsor NBFCs / IFCs and non-sponsor NBFCs / IFCs to the equity anddebt of the IDFs would be governed by the extant credit concentration norms as given in para18 of the Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential

Norms (Reserve Bank) Directions, 2007.

8. Notification containing the detailed guidelines issued with regard to regulation of IDF-NBFCs viz; DNBS.PD.No.233/CGM (US)-2011, dated November 21, 2011 are enclosed formeticulous compliance. As regards foreign exchange related aspects of the functioning ofIDF-NBFCs, a separate circular is being issued.

Yours faithfully,

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(Uma Subramaniam)Chief General Manager-In-Charge

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RESERVE BANK OF INDIA

DEPARTMENT OF NON-BANKING SUPERVISION

CENTRAL OFFICE

CENTRE I, WORLD TRADE CENTRE,

CUFFE PARADE, COLABA,

MUMBAI 400 005.

Notification No. DNBS.233 / CGM(US)-2011 dated November 21, 2011

The Reserve Bank of India having considered it necessary in the public interest and beingsatisfied that for the purpose of enabling the Bank to regulate the credit system to theadvantage of the country, it is necessary to give the Directions set out below, hereby, inexercise of the powers conferred by sections 45JA, 45K, 45L and 45M of the Reserve Bankof India Act, 1934 (2 of 1934), and of all the powers enabling it in this behalf, hereby givesthe Directions hereinafter specified.Short title and Commencement of the Directions

1. These Directions shall be known as the Infrastructure Debt Fund-Non-Banking Financial

Companies (Reserve Bank) Directions, 2011 and shall come into force with immediate effect.

Applicability of Directions

2. These Directions shall apply to every Infrastructure Debt Fund-Non-Banking FinancialCompany (IDF-NBFC),

Definitions

3. For the purpose of these directions, unless the context otherwise requires,-

(a) Concessionaire means a party which has entered into an agreement calledConcession Agreement with a Project Authority, for developing infrastructure.

(b) Infrastructure Debt Fund-Non-Banking Financial Company or IDF-NBFCmeans a non-deposit taking NBFC that has Net Owned Fund of Rs 300 crores ormore and which invests only in Public Private Partnerships (PPP) and postcommencement operations date (COD) infrastructure projects which havecompleted at least one year of satisfactory commercial operation and becomes a

party to a Tripartite Agreement.

(c) Project Authority means an authority constituted by a statute for the

development of infrastructure in the country.

(d) Tripartite Agreement means an agreement between three parties, namely, theConcessionaire, the Project Authority and IDF-NBFC that also binds all the partiesthereto to the terms and conditions of the other Agreements referred to therein

4. Words and expressions used but not defined herein and defined in Reserve Bank of IndiaAct, 1934 or the Directions issued under Chapter III thereof shall, unless the contextotherwise requires, have the meaning assigned to them thereunder.

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Credit Rating

5. IDF-NBFC shall have at the minimum, a credit rating grade of 'A' of CRISIL or equivalentrating issued by other accredited rating agencies such as FITCH, CARE and ICRA;

Capital Adequacy

6. The IDF-NBFC shall have at the minimum CRAR of 15 percent and Tier II Capital ofIDFNBFC shall not exceed Tier I.

Investment

7. IDF-NBFCs shall invest only in PPP and post COD infrastructure projects which havecompleted at least one year of satisfactory commercial operation and are a party to aTripartite Agreement with the Concessionaire and the Project Authority for ensuring acompulsory buyout with termination payment.

Credit Concentration Norms:

8. i. The maximum exposure that an IDF-NBFC can take on individual projects will be at 50percent of its total Capital Funds (Tier I plus Tier II as defined in Para 2 (xx) and (xxi)for the Non-Banking Financial (Non-Deposit Accepting or Holding) CompaniesPrudential Norms (Reserve Bank) Directions, 2007).

ii. An additional exposure up to 10 percent could be taken at the discretion of theBoard of the IDF-NBFC.

iii. RBI may, upon receipt of an application from an IDF-NBFC and on being satisfiedthat the financial position of the IDF-NBFC is satisfactory, permit additional exposure

up to 15 percent (over 60 percent) subject to such conditions as it may deem fit toimpose regarding additional prudential safeguards.

