meeting the financing challenge in the energy sector in india

8/12/2019 Meeting the Financing Challenge in the Energy Sector in India

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IEC 2013Securing tomorrows energy today:Policy & RegulationsMeeting the Financing Challenge in the

Energy Sector in India

February 2013www.deloitte.com/in


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We are energy secure when we can supplylifeline energy to all our citizens irrespective

of their ability to pay for it as well asmeet their effective demand for safe andconvenient energy to satisfy their variousneeds at competitive prices, at all times

and with a prescribed condence levelconsidering shocks and disruptions that canbe reasonably expected.- Integrated Energy Policy , Government of India


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Background Paper on Financing Challenges | 3

Contents

Strategic context 4

Policy and regulatory framework 8

Pricing of energy in india 13

Discussion points 17


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4

Strategic Context

Indias infrastructure spending for the 12th ve yearplan period is estimated by the Planning Commission1

to be of the order of Rs.56.3 trillion (roughly USD1.05 trillion). This is effectively double the investmentsachieved over the eleventh ve year plan period(2007-12) in Infrastructure sector. The investment byprivate sector in infrastructure needs to rise from 38%in the eleventh ve year plan period to about 50% forthe overall target of investments to be realized over thetwelfth ve year plan period. This gradual shift awayfrom public nancing of infrastructure2 is in line with theGovernments strategy to focus scarce public resourceson social sectors of the economy.

The large investment requirements and the increasingrole of the private sector both translate to severalchallenges in nancing. A sub-group on Infrastructurefunding requirements for the 12th Five Year Plan periodwarned that such investments cannot be taken forgranted and nancing could fall short by more than

Rs.10 trillion under the current environment unlessseveral policy and regulatory changes are implementedexpeditiously to ensure that additional nancialresources can be mobilized to bridge this gap on theone hand and to facilitate easier investment ows byfrom the private sector on the other hand into thevarious sectors of infrastructure, including investment inenergy related sub-sectors.

Power, by far, accounts for the largest share ofprojected investments amongst all the infrastructuresectors, accounting for almost a quarter of the total

infrastructure funding requirements over the 12thve year plan period. Oil and gas and coal sectorinvestments, which along with electricity are part of thecore sectors of Indian economy, account for a furtherapproximately Rs.6 trillion in investments over the 12thplan period.

The following sections outline the challenges ofmobilizing nances and channelizing investments of thismagnitude along the four dimensions outlined in thediagram above and summarized as follows. At the core is the requirement to address sector-

specic policy and regulatory impediments. These arethe rst set of issues outlined in the paper

It is well-established that Indias domestic savings rateis high and can nance much of the infrastructurenancing needs but intermediation of these savingson a large enough scale needs a well-diversied

1 Draft Twelfth Five YearPlan document, PlanningCommission, Government of

India2 Private investment in

Infrastructure formed 22%of all investments over the10th Five Year Plan periodand was 38% over the 11thFive Year Plan period.

and efcient nancial system with diverse nancialinstitutions, diversity in nancial instruments anddepth in the capital markets to support long-termfunding requirements of infrastructure and coresectors of the economy. This forms the second set ofissues discussed in the paper.

The third section focuses on means of tappinginternational capital ows, including foreign directinvestments in energy and tapping of externalcommercial borrowings.

The fourth section outlines the crucial role ofmultilateral development banks such as the WorldBank and Asian Development Bank in enhancingthe investment climate in certain segments ofenergy through risk-intermediation, tapping intoconcessional sources of nance and building capacityof nancial institutions and utilities.

Figure 1: Enabling Financing Flows to Energy

Addressing SectorPolicy & Regulatory Impediments

2

1

3 4

InternationalCapital Flows

Role ofMultilateral

Agencies

ChannelisingLong-termFlows/Savings

Enabling Financial Flows


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Addressing Sector-specic Barriers

To mobilize the high levels of private capital for Powerand other Energy sectors, it is essential to pursuereforms in several directions. While certain cross-cutting enabling frameworks need to be addressedcomprehensively, such as with regards to landacquisition and environmental clearance, there are othersector-specic issue, which require a quick resolution forlarge-scale investments ows to be catalysed and thetwelfth ve year plan targets to be realised.

Some of these concerns commonly voiced by keystakeholders are outlined in this section for Power, Coaland Oil & Gas sectors.

Cross-cutting ConcernsDelays in Land Acquisition, Rehabilitation andResettlement and obtaining Environment and ForestClearances have proved to be the bugbear of severalenergy sector projects and are likely to be even morevexed in the coming days, unless well-coordinated

actions are taken by the Central and State Governmentsto ensure genuine projects are moved forward.

Land Acquisition and Rehabilitation andResettlementLand acquisition (and R&R) is at present the single-largest roadblock for development of infrastructure,with several power and coal mining projects heldup or delayed due to land related issues. The lackof a transparent framework for valuation of privateland and administrative inefciencies in planning andimplementing rehabilitation packages in most partsof the country, leads to mistrust, which quickly getsexploited by vested interest groups leading to a cycle ofdisputes and litigations.

