Infrastructure

Grace under fire

December 2007

Shirish Rane ● Bhoomika Nair ● Salil Desai

 Sector report
INDIA RESEARCH

Infrastructure
3 December 2007
Grace under fire
BSE Sensex: 19603
The need for scaling up infrastructure investments for sustained economic
growth and the role of the private sector in the same is now well established.
However, challenges of financing, inadequate regulation, land acquisition,
shortage of manpower and equipment as also coordination between the centre
and states remain the key hurdles in realising the estimated infrastructure
investment potential of Rs17.3tn over the next five years. Despite these
challenges, private developers have successfully executed large and complex
projects across sectors. Going forward too, we believe private sector players
have the potential to exploit the huge opportunity and create substantial value for
shareholders on the back of their risk mitigation and execution skills.
A Rs4.2tn infrastructure development opportunity for private players: With
established consensus on stepping up infrastructure development to sustain high
economic growth rates, Rs17.3tn is expected to go into infrastructure creation over the
next five years. Private investments are likely to emerge as a critical source for meeting
the funding requirement, driven by the government’s limited financial resources as
well as an improving external environment for private developers. We estimate private
sector players to invest Rs4.2tn across infrastructure segments over FY08-12.

Huge opportunity but tough challenges: Though a huge opportunity pie is

attracting large investments, sustaining the private sector’s interest needs addressing of
macro hurdles such as financing and inadequate regulation in some sectors. Further,
there is an urgent need to overcome execution challenges such as land acquisition,
manpower and equipment shortage, and centre-state coordination. The government
has taken active steps in this direction, but further key policy initiatives are necessary
to tackle the issues in order to fully realise the infrastructure potential.

Private players to stand up to challenges; create shareholder value: Private

infrastructure developers have, in the past, executed a number of large and complex
projects on the back of their strong risk mitigation and project management skills.
Going forward too, we are confident of these developers’ ability to create substantial
Shirish Rane value for shareholders over the long term. We remain extremely positive on the
shirish@idfcsski.com
infrastructure development sector, driven by the huge opportunity and development
91-22-66 38 3313
capabilities of private players.
Bhoomika Nair
bhoomika@idfcsski.com
91-22-66 38 3337

Salil Desai
salil@idfcsski.com
91-22-66 38 3373

IDFC – SSKI Securities Pvt. Ltd.

701-702 Tulsiani Chambers,
7th Floor (East Wing),
Nariman Point,
Mumbai 400 021.
Fax: 91-22-2204 0282
“For Private Circulation only” “Important disclosures appear at the back of this report”
 IDFC - SSKI INDIA

Contents
Investment Argument...................................................................................... 4
Infrastructure opportunity: Lucrative, but challenging .......................................4
Private developers creating value despite challenges ............................................7

Infrastructure: In focus ................................................................................. 10

Huge potential, but challenges galore ........................................................... 14

Funding: A challenge, but not a concern ..........................................................14
Regulatory challenges: Improving framework ...................................................17
Land acquisition ..............................................................................................18
Manpower shortage..........................................................................................21
Equipment.......................................................................................................23
Centre-state coordination.................................................................................24
Private developers expected to create huge shareholder value ............................25

Sector-wise Opportunities and Challenges.................................................... 30

Roads: On the Expressway ............................................................................ 31

The Opportunity .............................................................................................31
Financial/ Concession structure........................................................................32
Risks ................................................................................................................35
Challenges........................................................................................................35

Power: Generation leap................................................................................. 37

The Opportunity .............................................................................................37
Concession / Project Structures ........................................................................38
Risks ................................................................................................................41
Challenges........................................................................................................42

Ports: Rising tide........................................................................................... 44

The Opportunity .............................................................................................44
Concession structure ........................................................................................45
Risks ................................................................................................................46
Challenges........................................................................................................47

Airports: Taking Off ..................................................................................... 49

The Opportunity .............................................................................................49
Concession structure ........................................................................................50
Risks ................................................................................................................53
Challenges........................................................................................................53

DECEMBER 2007 2
 IDFC - SSKI INDIA

Water supply, Sanitation: Strong flows .......................................................... 55

The Opportunity .............................................................................................55
Concession Structure .......................................................................................56
Risks ................................................................................................................57
Challenges........................................................................................................58

Railways: Chugging along............................................................................. 59

The Opportunity .............................................................................................59
Financial / Concession structure.......................................................................60
Risks ................................................................................................................61
Challenges........................................................................................................61