Risk Weights for the Purpose of Capital Adequacy:

9. For the purpose of computing capital adequacy of the IDF-NBFC,

i. bonds covering PPP and post commercial operations date (COD) projects in existence overa year of commercial operation shall be assigned a risk weight of 50 percent.

ii. All other assets shall be risk weighted as per the extant regulations as given in para 16 ofthe Non-Banking Financial (Non-Deposit Accepting or Holding) Companies

Prudential Norms (Reserve Bank) Directions, 2007.

Other Prudential Norms

10. All other prudential norms as specified in Non-Banking Financial (Non-DepositAccepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007including income recognition, asset classification and provisioning norms will be applicablefor IDF-NBFCs.

(Uma Subramaniam)Chief General Manager In-Charge

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ATTACHMENT 2

India Infrastructure Debt Fund: A Concept Paper- Gajendra Haldea

Creation of world-class infrastructure has been recognised as a key priority and a necessary

condition for sustaining the growth momentum of the economy. Investment in infrastructure

during the Eleventh Five Year Plan (2007-12) is expected to be Rs. 20,000 bn as compared to

Rs. 9,000 bn during the Tenth Plan while the share of private investment would rise from Rs.

2,250 bn (25%) in the Tenth Plan to Rs. 7,400 bn (36%) in the Eleventh Plan. A large

proportion of this private investment is expected from PPP projects based on long-term

concessions. Since infrastructure projects have a long pay-back period, they require long-

term financing in order to be sustainable and cost-effective. However, debt financing for

infrastructure projects has been largely confined to banks who have difficulty in providing

long-term debt due to their asset-liability mismatch. On the other hand, insurance and

pension funds have stayed away on account of their risk perceptions. This Concept Papersuggests the creation of a Debt Fund that would raise low-cost long-term resources for re-

financing infrastructure projects that are past the construction stage and associated risks.

Through a package of credit enhancement measures, it is proposed to channelise these debt

funds to infrastructure projects that are backed by a buy-out guarantee from the

government. This would enable the project sponsors to refinance their debt while sharing the

gains with the government/users. It would also release a significant proportion of the scarce

lending space of the banks, thus enabling them to lend to the robust pipeline of forthcoming

projects.

This is a proposal for setting up an India Infrastructure Debt Fund (the Fund) for Rs.50,000 crore ($ 11 billion) to meet the needs of long-term debt for infrastructure projects that

are set up through Public Private Partnerships (PPP). The Fund will also help bridge theemerging gap in the total debt required for funding infrastructure projects which presentlyrely on commercial banks. The provision of low-cost long term debt is necessary for reducingthe cost of infrastructure projects and this Fund would be a significant step in that direction.The Fund would only lend to projects that have entered into commercial operation aftercompletion of construction. This would imply taking over of the existing debt of commercial

banks and thus releasing their lending space for provision of loans to new projects. When theFund is fully operational, it will also help create a secondary market for debt bonds.

1. Context

Infrastructure has been recognised as a key priority in the Eleventh Five Year

Plan (2007-12), both with a view to addressing the deficit of the past years and for keepingpace with the needs of a rapidly growing economy. The Eleventh Five Year Plan has set a

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target (revised) for scaling up investment in infrastructure from about 5% of GDP, asprevailing in the Tenth Plan, to 8.4% by the terminal year of the Eleventh Plan (2011-12). Inabsolute terms, this implies an investment of about Rs. 20,54,000 crore (US $ 513.55 billion)during the Eleventh Plan as compared to Rs. 9,06,074 crore ($ 227 billion) during the TenthPlan. For achieving this sharp increase in investment, the role of the private sector would

have to be enhanced besides an increase in public sector outlays. It is envisaged that 36% ofthe total investment during the Eleventh Plan would need to be mobilised from the privatesector as against 25% achieved during the Tenth Plan, which implies an increase from Rs.2,25,200 crore ($ 56 billion) in theTenth Plan to about Rs. 7,43,000 crore ($ 185 billion) during the Eleventh Plan.