The Government of India has nalised the LandAcquisition and Rehabilitation and Resettlement (LARR)Bill to introduce a framework for land acquisitionsand to provide for a transparent compensation andrehabilitation mechanism. It has also implemented theScheduled Tribes and Other Traditional forest Dwellers(Recognition of Forest Rights) Act, 2006. The industry

has pointed out that overall this may lead to a rise in thecost of projects but is seen as the right way forward, if itsimplies the acquisition process. A comparison of someof the LARR Bill 2011 with the Land Acquisition Act,1894 is summarised in the table below.

Provision Land Acquisition Act, 1894 LARR Bill, 2011

R&R Land Acquisition Act, 1894 does notcover R&R. This is governed separatelyby the provisions of the National R&Rpolicy, 2007.

Integrates Land Acquisition with R&R.

R&R provisions apply to a private company thatpurchases more than 50 acres of land in urban

areas or 100 acres in rural areas.Denition ofPublic Purpose

Includes several uses such asinfrastructure, development andhousing projects.

Similar

Consent ofproject affectedpeople

No requirement. Consent of X % of displaced people required incase of acquisition for private companies andpublic-private partnerships. Is not applicable forprojects of Public Sector Undertakings.

Social ImpactAssessment

No such provision. SIA to be undertaken in case of every acquisition

Compensation Based on the market value, determinedon the basis of current usage with an

additional solatium of 30%.

Based on twice the Market Value in urban areasand four times the Market Value in rural areas.

SubsequentTransfer or Sale ofLand

No provision. Only with prior permission of the government;20% of prots to be shared with original landowners.


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Environment & Forest related clearancesA total of 245 developmental projects 3 received underthe Environmental Impact Assessment (EIA) Notication,2006 were pending as on 30 June 2011. They coverhydropower sector including irrigation, thermal power,mining, and building and construction projects andare pending for varying durations with the Ministry ofEnvironment & Forests for environmental clearance.

Environmental clearance often takes the longest timeand causes maximum delays to projects. Cumbersomeprocedures for environmental clearance and publichearing, submission of incomplete information, poorquality of EIA/EMP, disproportionate details requiredwith applications, delays in the meetings of the ExpertCommittees and site visit, etc., are the major reasonsbehind delays.

MOEF has taken several measures to reduce delays inthe grant of environmental, forest and coastal zone

regulation clearances. The investment limit as well asthe list of projects requiring environmental clearanceshas been simplied over the years. Besides takingup various activities in parallel, MOEF should also setup reengineered systems to examine the documentrequirement at the stage of receipt of application.

Although statutory clearances are to be granted byrelevant agencies, coordination committees, withrepresentation of all concerned including States, shouldbe set up for expediting decisions and complyingwith information related to environment and forestclearances. Diversion of forestland for pre-constructionactivities may be permitted after the non-forest landidentied for compensatory afforestation has beentransferred to the forest department and funds forraising compensatory afforestation deposited.

Bidding authorities also have a tendency for bidding outprojects under administrative pressures without requisiteenvironmental and forest related clearances. This is apractice best avoided through strict guidelines, whichshould mandate obtaining all such clearances beforeprojects are bid out.

Re-engineering of regulatory processes prescribed undervarious legislations, regulations, etc., is necessary to

simplify the procedures for grant of approvals, reducedelays & ground level hassles and simplify the regulationof projects during their operational phase. As manyapprovals as are possible should be placed on self-regulation, i.e., under automatic approval upon ling ofnecessary documents.

3 http://pib.nic.in/ newsite/erelease.aspx?relid=753322


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A Group of Ministers was constituted by theGovernment of India on 3rd February 2011 to considerall issues relating to reconciliation of environmentalconcerns emanating from various developmentalactivities including those relating to infrastructureand mining. To have a focussed discussion on issues,the GoM in turn constituted a committee chairedby Mr.B.K.Chaturvedi, Member (Energy), PlanningCommission to consider the above issues and come upwith recommendations.

The Committee pointed out inter alia the followingcritical issues and recommended solutions, which arepending consideration of the Central Government. Forest Clearance norms are in accordance withlegal provisions but procedures followed have oftenled to delays of 3 to 6 years, which is unsustainable.Major reasons for delay have been identication ofcompensatory afforestation, land acquisition, R&R anddelays at processing proposals at the State level. TheCommittee recommended the creation of Nodal Agencyat the State level for quick processing of forest clearancecases, land acquisition and R&R issues. The policy of Go/No Go areas for coal block

clearances has no legal basis. The Committee feltthere is merit in classifying areas based on their oraland faunal parameters and only those blocks withdense forests and other ecological and environmentalconsiderations of serious nature should be kept out ofmining considerations.

The Committee recommended relaxing Forest RightsAct provisions for transmission lines, which require

only right of way. Provisions for acquisition of land forsubstations should however continue.

The Committee recommended that up to 25%expansion in existing coal mines be permitted withoutany public hearing.

The Committee also made several recommendationsto ensure better quality forests are regenerated in atime-bound manner after mining operations get over.

Power SectorThe 12th ve year plan targets for generation capacityaddition have been set at approximately 88.5 GW forconventional power and 30 GW from renewables,totalling 118 GW.