Irrigation: Channelling growth ..................................................................... 62

Gas: Stepping on it........................................................................................ 63

DECEMBER 2007 3
 IDFC - SSKI INDIA

INVESTMENT ARGUMENT
Political consensus on infrastructure development is expected to drive
investments of Rs17,289bn in the sector over the next five years. Budgetary
constraints, coupled with an improving external environment, are attracting
private investments into the sector; we expect private players to fund 25%, or
Rs4,246bn, of the total infrastructure potential. However, financing, regulation,
land acquisition, manpower and equipment shortage, and centre-state
coordination are the key impediments in realizing the potential. Nevertheless,
private sector players have risen to these challenges in the past and have
executed a number of large and complex infrastructure projects across
segments on the back of their strong execution and risk management skills.
Consequently, we expect private infrastructure developers to continue
creating significant value for shareholders over the medium term.

INFRASTRUCTURE OPPORTUNITY: LUCRATIVE, BUT CHALLENGING

Infrastructure development gaining prominence…
Infrastructure space Over the past 3-4 years, a clear political consensus has emerged on the need for
attracting high speeding up the development of the country’s infrastructure. A number of large
investments from the
infrastructure projects have received support from the government, irrespective of
private sector
which political party is in power. This has resulted in a robust flow of investments
into the sector in the last few years. This process is expected to gather pace over the
next five years with an estimated Rs17,289bn of investments lined up for
infrastructure development over the next five years.

…with increasing participation from private sector players

Rising budgetary deficit While the need for stepping up the pace of investments in infrastructure is now
making private sector well established, rising government deficit is constraining the flow of funds to the
investments crucial to sector. In order to plug the gap between funding requirement and fund availability,
infrastructure creation
the role of private sector investments in infrastructure is assuming considerable
importance. India is expected to follow the global model of public-private
partnership (PPP) to encourage the participation of the private sector in
infrastructure development. PPP refers to the coming together of the government
and private sector for providing infrastructure services in a more efficient and cost-
effective manner than what each entity could have managed on its own. The key
aspect of PPP is effective risk distribution, with the private sector managing project
and operations risks and the government managing the regulatory environment.

External environment also turning conducive for PPP

Government encouraging Realizing the benefits of private sector participation in infrastructure development
private sector involvement (in the form of efficient project management and timely execution of projects), the
through tax benefits and
government has been incentivizing investments by the private sector through tax
favourable regulations
benefits and regulatory changes. Also, there has been a wide acceptance of payment
of user charges for use of infrastructure services, which has paved the way for
smoother implementation of PPP projects. Moreover, a decline in interest rates
from 15-16% 4-5 years ago to 10-11% has reduced the benchmark IRRs.

DECEMBER 2007 4

Bulk of the private sector
investments expected to
flow to power and road
segments
A large chunk of funds
earmarked for build-up of
infrastructure likely to be
via debt, raising which
could be a challenge
The sector lacks
independent regulatory
bodies in most segments
However, we see adequate
steps being taken on both
the fronts to facilitate the
build-up of infrastructure
DECEMBER 2007
IDFC - SSKI INDIA
Huge opportunity for private sector
On the back of the huge infrastructure rollout planned over the next five years and
an improving external environment, we estimate a Rs4.2tn opportunity for the
private sector over FY08-12. Bulk of the private sector investments are expected to
flow to power (Rs1.63tn) and road (Rs1.1tn) segments.
Financing and regulation – macro risks in realizing the
opportunity...
While the infrastructure sector presents a huge opportunity for private sector
players, funding the large investments and facilitating an investor friendly
regulatory environment are important challenges for the government in ensuring
rapid rollout of the planned development.
Financing
The planned investments of Rs17.3tn in infrastructure development over the next
five years will require huge financial resource mobilization. Of the total funds
required, we estimate Rs9.3tn to be in the form of debt (both direct borrowings
and leverage by private players), and raising such a quantum of debt may prove to
be a challenge.
Regulatory
An independent regulator is the key to attracting and encouraging private
investments in a sector such as infrastructure, where many natural monopolies exist
and the monopoly operator is sometimes also the concession awarding authority.
Most infrastructure sectors currently have no independent regulator (railways and
roads); where a regulator exists, it has limited powers (ports) to redress grievances
and resolve disputes for private developers.
…but we do not see them as material risks
The total debt requirement of Rs9.3tn for infrastructure development is estimated
to be about 47% of the overall incremental lending in the banking system.
Therefore, we do not see any constraints in funding for infrastructure projects.
Moreover, the government is also taking active steps in allowing the use of the
country’s burgeoning foreign exchange reserves for funding infrastructure projects,
thus opening up a vital source of funds. Overall, we believe funding constrains are
unlikely to impede the infrastructure development planned over the next five years.
There has been considerable progress on reforming the regulatory framework also.
The government, recognizing the need for an independent regulator in each
segment, has drafted a consultation paper on the approach to be adopted towards
the regulation of infrastructure. Regulatory authorities are likely to be formed for
each segment over the next 12-18 months (for example, the Aero Economic
Regulatory Authority).
5
 IDFC - SSKI INDIA