2. The debt gap

The aforesaid private investment of Rs. 7,43,000 crore ($ 185 billion) would require anequity contribution of about Rs. 222,900 crore ($ 56 billion) and debt of about Rs. 520,000crore ($ 130 billion). In addition, the debt required for public sector projects has been

projected at Rs. 506,000 crore ($ 126 billion) during the period of Eleventh Plan. Thus, the

total debt requirement for infrastructure would be Rs.102,6000 crore ($ 257 billion).Projections for debt resources that are likely to be available for infrastructure suggest thatthere would be a gap of Rs. 201,300 crore ($ 50billion) during the Eleventh Plan period.However, this gap has not surfaced during the past three years mainly because of the slowroll-out of projects on account of several reasons including the global financial crisis. Thissituation is likely to change as somerecent initiatives of the government, coupled with a simplified and standardised policy andcontractual framework, are likely to lead to an accelerated roll-out of projects to beundertaken by private entities through Public Private Partnership (PPP). The targets for theEleventh Plan may also be met albeitwith a delay of about two years.

3. Lack of long-term debt

The problem of inadequate debt resources is compounded by the lack of long term debt forfinancing infrastructure projects, which are financed mainly by the commercial banks.Insurance and pension funds do not lend to project companies setting up greenfieldinfrastructure projects and the bond market has not matured sufficiently for addressing theneeds of such projects. Commercial banks typically lend for the medium term as their asset-liability mismatch prevents them from undertaking long-term commitments. In the absence oflong-term debt, the cost of projects increases significantly on account of the short pay-back

period for debt, thereby imposing a greater burden on the users and the public exchequer. Toovercome this bottleneck, the government had set up the India Infrastructure Finance

Company Ltd. (IIFCL) with the objective of providing long-term debt for infrastructureprojects. However, its lending is restricted to about 30% of the project debt, thus leaving thebalance 70% to be raised mainly from the commercial banks.

4. Sourcing long-term funds

For providing long-term debt to infrastructure projects, it would be necessary to shift fromcommercial banks to institutions that have the capacity to provide long-term debt. It is alsonecessary to create a liquid secondary market in debt. Typically, the holders of such long-term debt would be insurance and pension funds (including provident funds), both Indian aswell as foreign. In addition, some sovereign funds could also be tapped for this purpose.

These funds have so far stayed away from financing Greenfield projects set up by specialpurpose vehicles since they are regarded as risky investments, especially from the perspective

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of pension and insurance funds. If this risk perception and liquidity can be suitably addressed,it should be possible to persuade insurance and pension funds to lend for infrastructure

projects.

In addition, multi-lateral institutions such as the IFC and ADB (private sector window) could

be invited to participate as Sponsors of the Fund. Further, the World Bank and ADB couldalso be approached for participating in this Fund through their normal lending windowsupported by sovereign guarantees. This would not only provide the much-needed long-termdebt, it would also increase the volume of debt flows to the infrastructure sector which isexpected to face a debt crunch in the years to come.

5. The proposed India Infrastructure Debt Fund

This paper outlines a proposal to create an Infrastructure Debt Fund of about Rs. 50,000 crore(US $ 11 billion) and suggests a structure that could address the concerns of all principalstakeholders. The Debt Fund could be set up for a smaller amount and expandedsubsequently. This model could also be replicated for setting up other similar funds.

6. Who will set up the Fund?

The Fund will be set up by one or more sponsors (the Sponsor), who will act as theGeneral Partners of the Fund. The Sponsors could be one or a combination of IIFCL, SBI,ICICI, LIC, IDFC, UTI, an infrastructure NBFC or an investment bank. A combination oftwo or three General Partners/ Sponsors may be preferred. In addition, the Sponsors may alsoinclude one or two foreign entities such as IFC or ADB as General Partners in order toenhance the credibility of the Fund from the perspective of foreign investors. The Sponsorswould be required to invest at least 10% of the total investment in the form of subordinateddebt.