After growing at a staggering annual growth rate ofapproximately 50% over the last 3-4 years, nancingto the power sector registered a sharp decline inthe nancial year ending 31 March 2012 to 9%. Inparticular, three specic concerns were the causeof signicant concerns on the part of investors andnanciers. These are as follows. Fuel side concerns : It became increasingly apparent

in 2011 and 2012 that Coal India Limited had issuedLetter of Allocation (LoAs) for capacities translatingto over 700 million tonnes (MT) of annual output,while its current production is around 450 MT. TheWorking Group of Coal for the 12th Five Year Planestimates a best case production scenario of 615 MTof coal in the optimistic scenario by the terminal year(FY2016-17). With about 75 GW of plants dependenton linkage coal under various stages of development,and only about 35 GW of this capacity possibleto be supported by this level of production, largeproportion of power plants could be stranded forwant of fuel.

With 50 per cent of the new capacity being createdin the private sector fuel supply agreements haveto be legally binding with credible penalties toreassure bankers and other nanciers nancing

the establishment of capacity. CIL has only recentlystarted signing acceptable FSAs with developerswhose plants are likely to be commissioned over the12th ve year plan period.

Health of distribution utilities : The combinednancial losses of the distribution utilities areexpected to be of the order of Rs.75,000 Crores inFY11-12. However a more alarming dimension of theaccumulated losses on this occasion is the fact thatbulk of it is nanced through short-term liabilitiesfrom the nancial institutions, including Public SectorBanks. This led to the Central Government devisinga debt restructuring scheme in October 2012,which is summarised in the box overleaf. This debtrestructuring proposal would only be meaningful if itis not treated as yet another bail-out and adhered toby both the State Government and the Discoms


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Concerns with the Competitive BiddingFramework: Emergent fuel supply conditionshave necessitated a relook at the fuel supplyrelated obligations and risks under the existingStandard Bidding Documents for Case 1 and Case2 projects. In particular, the following changes havecreated uncovered risks for the bidders in post-bidenvironment with little exibility to re-negotiatecontracts.- Domestic Captive Coal Mine Based Projects

coal reserve estimations were inadequate in mostcases bid out with the result that reserves of coalmines allocated are substantially at variance withthe requirements of the power project leading toallegations of misuse and proteering.

- Linkage based projects actual coal supply hasvaried signicantly from assumptions at the biddingstage with assured coal quantity at only 50%-60%of installed capacity, balance being procured fromother sources. Wide post-bid variations in fuel

supply conditions for a Power Project makes a rmenergy price bid impractical in current times

- Imported coal based projects legal/regulatorychanges in the countries from where coal isimported not recognised

The Ministry of Power is currently reviewing theStandard Bidding Documents and is likely to proposesubstantive changes to improve the risk-sharingarrangements in the power purchase agreements.


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Scheme for Financial Restructuring of Distribution Companies1. (a) 50 per cent of the outstanding short term liabilities (STL) as of 31 March 2012 to be taken over by State

Governments by way of bonds to participating lenders shall be rst converted into bonds to be issued byDiscoms duly backed by the State Government guarantee. The State Government will take over the liabilityduring the next two to ve years by issuance of special securities in favor of participating lenders in a phasedmanner keeping in view the scal space available till the entire loan (50 per cent of STL) is taken over by theState Government.

(b) The State Government would provide full support to the Discoms for repayment of interest and principal.

2. Balance 50 per cent of the STL will be rescheduled by lenders and serviced by the Discoms with a moratoriumof three years on principal and would be backed by a State Government guarantee. The best possible terms areto be extended for the rescheduled loans to improve viability of Discoms operations.

3. The restructuring/reschedulement of loan is to be accompanied by concrete and measurable action by theDiscoms/States to improve the operational performance of the distribution utilities. In order to make the effortmeaningful, the State Government/ Discoms have to commit themselves and carry out certain mandatory andrecommendatory conditions contained in part (c) of the Scheme including mandatory tariff lings, privateparticipation in distribution, etc.

4. To set up a Transitional Finance Mechanism in support of the restructuring effort of the State Government fortheir distribution utilities having the following features:

(a)For providing liquidity support by way of a grant equal to the value of the additional energy saved by wayof accelerated AT&C loss reduction beyond the loss trajectory specied under Restructured AcceleratedPower Development and Reform Programme

(b)The eligibility of grant would arise only if the gap between ARR and ACS for the year has been reduced byat least 25 % during the year judged against the benchmark for the year 201011.

(c)This scheme would be available only for three years beginning 201213.

Incentive by way of capital reimbursement support for 25 per cent of principal repayment by the StateGovernment on the liability taken over by the State Government under the scheme. The amount to bereimbursed only in case the State Government takes over the entire 50 per cent of the short-term liabilitiescorresponding to the accumulated losses outstanding as on 31 March 2012. Detailed guidelines for theTransitional Finance Mechanism as outlined above would be worked out by the Ministry of Power in consultationwith Ministry of Finance.


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Renewable Energy SectorThe 12th Five Year Plan has proposed a capacityaddition of 30,000 MW from renewable energy inthe 12th Five year Plan. It can be expected that theinvestment requirement for the renewable energy (RE)sector in the 12th Five Year Plan can be well above theRs 1.37 trillion.