Execution challenges may pose a threat

Land acquisition
Delay in land acquisition Land acquisition has historically been a challenge for execution of infrastructure
leads to time and cost projects. Resistance to land acquisition stems from the displacement of homes as
overruns for projects well as of livelihoods of project affected persons (PAPs). The problem becomes
even more acute because of poor coordination among various government agencies
involved in the process, and the resultant delays and cost pressures in project
execution.

Manpower
Demand for an additional Stagnant capacity building in education of construction engineers and skilled civil
60m skilled and unskilled workers, coupled with rising attrition fuelled by attractive opportunities in overseas
workers estimated in
construction sector in the
markets and lucrative alternatives in the domestic market, are expected to severely
next 3-4 years constrain the construction industry over the next five years. A recent study by
ASSOCHAM estimates a demand for 60m additional skilled and unskilled
manpower in the construction industry over the next 3-4 years. With no
announced plans by the government for gearing up the country’s education and
training system to match the growing demand, manpower shortage is expected to
be the key risk to the planned infrastructure rollout over these years.

Equipment shortage
Long delivery timelines for The infrastructure sector has been facing time and cost pressures in acquiring key
equipment pose a tough machineries and construction equipment. Lead times in acquiring equipment have
challenge for developers increased by 2-3 months in the last 2-3 years, while cost of some equipment has
risen by 15-20% over the same period. Going forward, delivery timelines of critical
equipment are likely to come under further pressure as construction spend
accelerates to Rs6.7tn over the next five years. This, we believe, would pose a tough
challenge for infrastructure developers.

Centre-state coordination
Multiple approvals and In infrastructure projects, the concession awarding authority is typically a central
clearances required at government entity, while many clearances and approvals have to be sought from
various levels prolong the
the local state or district government administration. The involvement of both the
gap between award and
execution of a project central and state government creates multiplicity of approvals and clearances
required for a project, which has been a key reason for delays in execution of
infrastructure projects across different sectors. Moreover, coordination between
various government departments is usually missing and local bodies do not always
share the same sense of urgency for execution of the project as the developer does.
This results in a long gap between the project being awarded and commencement
of actual execution.

Significant progress on alleviating challenges

NRRP 2007 aimed at The government has recently notified the National Rehabilitation and
addressing key concerns Resettlement Policy 2007 (NRRP 2007). The policy, among other things, makes
of landowners; however,
regulatory provisions like land-for-land, job preferences for land losers, making
certain issues still pending
landowners stakeholders in the project, etc. The policy aims to restore both homes
and livelihoods, and is expected to go a long way in addressing the key concerns of
landowners. However, we believe certain key issues like improved centre-state
coordination, and framing consistent and comprehensive land acquisition laws to
ensure a smooth land acquisition process for infrastructure projects still need to be
ironed out.

DECEMBER 2007 6
 IDFC - SSKI INDIA

On the manpower front, a large number of engineering colleges, the IITs, the
National Institute of Construction Management and Research (NICMAR) and the
Industrial Training Institutes (ITIs) have announced increased student intakes. The
move is expected to ease, to a certain extent, manpower shortage for the
infrastructure and construction sectors.

While no specific policy is in place for addressing the pressure on equipment

procurement, we believe the government must encourage leasing and pooling of
equipment to tide over delays in deliveries and tackle rising costs.

PRIVATE DEVELOPERS CREATING VALUE DESPITE CHALLENGES

Private developers have demonstrated strong execution skills
Despite challenges, The key advantage of PPP in infrastructure development is that project
private developers have management and execution skills of the private sector players can be leveraged to
executed large and
complex projects across ensure timely completion of the project, and within the budgeted costs. True to
segments this objective of PPP, private developers have demonstrated their strength in
project management and execution. They have successfully completed a number of
large and complex infrastructure projects across sectors despite challenges in
financing, regulation, land acquisition, manpower and equipment shortages, poor
centre-state coordination, etc.