7. Who will be the borrowers?

Any infrastructure project which is based on Public Private Partnership (PPP) where a publicauthority has provided for a compulsory buy-out of the project on payment of a pre-determined termination payment shall be eligible to borrow from the Fund. Further, theeligibility would be restricted to projects which have completed at least one year from theirentry into commercial service, i.e., their commercial operation date (COD), without anymaterial default in debt service or in the performance of their obligations under the respective

project agreements. The lending would also be restricted to projects which are awardedthrough competitive bidding as they would carry the assurance of a sustainable pricediscovery. The borrowings from the Fund would be used for discharging the secured debt of

the project.The Fund would normally cover road, railways, port, metro rail and airport projects thattypically provide for a compulsory buy-out by the authority granting the concession. It wouldalso cover power and other projects which fulfill the aforesaid conditions.

8. What about projects other than PPP?

Projects other than PPP will not be eligible for borrowing from the Fund as they do not carrya compulsory buy-out guarantee from a public authority and therefore, pose risks that theFund may not be able to manage. Moreover, a higher risk perception relating to such projectsmay raise borrowing costs of the Fund and also pose other difficulties. Since these projectsare being set up on the basis of prevailing market conditions, they may continue to rely on

available market mechanisms for financing such projects. If the need arises, a separate fund

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may be explored for such projects. In the meanwhile, such projects may access the recentlyapproved take-out finance facility of IIFCL.

9. What will be the extent of lending for each project?

The Fund would re-finance upto 85% of the outstanding project debt from senior lenders.

This would enable the project companies to substitute their existing debt by long-term bondsat comparatively lower interest rates. The restructuring of project debt would also release alarge volume of the present lending capacity of the commercial banks, thus enabling them tolend more to new projects.

10. What will be the security and credit enhancement?

Concessions for PPP projects typically provide that in the event of termination on account ofdefault by the concessionaire, the project would be taken over by the public entity against atermination payment that normally covers much of the project debt. For example, in the caseof national and state highways, the concessionaire would be entitled to receive 90% of the

project debt which forms part of the agreed project costs. This implies that 90% of theaforesaid debt is guaranteed by the government or a statutory entity and is also secured by aneconomic asset that would continue to generate revenue streams. Thus, it should be possiblefor the Fund to take over a significant proportion of the existing debt with minimal risks.

It would be useful to ensure that the existing senior lenders continue to have some stake inthese projects. As noted above, senior lenders would be free to transfer exposure of up to 85%of the project debt to the Fund while retaining at least 15% of their debt exposure for a periodof at least seven years from the COD of the respective projects.

This exit financing or re-financing may require the existing loan facility to be synched upwith the terms of the Bond debt. The Fund will hold apari passu charge along with seniorlenders, but in the event of termination, the Fund will get paid first out of the termination

payments due and payable by the project authority and the balance will be appropriated bythe senior lenders. This will also minimise the incentive of commercial banks to offer onlyunderperforming assets to the Fund.The Fund will subscribe to the project bonds on the basis of a tripartite agreement to besigned among (a) the Fund; (b) the project company; and (c) the project authority (such as

NHAI or a state government in the case of highways). Under the proposed tripartiteagreement, the concerned project authority would guarantee that the termination payment dueunder the respective project agreements would be transferred to the Fund for discharging its

debt in the event of termination. The Fund would also have the right to seek substitution ofthe concessionaire or trigger a termination event for receiving termination payments if defaultin debt service by its borrower project company persists beyond 180 days. Such anarrangement would make the bonds virtually risk-free and enable insurance and pensionfunds to provide long-term and low-cost debt to the Fund.

All lenders other than the Sponsors would have apari passu charge on the Fund.The Sponsors would provide subordinated debt with a view to improving the return profilefor all other participants, thereby lowering the cost of borrowing. This would help reduce therisk perception in respect of the other investors and align the interests of the Sponsors withother lenders as defaults upto 10% of the total lending would be borne entirely by the

Sponsors. By way of compensation, the Sponsors may be entitled to an additional return of

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about 1.5% on their subordinated debt. Further, the subordinated debt provided by theSponsors shall not be transferred by the Sponsors to any other entity for a period of ten years.

