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Project Finance for Infrastructure Projects

As India’s cities get cramped, the need for infrastructure development – road, bridges, industry parks, railroad is paramount. It will only grow as the GDP growth puts additional pressure on feeble Indian Infrastructure. Budgetary support can only be limited – rest needs to come through an effective “recourse financing” more commonly – project finance. Lenders (banks/financial institutions) finance project based on credit profile of project and not that of the borrowing party and as the name recourse would suggest, borrower too has limited liability as security is confined to project assets only and not borrower balance sheet.

It is a fair assumption that none of the infrastructure project will come without risks. Risks in forms of construction phase risk (completion risk), operation phase risk (resource/reserve risk), credit, technical risk, currency, regulatory, sovereign, political and force majeure risks to name a few are worthy to be allocated amongst various stakeholders not limited to creditor/debtor but can include third party players like insurance companies. Popular risk allocation method remains the 4 age old mechanism avoid, transfer, accept or mitigate. In case risk has to accepted financiers will need to build it into the interest rate margin for the loan.

BOT (build, operate and transfer) is a convenient and popular approach in infrastructure development which encourages direct private party investments in developmental areas which otherwise were constraint through limited government support. BOT is a simple mechanism in which a private party (and/or consortium) signs a MoU with federal agencies and invest in building and operating a particular project for a defined time frame during which they generate their payoff through usage of facility and charges levied to users. After the concessionary period has lapsed the company transfer ownership and operation to relevant authority for further up-keeping.

Major stakeholders apart from government agency and sponsor are the O&M contractor and lenders. Lenders would eventually finance the sponsors and thus will have the first security over the infrastructure created. They also extend a stand-by-loan facility to cover cost overruns over and above the construction contract.

BOT projects have been typically successful because while the state benefits in terms of getting its infrastructure growth mobilized by private parties, it also ensures efficiency, quality and best in breed exchange of technology. Since such projects are often awarded through the ICB route, state is guaranteed of construction at the lowest possible costs. There is incentive for everyone to complete the project in the stipulated time frame (if not earlier).

NHDP (Golden Quadrilateral) projects developed by NHAI is one premier successful project in the BOT category, however success stories of BOT arrangements also exits in mine, pipeline, power, shipping, hospital, prison apart from road, railways, refineries and bridges sectors.

An effective knowledge base is required to establish the contractual agreements to support recourse financing with regards to project feasibility and risk-reward ratio. Project Finance is totally different then other traditional finances like mortgages because here the lender is looking largely at the asset to be constructed and the revenue stream it will generate to service the loan and not wholly dependent on credit risk of the sponsors. Consulting in this area is very expansive as minute details regarding preparation of financial plan, assess of risk, design of financing mix and actual raising of funds is required and they need to be effectively saddled in the financing plan contracts. Bottom line is that determining a project borrowing capacity vis a vis its expected rate of return upon completion has to be meticulously planned by experts taking into account all accounting, tax, technical considerations.

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