Exhibit 1: Private developers have successfully executed projects across sectors

Roads Ports Airport Railways Power

• Mumbai-Pune • Mundra Port • Mumbai • Kutch Railway • Baspa &

Expressway Vishnupravyag
• Pipavav Port • Delhi • Pipavav Railway
• Jaipur- • Sasan/Mundra
• Bangalore
Kishangarh UMPP
Expressway • Hyderabad

Source: IDFC – SSKI Research

Deriving returns through effective risk management

As the risks in a project
reduce, its value increases
Risk management is the key to returns in an infrastructure project and as the risks
in a project reduce, its value increases. Private developers, by way of their superior
project management and execution skills, have mitigated the risks arising from the
challenges that lay in execution of infrastructure projects, thereby enhancing
returns from these projects. Moreover, on the back of their strong financial
acumen, private developers have extracted maximum value from the concessions.

DECEMBER 2007 7
 IDFC - SSKI INDIA

Indian PPP to follow the global model in value creation

Globally, infrastructure development companies have created huge value by
following the “4R” framework, namely re-rating, renegotiation, rolling forward and
re-gearing.

The “4R” framework Re-rating: As a concession makes progress on execution, risk premium for the
comprises re-rating, project falls and its value increases dramatically.
renegotiation, rolling
forward and re-gearing
Renegotiation: Extension or renegotiation of the terms of the concession can create
value for investors.

Rolling forward: As a concession crosses the execution phase and enters the revenue
ramp-up phase, value creation accelerates.

Re-gearing: After the construction phase of a concession, the concessionaire can

increase the leverage on the project, thereby creating significant value for investors.

Exhibit 2: The “4R” framework for value creation of development companies

Rolling Forward Rerating

s
l ow
as hf
gc
inin
re ma
f Framework Agreement
Risk

V o
NP

Concession life Concession life

Regearing Renegotiation

Equity
Commitment
Revenues

Extension

Concession life

Source: SSKI Research

GMR, GVK, MPSEZ – successful examples of Indian PPP models

Leading infrastructure GMR Infrastructure (GMR), GVK Power and Infrastructure (GVK) and Mundra
developers effectively Port and SEZ (MPSEZ) have successfully adopted the holding company model to
using 4R framework for
extracting maximum value emerge as India’s leading private infrastructure developers. These companies have
from concessions effectively used the 4R framework for extracting maximum value from concessions
and, in turn, driving shareholder returns – either through re-gearing of projects
(road annuities), or re-negotiating concession terms, rolling forward projects on
successful execution or re-rating driven by lower risk premiums on achievement of
execution milestones.

DECEMBER 2007 8
 IDFC - SSKI INDIA

Exhibit 3: GVK – price performance GMR – price performance

(Rs) (Rs)
800 300

600 225

400 150

200 75

0
0
Feb-06 Apr-06 Jun-06 Aug-06 Oct-06 Dec-06 Feb-07 Apr-07 Jun-07 Aug-07 Oct-07 Aug-06 Oct-06 Dec-06 Feb-07 Apr-07 Jun-07 Aug-07 Oct-07

Source: IDFC – SSKI Research

Infrastructure developers to create significant shareholder value

Given the opportunity
canvas, we are bullish on
private sector
infrastructure developers
Indian private sector infrastructure developers have demonstrated strong risk
mitigation capabilities and financial acumen. They have successfully executed a
number of challenging projects across sectors, in turn creating significant value for
shareholders. With the huge infrastructure development potential in the coming
years, an unprecedented opportunity exists for private infrastructure developers,
and thus scope to create further shareholder value. The large opportunity canvas
and development capabilities of developers make us extremely positive on the
private infrastructure development space. We believe the developers would create
significant shareholder value in the medium term.