The Central Government will provide a comfort letter to all lenders to the effect that it wouldprovide assistance and support to the Fund for recovery of its dues from the respective project

authorities in accordance with the provisions of the aforesaid tripartite agreements. Thecomfort letter will clearly exclude any direct or indirect sovereign guarantee in respect of any

payment defaults.

11. What will be the instrument of lending?

The Fund will issue negotiable bonds to its investors. The bonds will carry standardisedcovenants so as to simplify the credit evaluation process and enhance the potential ofsecondary trading. As such, the Fund will not borrow on a project-specific basis, it will poolall its borrowings for lending to project companies.The project company will be required to issue a negotiable bond to the Fund. In due course,these bonds could be traded in the market, either individually or through an intermediate

bond created by securitizing the bonds issued by a group of companies/SPVs (to enhancesecondary market liquidity). The bonds may be issued in two separate streams one wherethe source of funds is in foreign currency and the other where the source is in rupees.

12. What will be the interest rate?

The Fund will endeavor to earn a long-term spread of about 100 basis points above the rate ofinterest paid by the Fund to its investors (the standard rate). This margin would cover theoperating costs of the Fund, including the premium payable to the Sponsors on theirsubordinated debt. The balance would be held in a corpus for meeting the liabilities arisingout of any non-performing assets (NPAs). The Fund may charge higher rates of interestsdepending upon the risk perception associated with the respective projects. Since the Fundwill compete with the banks and also face pressure from project authorities and sponsors tokeep interest rates low, it will have to offer market competitive terms. The Fund will be freeto refuse any proposal, fully or partially from a project company. The Fund will also have thefreedom to determine the quantum of debt, its tenor and a covenant package that it considersnecessary forsafeguarding investor capital.

13. Who will bear the exchange risks?

Foreign lenders such as insurance and pension funds which provide low-cost long-term fundswould be averse to bearing exchange risks. The Fund would, therefore, assume the exchange

risks and manage them through one or more of the following options viz. (a) lend in thedenomination of the borrowed funds and allocate the exchange risk to the project company;(b) lend in forex but require the borrower project company to hedge the exchange riskincluding the roll-over risk of hedging; or (c) charge an interest rate equal to the sum of theinterest rate on borrowed funds and a hedge premium equal to the prevailing market rate plusan appropriate spread. Alternatively, the Fund may charge a premium at a flat rate of 3% ofthe debt and use the premium for creating a separate account for meeting the exchange risks.Any losses beyond the said 3% premium may be underwritten by the Government.

14. How will the refinancing gains be shared?

It is expected that interest rates on the debt provided by the Fund to project companies would

be lower than the rates paid by such project companies to commercial banks, especiallyduring the construction period. In the UK, it is a common practice to refinance the initial loan

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of a PPP project to take advantage of reduced risk in the project and also to benefit from amore mature PPP financing market. The refinancing gains are normally shared between the

project authority and the project company. On the same analogy, the project authorities inIndia may appropriate 50% of the refinancing gains when they sign the respective TripartiteAgreements referred to above.

15. Will there be an exit route?

While the risk-perception among domestic investors might be comparatively stable, foreigninsurance and pension funds as well as the sovereign funds would require the comfort of anexit route and an independent valuation of the bond portfolio (ideally, a market valuation).Therefore, secondary liquidity will be enhanced by a largely standardised set of bondcovenants as well as ratings provided by international rating agencies.While all participants would have the freedom to buy and sell among themselves as well as inthe secondary market, foreign debt other than multilateral debt (which carries a sovereignguarantee in any case) may also be redeemed by sale to the Sponsor which shall buy one-half

of such debt at a discount of about 5% on the residual nominal value of the respective debt.Funds may be raised by the Sponsor for this purpose either on its own or on the strength of asovereign guarantee.

16. Who will set up the Fund?

The Fund will be set up by the Sponsor, which will act as the General Partner of the Fund.The Sponsor will include one or two more entities as General Partners, of whom one should

preferably be foreign in order to enhance the international credibility of the Fund. The Fundcould either be set up as a trust or as a company.