Given the huge nancing requirement for achieving thetargets for the 12th Five year plan, the challenge for thepolicy makers and key stakeholders shall be to overcomethe nancing issues faced by the renewable energysector and implement measures for tapping funding forthe sector. Following are some of the key issues thatrequire to be addressed for nancing to improve for therenewable segment. RE projects have to compete with conventionalpower projects when it comes to securing nance fromScheduled Commercial Banks. With smaller investmentsizes, SCBs have an obvious propensity to go for larger

ticket sizes to optimize on transaction costs and efforts.Renewable Energy should be treated as a sector distinctfrom conventional power in the determination ofsectoral limits of exposure for Scheduled CommercialBanks. Renewable projects are capital-intensive in nature

with relatively lower O&M Costs (except for Biomassbased projects). The risks inherent in renewableprojects are also high as the sector is in its infancy andtechnology and resource availability pose additionalrisks compared with conventional power. Certainsegments of RE (e.g., solar thermal, offshore wind,

etc.) would benet from higher provision of publicnancing and require government to play an activerole in risk mitigation to ensure ow of nancing andto keep costs of nancing within reach for renewableinvestors.

Awareness amongst nancial institutions is alsoinsufcient about the sector-specic risks &opportunities. It is preventing them from adaptingtheir standard corporate or project nance productsto renewable requirements and conditions. Forexample, insurance products for mitigation of loss ongeneration are not available for renewable projects.

Most renewable technologies yield tariffs higher thanconventional power projects and hence nd lessfavour with already cash-strapped distribution utilities.In the absence of stringent enforcement of renewableportfolio obligations, renewable projects in severalstates continue to face signicant payment risks.

Bankability of solar power projects is emerging tobe a major concern with the aggressive biddingwitnessed in solar projects under JNNSM. Mostprojects so far have been nanced on a non-recoursebasis with concessional EXIM or donor nance.Almost none of these projects have hedging coveralthough several have accessed foreign capital. ForIndia to realize i ts dream of 20 GW of solar capacityby 2022, it will have to broaden the participation ofCommercial Banks in RE nancing on a non-recoursebasis. This calls for a more structured role for theCentral Government to create appropriate risk-intermediation measures for commercial capital toow through to the sector.

Renewable Energy Certicates (REC) provides amarket-linked alternative source of revenue forprojects in RE segment. Uncertainty in long termREC pricing enhances future cash ow risk for theprojects. For example, under current REC framework,solar REC prices can be expected to reduce drastically

as REC prices reect the gap between the averagepower purchase cost and Feed in tariff.

Availability of funding is a major constrain for stateutilities to enhance the evacuation infrastructurespecically for renewable energy projects. Mostof the states do not have a ded icated renewabletransmission plan. The Green Energy Corridorscheme covering intra/inter-state transmission systemstrengthening, facilities like exible generation,establishment of Renewable Energy ManagementCentres, etc. to address intermittency and variabilityaspects as well as grid integration issues of large scale

RE generation, was launched by the Government ofIndia in September 2012. It needs to be implementedon a priority to build a reliable transmissioninfrastructure for RE.


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Oil and Gas SectorThe New Exploration Licensing Policy (NELP) of theCentral government provides freedom to the operatorto price gas produced from the NELP blocks at a market-determined price, subject to Government approvingsuch pricing formula. Several questions have howeverbeen raised with respect to interpretation of variousclauses of the existing contracts The entire structure ofNew Exploration Licensing Policy (NELP) also came upfor review after the Comptroller and Auditor Generalsobservation on existing Production Sharing Contracts(PSCs) entered into by the Central Government. Apanel headed by C.Rangarajan, Chairman of the PrimeMinisters Economic Advisory Council was constitutedto examine the existing PSCs, including in respect ofthe current prot-sharing mechanism and recommendnecessary modications for the future PSCs. The panel isreported to have submitted its report on 20 December2012, contents of which are not yet public.

A stable and attractive policy regime is required toattract investments into the technology-intensive andhigh-risk segments of exploration, which depends onlarge global players, who expect terms of businesscomparable with those offered elsewhere in the world.Primary amongst these is clarity on the price producerswill receive, investment multiples, stability in the taxregime and clarity on marketing rights. A quick decisionon the terms of the PSC and clarity on honouring theexisting PSCs would help revive the next round of NELP,which have been kept on hold.

Investors in both exploration and rening are lookingforward to a more stable pricing regime in oil and gas.With the continuation of high oil and gas prices in theworld market and our rising dependence on imports,there is an urgent need to align domestic oil and gasprices to market prices for sound development of thesector and to send the right signals to consumers andproducers.

Besides the NELP related contractual clarity ahead ofthe Xth round of NELP bidding, there are several otherpolicy and regulatory issues which need to be urgentlyaddressed over the 12th ve year plan period. Theseinclude the following.

The Integrated Energy Policy laid out the need forindependent regulation in the upstream segment

of the industry. At the moment, the Governmentis involved in contract administration, monitoringand review of investments and pricing decisions. Anindependent regulator must take up these roles, asrecommended under the IEP.

There is a need to rationalise tax structures in sales ofpetroleum products considering its thermal value forits use in transport, industry, power, households andother sectors.