DECEMBER 2007 9
 IDFC - SSKI INDIA

INFRASTRUCTURE: IN FOCUS
Political consensus has paved the way for creation of the much-needed
infrastructure in India. The sector is estimated to attract investments of
Rs17.3tn in the next five years. Enthused by an improving external
environment, private players have lined up huge investments into the sector.
The development assumes higher relevance in view of the budgetary
constraints on the one hand and a huge opportunity on the other. With the
success of the public private partnership so far, we estimate the private sector
to fund Rs4.2tn, or 25% of the total envisaged investments, into infrastructure
over the next five years.
Political consensus on infrastructure development gaining ground
Renewed policy thrust on After years of neglect, which had resulted in investments into infrastructure
infrastructure development reducing to a trickle, the sector has gained recognition as being critical to sustained
driving investments into
the sector economic growth. Consensus has emerged among political parties across ideologies,
as is evident in the step-up in infrastructure investments by the previous two
governments at the Centre. One example of this is the thrust on the country’s road
network, manifested through the National Highway Development Programme
(NHDP). Despite rising budgetary deficits, and a change of government at the
Centre, the NHDP has been accorded top priority and its scope has been
significantly expanded beyond the Golden Quadrilateral and North-South and
East-West corridors.

India needs to invest Rs17.3tn into infrastructure over FY08-12

Within infrastructure, bulk
of investments to flow into
power and road projects
We have estimated total investments of Rs17.3tn in various infrastructure sub-
segments over the next five years (FY08-12). Our estimates are based on the
th
bottom-up estimates of the Planning Commission for the 11 5-year Plan. With
Rs6.16tn estimated to be invested in power generation, transmission and
distribution, the power sector is expected to see the bulk of the investments over
this period, followed by roads (Rs3.12tn) and railways (Rs2.55tn).

Exhibit 4: Bottom-up estimates indicate investments of Rs17.3tn in infrastructure over FY08-12

Sector Total
Roads 3,118
Airports 349
Ports 740
Railways 2,550
Power 6,165
Water Supply & Sanitation 1,990
Irrigation 2,172
Gas 205
Total 17,289
Source: IDFC SSKI Research; Planning Commission

But constrains in budgetary allocations...

Central and state While the need for stepping up the pace of investments in infrastructure is widely
governments facing a recognized, the Centre and state governments have been facing a financial resource
resource crunch…
crunch to fund the same. Moreover, the incumbent government has made
‘inclusive growth’ its focus, and hence a large part of the budgetary allocations are
likely to be channelled into social infrastructure.

DECEMBER 2007 10

…and thus seeking active
participation of private
developers
The trend of public-private
partnership catching up in
India too
Exhibit 5: Evolution of private sector participation in infrastructure
Advisory – pvt. sector
advices govt. on how
to improve service
efficiency
Source: IDFC – SSKI Research
DECEMBER 2007
IDFC - SSKI INDIA
...make private investments critical for infrastructure development
With limited resource allocation by the government, the role of the private sector
in infrastructure funding has been gaining prominence. Recognizing this, the
government has been encouraging, through incentives, the private sector to invest
in developing the country’s infrastructure. On the part of the private sector also,
there has been active interest, considering the sheer size of the opportunity and the
potential to earn high returns.
India tending towards the global model of private participation
India, following the global trend, is building the principle of public-private
partnership for the participation of the private sector in infrastructure
development. PPP refers to the coming together of the government and the private
sector for providing infrastructure services in a more efficient and cost-effective
manner than what each entity could have managed on its own.
One key aspect of PPP is that it allocates the risks in an infrastructure project to
players that are best qualified for the project. The private sector is assigned the
project risk, for which it is well qualified given its ability to deliver higher cost and
time efficiencies for the development of the project as compared to the
government. On the other hand, the government manages the regulatory
environment, and protects the interests of all entities (government, private players,
public, etc).
Privatisation – pvt.
sector owns the
infrastructure; govt.
acts as regulator
Concessions – pvt. sector
builds the infrastructure &
owns and/or operates for a
ltd. period; ownership reverts
to govt. eventually
Contracting – govt.
outsources projects
to pvt. Sector but
operates the service
on its own
Involvement of private sector
11
 IDFC - SSKI INDIA

The government is realizing the benefits of PPP...

Risk allocation under PPP As discussed, one key aspect of PPP is that it allocates the risks in an infrastructure
ensures efficient project project to parties which have the expertise to manage the projects. The distribution
implementation
of risk ensures efficient implementation of infrastructure projects. Consequently,
private participation in infrastructure development has so far translated into timely
completion of projects, fewer cost overruns, and far superior quality compared with
the traditional contract route. The success of PPP in India has been amply
demonstrated in projects like the Mumbai-Pune Expressway, container terminal
BOTs by private players at various ports across the country, and many BOO and
BOT hydel and thermal power projects.

...and the external environment is also turning conducive for PPP

In addition to the need for private investments in infrastructure, the emerging
importance of PPP has also been underlined by a number of external factors like
favourable government policies, acceptance of user charges, a favourable interest
rate scenario, etc.