17. Who will manage the Fund?

The Fund will be an independent legal entity to be managed by a small team of experiencedprofessionals selected for this purpose. In order to carry conviction with the prospectiveparticipants, the Fund would be managed by a Fund Manager of international repute whoshould be perceived as neutral and free of any conflict of interest or moral hazard. The FundManager will have the power to accept or reject assets based on its own credit analysis of the

projects submitted to it. The remuneration of the Fund Manager may be linked to the totaldisbursements and the returns of the Fund. Lenders to infrastructure projects will have no sayin the management of the Fundas they would be the direct beneficiaries of the take-out financing provided by the Fund.An Advisory Board for the Fund shall be constituted with representation from different

stakeholder interest groups. Selection of the Fund Manager should be preceded by a stringentprequalification process aimed at short-listing Fund Managers of international repute andexperience. Final selection from amongst the short-listed applicants should be based onfinancial bids. The entire process should be carried out transparently and in conformity withinternational best practices. In particular, any conflict of interest should be carefullyidentified and eliminated.

18. What will be the tenor of lending by the Fund?

The purpose of setting up this Fund is to provide long-term debt for infrastructure projectsand the minimum maturity of bonds to be subscribed by the Fund would, therefore, be ten

years. Projects requiring debt for less than ten years can continue to rely on the normalbanking system. The bonds would carry a moratorium of at least three years on repayment of

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principal, which would be recovered through equated monthly instalments (EMI) spread overthe remaining tenure of the bonds. The entire repayment shall be completed two years prior tothe expiry of the respective project contracts. The project sponsors may also have the optionof borrowing 50% of their debt in the form of bonds that will carry a bullet payment for the

principal amount. The bullet payment shall be made no later than a date five years prior to the

expiry of the respective project agreements. The maximum tenure of debt shall not exceedtwenty years.

19. From whom would the Fund borrow?

The Fund should explore various options, domestic as well as foreign, for raising long-termdebt. Tentatively, the following could be approached for participating in the proposed Fund tothe extent indicated below:(a) Domestic insurance/ pension funds Rs. 20,000 cr.(b) Foreign insurance/ pension funds Rs. 10,000 cr.(c) Foreign sovereign funds Rs. 10,000 cr.(d) World Bank/ ABB Rs. 5,000 cr.

(e) Sponsors (IIFCL, SBI, ICICI, UTI, IDFC etc.) Rs. 5,000 cr. Total Rs. 50,000 cr.The above amounts may be raised in multiple tranches over a period of three years based onthe emerging disbursement opportunities. To begin with, the Fund may seek investments fromdomestic sources and gradually invite foreign investors to join over time. The option ofsetting up multiple funds for different target groups should also be kept open. The Fund mayalso be allowed to issue long-term bonds for investments by non-resident Indians.

20. How will the Sponsors raise their contribution?

Sponsors may be allowed to raise their contribution by issuing tax-free bonds under thescheme recently announced by the Finance Minister. Alternatively, a government guaranteemay be provided in the case of institutions like the IIFCL for raising the requisite funding. Insome cases, the Sponsors may be able to raise the required funds without any governmentsupport.

21. What will be the role of the Government?

The role of the Government will be one of an enabler and facilitator. The borrowings of theFund will not be guaranteed by the Government except in the case of loans from the WorldBank and ADB as they cannot lend without a sovereign guarantee. The Government mayconsider providing guarantees or tax-free bonds for raising the Sponsors contribution, on acase by case basis. The Fund would, therefore, have to face the market test in its evolution aswell as in its operation. However, to kickstart the process, the Government may play a pro-

active role in setting up the first such Fund.

BIBLIOGRAPHY

(n.d.). Retrieved from http://bankingindiaupdate.com/takout.htm(n.d.). Retrieved from http://www.thehindubusinessline.com/industry-and-

economy/banking/article2964281.ece?homepage=trueHaldea, G. (n.d.).India Infrastructure Debt Fund: A Concept Paper.Khan, H. R. (n.d.).Infrastructure Financing in India Progress and Prospects*.ministry, F. (n.d.). Retrieved from http://finmin.nic.in/press_room/2011/infra_debt_fund.pdf

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plans, p. c.-5. (n.d.). Retrieved fromhttp://planningcommission.nic.in/plans/planrel/fiveyr/welcome.html