Devise a policy for exploration and use ofnon-conventional fuels such as shale gas, coal bedmethane, etc.

Devise a policy for development and production ofbiofuels by the oil sector exploration, productionand marketing companies at commercial level. Anintegrated policy facilitating development of bio-fuelshas to be evolved by both the States and the CentralGovernment.

In order to attract global E&P players, it is necessaryto provide seismic and other technical data of the

acreages on offer. The entire unlicensed sedimentaryarea should be surveyed and a National DataRepository be readied to facilitate all-year roundacreage award. The Government should movetowards introducing Open Acreage Licensing Policy sothat the target of full exploration coverage by the endof the Plan period can be achieved.

Accelerate deployment of city gas distribution in the300 identied cities in the country.

The 12th Five Year Plan document outlines the needfor operationalizing a roadmap to move petroleumprices received by marketing companies aligned

to global prices. It acknowledges that it may notbe possible immediately but needs to be achievedby the end of the 12th ve year plan period fordiesel and petrol. Subsidies are also envisaged to bephased out on domestic gas and kerosene, with dueconsideration of converting subsidies to equivalentcash transfers. Kerosene supplies should also bereduced considering improved electricity access underRGGVY and provision of LPG in rural areas.


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Coal SectorSubstantial investments are required across the board incoal mining in India in order to address the substantialconstraints the country faces with regards to availabilityof domestic coal. The 12th Five Year Plan documentenvisages Coal India Limited (CIL) to step up productionby 8% per annum 4 to reach a terminal year productionof 650 million tonnes. This requires substantialinvestments by CIL and an expeditious resolution ofenvironment and forest clearances, land acquisition andR&R issues, which plague CIL at various sites.The Central Government is taking a series of initiativesto address coal production issues. An important part ofthis is expediting the allocation of captive coal blocksto the private sector under a competitive biddingframework, which has been nalised and should bemade operational during 2012-13.

The Working Group on Coal formed by the PlanningCommission identied several critical policy areas, which

need to be addressed on a priority, given the importanceof coal to Indias energy security. These are as follows. Address the institutionalization of the Coal Regulator

on a priority. CMPDIL to be made an independent organisation to

develop and maintain the repository of all geologicalinformation in the country on the lines of CEA forpower sector or the DGH for petroleum and naturalgas sector.

Expedite clearances through a mechanism of aCoordination Committee at the Central and Statelevel involving senior representation from the

concerned departments. Uniform R&R and landacquisition policies through central legislation.

Allocation of coal blocks to private sector through atransparent competitive bidding mechanism in therst year of the 12th Five Year Plan period. Devise andimplement an institutional framework for pricing ofexcess coal from such blocks. Create an institutionalmechanism for planning and development ofcommon infrastructural facilities with participationof coal mining companies and the respective StateGovernments.

Develop a comprehensive plan for increasing theshare of production from underground mines andsuitable policy initiatives such as cost plus pricing,scal incentives and so on need to be introduced toimprove potential returns currently available fromunderground mines.

Take steps to improve productivity of CIL includingthe need for hiving off its subsidiaries into separatecompanies.

4 Actual annual growth rateachieved over the EleventhFive Year Plan period was4.6%.


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Channelizing Long-term Flows

In India, nearly 85% of total banking sectors exposureto infrastructure is limited to Public Sector Banks (PSBs).This is a matter of concern as Scheduled CommercialBanks are likely to face asset-liability managementissues with most of their assets raised through short-tenor current and savings accounts, while infrastructuresectors require long-tenor nancing.This underlines the need to mobilize funds from sourcessuch as pension and insurance funds, channelizinghousehold savings and developing a vibrant bondsmarket with sufcient depth. It will require diversityin nancial intermediation, some of which have beenimplemented in recent times such as the provisionof Infrastructure Finance Companies (IFCs) andInfrastructure Debt Funds (IDFs) with specic regulatorydispensations for raising and disbursing funds.

Role of Infrastructure Debt Funds (IDF)The Union Finance Minister in his Budget Speech of2011-12 announced the setting up of Infrastructure

Debt Funds for ow of long-term debt fund toinfrastructure. IDFs would raise low-cost, long-termresources for re-nancing infrastructure projects thatare past the construction stage, which its associatedrisks. Through a package of credit enhancementmeasures, it is proposed to channelize these debt fundsto infrastructure projects that are backed by a buy-outguarantee from the government. This would enable theproject sponsors to renance their debt while sharingthe gains with the government/ users. It would alsorelease a signicant proportion of the scarce lendingspace of the banks, thus enabling them to lend to the

robust pipeline of forthcoming projects

IDFs could either be in the form of Mutual Funds orNon-Banking Financial Companies (NBFCs) and thuswould be regulated by SEBI and RBI respectively. Acomparison of both modes of IDF is provided in thetable below.

Investors in the IDFs are envisaged to primarily bedomestic and off-shore institutional investors (insuranceand pension funds). Banks and Financial Institutionswould only be allowed to invest as sponsors of an IDF.Credit enhancement in Public Private Partnership (PPP)projects would be available for IDFs issuing bonds. IDFswould renance PPP projects, involving lower risk leveland a higher credit rating, enabling the ow of funds ata competitive cost.