User resistance to pay is diminishing

Users accepting the Over the past few years, users of infrastructure are slowly accepting the idea of
concept of paying for paying for the use of better and improved facilities as they recognise the tangible
better and improved benefits of the same. Highway users, for example, have realised that good roads
infrastructure
reduce travel time and fuel consumption as compared to use of old, inefficient and
congested routes. Similarly, in the power sector, metered sales have helped reduce
instances of theft and increased efficiency of power facilities – and have thereby
enhanced returns on investments. Going forward, we believe that users’ willingness
to pay for better and improved infrastructure would be a key driver of
infrastructure development.

Improving regulatory framework

Independent regulators The government has been taking active steps to improve the regulatory framework
being set up across for private sector investments in infrastructure. Apart from framing model
segments
concession agreements for PPP projects in sectors such as roads and ports, the
government is also in the process of appointing independent regulators in sub-
segments like airports. This would go a long way in improving the private sector’s
confidence in the opportunity.

Softer interest rates lowering the required benchmark IRRs

Better investor returns Interest rates have dropped radically over the past 4-5 years from a high of 15-16%
attracting private to 10-11% currently. Lower interest rates have reduced project IRR requirement to
investments in the sector 12-14%, which implies investor returns (equity IRRs) of 15-18%. Several
infrastructure projects meet this IRR requirement, which has resulted in a
significant increase in private participation over the past 3-4 years.

DECEMBER 2007 12
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Huge opportunity for private players

We expect private sector to
invest Rs4,246bn in
infrastructure over FY08-12
Our analysis of various sub-segments of infrastructure suggests that investments by
private players are at an inflection point. Going forward, we expect that private
sector investments will flow across sub-segments of infrastructure such as roads,
ports, airports, power, water supply, sewerage, etc. Overall, we estimate private
sector investments of Rs4,246bn over FY08-12.

Exhibit 6: A Rs4.2tn opportunity for the private sector in infrastructure development

(Rs bn) Public
Sector Private Budget Grant MLB Market borrowing Internal accruals Total Public Unfunded Total
Roads 1,125 299 996 698 - 1,993 - 3,118
Airports 257 91 - - - 91 - 349
Ports 545 25 - 68 101 195 - 740
Railways 434 1,387 255 348 127 2,116 - 2,550
Power 1,625 951 201 2,570 419 4,141 399 6,165
Water Supply & Sanitation 54 1,420 206 310 - 1,936 - 1,990
Irrigation - 1,520 - 651 - 2,172 - 2,172
Gas 205 - - - - - - 205
Total 4,246 5,693 1,658 4,645 647 12,644 399 17,289
Source: IDFC – SSKI Research; Planning Commission

DECEMBER 2007 13
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HUGE POTENTIAL, BUT CHALLENGES GALORE

While infrastructure development in India presents a huge Rs4,246bn
opportunity over the next five years for the private sector, there remain a
number of challenges in actually realizing this potential. The challenges range
from raising the financial resources required to improving the regulatory
framework to augmenting the labour and equipment capacity necessary for
execution. We discuss below these generic issues that are likely to impact PPP
investments over the next five years and follow them up with sector specific
challenges likely to be faced by private investors.

FUNDING: A CHALLENGE, BUT NOT A CONCERN

The total infrastructure spend of Rs17.3tn (61% of FY07 GDP) is likely to be
funded by a mix of government spending, funds from government-nominated
entities and public private partnership (PPP). Funding by way of borrowings is
likely to be a key component in infrastructure financing (54% of the total
investments), as apart from the direct debt taken at project level, private players will
use leverage to fund projects developed by them. The total debt requirement of
Rs9.27tn constitutes 47% of the overall incremental lending in the banking system,
which we believe is not a constraint for financing infrastructure projects over the
next five years.

Exhibit 7: Funding sources for infrastructure development over the next five years
Source Rs bn
Budgetary grant 5,693
Multi lateral borrowings 1,658
Planned infrastructure
spend of Rs17.3tn to be Market borrowings 4,645
met by public funds, Internal accruals 647
government nominated Sub-total 12,644
entities as also PPP Privatisation/ BOT 4,246
Sub-total 16,890
Funding not tied up 399
Total 17,289
Source: SSKI Research

Central government to spend Rs5,693bn over FY08-12

Total infrastructure spend Based on the 11th 5-year Plan estimates, the government would spend an
likely to be 58% of Centre’s estimated Rs5,693bn over FY08-12 on infrastructure through provisions in the
total capex spend in FY06
central budget. As per the FY07-08 Budget, the government is expected to spend
Rs1,958bn on plan capital expenditure, including investments by PSUs.
Consequently, the total infrastructure spend to be funded by the government is
likely to be ~58% of the government’s annual total plan capital expenditure. We
believe there are unlikely to be any slippages in infrastructure spending from the
government’s funding perspective.

DECEMBER 2007 14
 IDFC - SSKI INDIA

Government entities' internal accruals and equity to add Rs647bn

Projects to be partly Some of the infrastructure projects such as power plants, transmission lines,
funded from internal railways capex, etc are being executed by government entities including NTPC,
accruals and proceeds of
equity issues of NHPC, Power Grid and IRFC. As a result, a part of the funding of these projects
government entities is likely to be met through internal accruals and the proceeds of equity issues of
these corporates. Overall, we estimate these entities to contribute ~Rs647bn or 4%
of the total infrastructure spend over FY08-12.

PPP to fund Rs4,246bn of infrastructure projects

Over the past 3-4 years, the government has been promoting public private
partnership projects, whereby it plays the role of a regulator and the private
participator invests in the build out of infrastructure. The government has
earmarked a certain number of projects in most sectors for private partnership,
which involve a total investment of Rs4,246bn over FY08-12.

Private players to raise Rs2,972bn as debt to fund the PPP projects

We estimate private players to fund their infrastructure projects by using leverage at
a gearing of 2.33x. Consequently, we expect private players to raise Rs2,972bn of
debt in their special purpose vehicles (SPVs) created for execution of infrastructure
projects. We believe the remaining component of Rs1,274bn is likely to be funded
through equity issuances, private equity investors, infrastructure focussed global
and Indian funds, and internal accruals.

Funding not a constraint for infrastructure rollout

We expect the requirement We believe the total infrastructure spending of Rs17.3tn is unlikely to hit any
to be funded by debt of funding roadblocks. We expect the requirement to be mainly funded via a debt of
Rs9.3tn, mainly domestic,
and multilateral Rs9,276bn (predominantly domestic debt), including multilateral borrowings of
borrowings of Rs1.66tn Rs1,658bn. Moreover, government capex and internal accruals of government
entities are also well within the projections, which will ensure sufficient funding for
infrastructure investments over the next few years.
The GoI has recently increased the annual cap of ECBs from US$18bn to $25bn
to ease the lending pressure on domestic banks. We have always maintained that if
India were to stay on its high growth path, higher capital inflows need to be
encouraged, more so given the huge funding needs of the infrastructure sector.

Exhibit 8: Bank lending to infrastructure on the rise

(Rs bn) (%)

Credit to Infrastructure % of Gross Bank Credit
1,800 9.0

1,350 8.8

900 8.5

450 8.3

0 8.0
FY05 FY06 FY07

Source: RBI

DECEMBER 2007 15
 IDFC - SSKI INDIA

Multilateral borrowing to meet Rs1,658bn of infrastructure spend

Multilateral agencies likely As a part of funding the infrastructure build out in the country, the government
to lend Rs1.7tn over the has tied up with various multilateral funding agencies such as the World Bank,
next five years across
various segments
Asian Development Bank, Japanese Bank for International Cooperation, etc. The
multilateral agencies are likely to lend Rs1,658bn over the next five years across
various segments of infrastructure on softer terms with longer repayment schedules
(>15 years).

Foreign exchange reserves to contribute $5bn annually

The Reserve Bank of India (RBI) has given an in-principle approval for the use of
India’s foreign exchange reserves in funding infrastructure projects. RBI’s in-
principle approval is in line with recommendations of the Deepak Parekh
Committee regarding establishment of a wholly-owned overseas subsidiary of the
Indian Infrastructure Finance Company Ltd (IIFCL) to borrow funds from the
RBI and lend to Indian companies implementing infrastructure projects in India,
or to co-finance their ECBs for such projects solely for expenditure outside India.
We expect the amount available for lending from the forex reserves to be in the
range of US$5bn per annum, and be an important source of funding infrastructure
projects.

Total debt funding pegged at Rs9,276bn over FY08-12

We see domestic We estimate a total debt funding of Rs9,276bn (33% of FY07 GDP), inclusive of
institutions comfortably debt borrowed by public private partnership projects, required for the
placed to fund the
debt component infrastructure rollout over FY08-12. With the total debt required estimated at 47%
of the overall incremental lending for the next five years, we do not foresee
domestic financial institutions facing any roadblocks in raising the funds.