IDFs offer several advantages for investors including thefollowing. Withholding tax on interest payments on the

borrowings by the IDFs would be reduced from 20%to 5 %, thus benetting foreign investors.

Income of the IDFs shall be exempt from income tax.So far, the following IDFs have been announced

although there has been limited demand for IDFpaper and it has been a challenge to raise resources.


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Criteria IDF as a Trust/ MF IDF as a Company/ NBFC

Regulatorybody

Would be regulated by SEBI and all Mutual Fund/AMCregulations will be applicable

Would be regulated by RBI

Sponsorship Any domestic entity with sufcient experience ininfrastructure nancing could be the sponsor

Firm commitment from the strategic investors forcontribution of an amount of at least Rs. 25 crores beforethe allotment of units of the scheme are marketed to otherpotential investors

Could be set up by one or more sponsors, including NBFCs,IFCs or banks

Sponsor IFCs would be allowed to contribute a maximum of49% to the equity with a minimum equity holding of 30%

Minimum NOF of Rs. 300 crores and CRAR of 15%, withnet NPAs less than 3% of net advances

Credit Risk Credit risks will be borne by the investors and not by the IDF Credit risks associated will be borne by the IDF

Investments Units would be listed in a recognized stock exchange andtrade-able among equivalent (domestic vs. foreign) investors

Would have to invest minimum 90% of its assets in the debtsecurities of infrastructure companies or SPVs

Returns on assets will pass to the investors directly, less themanagement fee

Can be launched either as close-ended scheme maturingmore than ve years or an Interval scheme with lock-inperiod of ve years

Would invest in debt securities of only PPP projects whichhave a buy-out guarantee and have completed at least oneyear of commercial operation

Renance by IDF would be up to 85% of the total debtcovered by the concession agreement

Would be allowed liberal prescription of risk-weightage(50% instead of 100%)

Investors Would have minimum 5 investors, each holding not morethan 50% of net assets of the scheme

Minimum investment would be Rupees One Crore with Rs.10 lakh as minimum size of the unit

Potential investors would include off-shore institutionalinvestors, off-shore High Net-worth Individuals (HNIs), NRIsand domestic institutional investors

Lead Sponsor Partners Announced Fund size tobe raised

Status of approval Type of Alliance

LIC & SREI LIC & SREI Dec 2011 NA SREI receivedin-principal approvalfrom SEBILIC is awaiting SEBIsapproval for debt fund

Mutual fund

ICICI ICICI Bank (31% ), Bankof Baroda (30%), CitiFinancial (29%) LIC (10%)

March 2012 Rs 10,000 Crore Approval receivedfrom RBI in March2012

NBFC

IDFC NA March 2012 Rs. 5,000 Crore Applied to SEBI inMarch 2012

Mutual fund

IIFCL IIFCL (26%), LIC (10%),IDBI (14%) AsianDevelopment Bank,HSBC and Barclays (willcontribute the remaining50% in the fund)

April 2012 Rs. 5,000 Crore Received provisionalapproval from SEBI inMarch, nal approvalexpected shortly

Mutual fund


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Pension and Insurance FundsGlobally, Pension and Insurance funds are the leadingsource of long-term nance for infrastructure. In Indiahowever, owing to the under-developed secondary debtmarket, pension and insurance funds have had relativelyfewer avenues to invest in infrastructure. These fundsusually stay away from Greeneld projects, which areconsidered risky. If risk and liquidity related factors aresuitably addressed, avenues for Pension and Insurancefunds to nance infrastructure increases. Althoughinvestment regulations for such funds in India havebeen liberalized over time and credit enhancementschemes are being launched to suitably address riskissues in lending to infrastructure, their contribution toinfrastructure nancing needs to go up substantially forIndia to realise its twelfth ve infrastructure investmenttargets.

Need to relook Investment Guidelines for PensionFunds in India

Under the investment guidelines nalized for the NewPension Scheme5 (NPS), pension fund managers willneed to manage three separate schemes, each investingin a different asset classes. The three asset classes are asoutlined below. The subscriber will have the option toactively decide as to how the NPS pension wealth is tobe invested in three asset classes. Asset class E (equity market instruments): The

investment by an NPS participant in this asset classwould be subject to a cap of 50%. This asset class willbe invested in index funds that replicate the portfolioof either BSE Sensitive index or NSE Nifty 50 index.

Index Fund Schemes invest in securities in the sameweightage comprising of an index Asset class G (Government Securities) This asset

class will be invested in central government and stategovernment bonds

Asset class C (credit risk bearing xed incomeinstruments) This asset class contains bondsissued by any entity other than Central and StateGovernment. This asset class will be invested in liquidfunds of mutual funds, xed deposits of SCBs, debtsecurities with maturity of not less than 3 years tenureissued by corporate bodies including SCBs and publicnancial institutions (provided that at least 75% ofthe investment in this category is made in instrumentshaving an investment grade rating from at least onecredit rating agency), credit rated public nancialinstitutions/ PSU bonds, and credit rated municipalbonds/ infrastructure bonds

Cash held in the schemes will be for trading andcash ow management purposes only. Cash will notexceed 10% of the assets of the scheme portfolios,except when cash or specic cash instruments areincluded in the investment universe

The sectoral cap of 75% of the investment having aninvestment grade rating under Asset class C scheme, hasled to Pension Funds missing out on the opportunity toinvest in infrastructure projects, as not many projects /companies in infrastructure enjoy such status in India.It calls for credit enhancement to ensure projects whichhave moved beyond the construction phase and henceof improved risk prole are able to tap into pension andinsurance funds.

Need to relook Investment Guidelines for InsuranceFunds in IndiaAs on 31st March, 2011, accumulated total investmentsof the insurance sector stood at Rs.15.12 trillion,

registering an Asset Under Management (AUM) increaseby 18.28% over nancial year ending 31 March 2010.Life insurers continue to contribute a major share oftotal investments held by the industry with a shareof 95% (Rs.14.30 trillion). Although Life Insurancecompanies are required to invest 15% of their Life Fundin infrastructure and housing, the share of infrastructurein the Life Funds have come down to 10% in FY11vis--vis 15% in FY07. This point to lack of investmentopportunities and a need for relook at the regulations toenable nancing ows to infrastructure.

As per current IRDA investment guidelines, every insurershall limit his investments based on the followingexposure norms. Investments permitted in an infrastructure SPV oated

by a Public Sector Enterprise (PSE) subject to thecondition that the parent company (PSE) meets therating criteria.

Stipulation that 75% of investments in debt,(excluding investments in Government Securities/ Other Approved Securities) should be in AAA ratedinstruments. This may need to be relooked as privatecompanies even with credit enhancement may notattain such ratings.

The current IRDA (Investment) Regulations andclarications issued thereunder , provide for debt/loaninvestment in Infrastructure companies to the extentof 25 per cent of the project equity/capital employedwhich in real terms works out to only 5 to 8.75

5 NPS is a denedcontribution based pensionscheme launched by theGovernment of India in2004. Pension schemesin India have traditionallybeen structured as dened

benets schemes and thelaunch to NPS was part ofpension reforms initiated bythe Central Government totransit from dened benetsto dened contributionbased pension schemes.


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per cent of the total project cost depending on theequity brought in by the promoters. In order to havea higher investment by the Life Insurance companiesthe exposure can be considered for revision to 20per cent of the total project cost as being done byIndia Infrastructure Finance Company Limited (IIFCL).

Recent announcement of proposal to increase the FDIcap in Pension Funds as well as Insurance companies to49% (from 26%) is expected to attract foreign entitiesinto this untapped segment in India.

Re-inventing India Infrastructure Finance CompanyLimited (IIFCL) for a Larger RoleThe Interim Report of the High Level Committeeon Financing Infrastructure outlined the need totransform the role currently played by IIFCL to addressspecic challenges faced by nancial institutions andinvestors in mobilizing funds for infrastructure. Backedwith sovereign guarantees and specic regulatory

exemptions, IIFCL, it observed, should not duplicateCommercial Banks in lending directly to projects butshould instead leverage its capital to provide guaranteesand credit enhancement mechanisms for infrastructureborrowers and to extend subordinated debt, such asto catalyse larger inows of additional funding forinfrastructure projects.

Credit Enhancement Scheme for InfrastructureCompanies & Deepening the Bond MarketBond nance is regarded as an important source ofnancing for infrastructure globally, as it offers long-

tenor, xed rate sources of nancing, not availablewith Commercial Banks. However, the bond marketin India has remained underdeveloped even thoughequity markets are well-developed in India. As a result,neither household savings nor long-term insurance andpension funds are being channelized effectively intoinfrastructure nancing. To promote off-shore inows oflong-term debt, Foreign Institutional Investors (FIIs) arecurrently permitted to invest in bonds of infrastructurecompanies. However, FII investments in infrastructuretoo are quite low for want of good investment gradeopportunities in the bond market.

Most Infrastructure Companies and Special PurposeVehicles get no better than a BB rating for debtinstruments. This prevents them from tapping the bondmarkets as it results in higher cost and lower receptivityfor such bond issues.

IIFCL has recently launched a scheme in associationwith the Asian Development Bank to provide partialguarantee on bond issues of infrastructure projectdevelopers so that their bonds reach a minimum creditrating of AA, enabling long-term investors includinginsurance and pension funds to participate in suchissues. IIFCL will undertake credit enhancement up to40% of the total project cost and provide unconditionaland irrevocable guarantee for up to 50% of the bondissuance. This scheme recommended by the High LevelCommittee on Infrastructure, was rolled out in the lastquarter of 2012.

Credit enhancement should lead to deepening ofthe bond market over time, with the availability ofinvestment grade paper to satisfy the demands ofpension and insurance funds, household investors andFIIs.

Tapping Household Savings for Infrastructure

Indian household savings account for around Rs. 20trillion annually. This savings is largely deployed innancial & physical assets like bank deposits (1-3 yearmaturity), land and gold.

Chapter IV A of the Income Tax Act, 1961, provides aunique way of mobilizing savings from retail investorsbut caps overall limit for tax savings at Rs. 1 lakh.This category of investment linked savings includesinsurance, pension, housing and specied cumulativeterm deposits. A limit of Rs 1 Lakh is out-dated and notin step with rise in household incomes.

An enhancement in this limit should be consideredor a percentage linked limit to basic wages / salaryincome could be considered for permissible investmentsunder this category. Further, a sub-categorization ofinvestments into long-term and other instruments wouldfurther enhance ows into infrastructure.

From FY2012-13 onwards, benets under Section 80CCFfor retail investors in infrastructure bonds has beendone away with and interest income on InfrastructureBonds have instead been made tax free. Tax incentiveson investments in infrastructure bonds should bereconsidered as it was effective in channelizing retailinvestments into infrastructure nancing.


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International Capital Flows

Tapping overseas markets for infrastructure projects hasoften been utilised in India, especially when the projectinvolves imports of some kind. External CommercialBorrowings could be from international banks,multilateral / bilateral nancial institutions, internationalcapital markets, export credit agencies or suppliers ofequipment and foreign collaborators.

The Government of India and the Reserve Bank of Indiahave focussed on reforms aimed at increasing foreigncapital inows into infrastructure.

Current ECB provisions and concerns can be summarisedas in the table.

Multilateral nancial institutions (MFIs) are much morethan mere sources of nance and bring substantialmarket, knowledge and strategic intermediation toaddress specic needs of the economy. The role of MFIsis particularly important in segments with high economic

and social returns and environmental sustainability.These are investments that, by supporting equitablegrowth in open market systems, crowd in productiveprivate investments. In addition, MFIs have a criticalrole to play in addressing structural risks in both thenancial and energy markets. Besides providing supportduring times of market and economic crisis, they alsohave a critical role in utilising lending as a vehicle forpolicy change and promoting shared international goals.Technical Assistance programmes bundled with lendingalso help to support objectives of poverty reduction,human development, environment protection, nancial

accountability and standards of public procurement thatcurtail corruption and promote competition.

In the Indian context and with regards to the energysector, while the MFIs have played an effective role indirect lending to investment projects greater emphasisis deemed necessary in supporting policy and structuralreforms to crowd in private sector investments overthe long run. Certain areas where MFI funds could beleveraged better in the Energy sector are as follows. Mobilize concessional resources, e.g., from Climate

Technology Fund sources for transformationalnancing in Renewable Energy and Energy Efciency.

Utilize Guarantees for enhancing credit e.g.participation in credit enhancement scheme of IIFCL,PCG for Solar Lending, etc.

Maximising market mechanisms, e.g.,disintermediation and creation of products for the

Particulars Details

Eligibility Corporates and Infrastructure Finance Companies are eligibleto raise ECBs

Recognized lenders International Banks, Multilateral Financial Institutions,International capital markets, export credit agencies, suppliersof equipment, foreign collaborators, foreign equity holders

All in cost ceiling Three years and up to 5 years: 3.5% over 6 months LIBORMore than 5 years: 5% over 6 months LIBOR

End use: permitted Import of capital goods, new projects, infrastructure sector

End use: notpermitted

On-lending, acquiring a company, repayment of existing rupeeloan (rupee debt swap now permitted in specic cases)

Key Concerns 1. Foreign Equity holders are not considered as recognizedlender under the automatic route unless they hold 25%directly in the borrower company

2. Rupee Debt swap is not permitted unless the borrower isforeign exchange earner in the last three years. (this is asper the June 2012 circular)

3. On-lending is not permitted and acquisition of companies isnot permitted.

4. Security (specically charge on immovable assets andnancial securities)) is a cumbersome process even wherethe sector may fall in sector which is open to FDI.

5. There is a need to relax the all-in-price ceiling for ECBs forinfrastructure projects with average maturity exceeding7 years. The interest rate ceilings set by RBI on ECBs putconstraints in availing foreign currency loans for domesticinfrastructure projects. Presently the all-in ceiling cap is500 basis points. At least this cap may be removed forcompanies with good track record.

6. Relaxation of the ECB ceiling of USD 500 Million per annumper company for automatic route will help make ECB stable

source of nancing and ensure increased ECB funding. Thismay be increased to $1 billion for Infrastructure nancing

secondary market. Capacity Building of institutions and utilities across

the energy ecosystem including providing policyadvice, research and analysis, and technical assistanceon a case to case basis.


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Contacts

Vedamoorthy NamasivayamSenior Director I ConsultingDeloitte Touche Tohmatsu India Pvt. Ltd.Deloitte Centre, Anchorage II, #100/2, Richmond Road,Bangalore, Karnataka - 560 025, IndiaEmail: [email protected]

Shubhranshu PatnaikSenior Director | Consulting - Energy and ResourcesDeloitte Touche Tohmatsu India Private Limited7th Floor; Building 10, Tower B, DLF Cyber CityComplex, DLF City Phase - II, Gurgaon - 122002,Haryana, IndiaEmail: [email protected] |

Debasish MishraSenior Director | ConsultingDeloitte Touche Tohmatsu India Pvt. Ltd.30th Floor, Tower 3, Indiabulls Financial CenterSenapati Bapat Marg, Elphinstone Road (West)

Mumbai- 400 013Email: [email protected]


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