In the worst-case scenario, if domestic financial institutions are unable to fund the
entire debt requirement, foreign borrowings can substitute the domestic debt.

Exhibit 9: PPP borrowings to be 32% of total debt funding for infrastructure financing
Source of debt Rs bn % of total
Multilateral borrowings 1,658 18
Domestic debt 4,645 50
PPP borrowings 2,972 32
Total 9,276 100
Source: IDFC – SSKI Research, Plan documents

DECEMBER 2007 16
 IDFC - SSKI INDIA

REGULATORY CHALLENGES: IMPROVING FRAMEWORK

Except power and ports,
independent regulator
absent in all segments
Need for independent regulators for infrastructure services
One of the crucial challenges in rapid acceleration of private investments in many
infrastructure sub-segments is the absence of an independent regulator on the lines
of the Telecom Regulatory Authority of India (TRAI) for telecom. In a few cases,
the monopoly player of infrastructure services also doubles as the regulator of the
sector – examples being the Indian Railways, the Airports Authority of India, etc.
In order to promote investments in the infrastructure sector, the government will
have to set up independent regulatory authorities such as the Central Electricity
Regulatory Commission, Aero Economic Regulatory Authority (AERA), etc.

With the limited exception of power and ports (to a certain extent), all segments of
infrastructure lack an independent regulator.

Exhibit 10: Current regulatory framework in infrastructure

Sector Relevant Statutes Regulatory status

• National Highways Act of India, 1998 • No regulatory authority.

• Central Road Fund Act, 2000 • NHAI acts as the regulator as well as the operator.
Roads
• The Control of National Highways (Land • States have floated their own corporations or agencies.
and Traffic) Act, 2002 • Investors have no recourse to an independent regulator.

• Indian Railway Board Act, 1905 • Railways act as the operator as well as the regulator.
Rail
• Railways Act 1989 • Investors have no recourse to an independent regulator.

• AAI is the operator as well as the regulator.

• Aircraft Act 1934 • Director General of Civil Aviation regulates safety and
Airports
• Airports Authority of India Act , 1994 technical aspects only.
• Proposal to set up a regulatory authority.

• Indian Ports Act 1908
Ports
• Major Port Trusts Act 1963
• Tariff Authority for Major Ports (TAMP) has the sole function
of tariff setting.
• Investors have no recourse to an independent regulator on
other matters such as dispute resolution, performance
standards, consumer protection and competition

• Regulatory commissions at Centre and States with very

Power • Electricity Act 2003 extensive functions and powers.
• Track record of regulatory commissions not as yet convincing.

Source: Planning Commission

Regulator must for dispute resolution

Investors need recourse to
a regulator in case of
disputes
An independent regulator, to whom investors can have recourse in case of disputes,
is a critical element in convincing the private sector to invest in infrastructure. The
government, recognizing the need for an independent regulator in each segment,
has drafted a consultation paper on the approach to be adopted towards the
regulation of infrastructure. It is likely to form regulatory authorities for each
segment over the next 12-18 months (for example, the Aero Economic Regulatory
Authority).

DECEMBER 2007 17
 IDFC - SSKI INDIA

Key points of the consultation paper

Regulation should aim at promoting competition wherever possible. In competitive markets, tariff setting must
be left to the markets and a light-handed approach to regulation must be adopted, while monopolistic segments
must be subject to close regulation.
Tariffs in monopolistic services, such as the railways, must also be set by an appropriate regulatory authority in
an independent and de-politicised manner.
The regulatory process must work towards standardizing concessions/ contracts in order to lend greater
predictability and enforceability for provision of infrastructure services.
In all cases, performance standards should be regulated for ensuring the quality of service.
• The infrastructure regulator must work closely with the Competition Commission, and the functions of the
two must be integrated in a comprehensive fashion.

LAND ACQUISITION
Land acquisition has historically been a critical and sensitive factor in industrial and
infrastructure development in India. The challenges posed in land acquisition stem
from issues such as poor land deeds and records to multiplicity of land acquisition
laws and poor co-ordination between various government agencies. With a number
of large projects facing extreme opposition from landowners, the land acquisition
process has recently acquired critical importance. In many cases, even though the
land is owned by the government, there have been difficulties in using it for
infrastructure projects due to encroachment upon them, typically by unauthorised
slums.

Exhibit 11: Land acquisition issues have delayed a number of large infrastructure projects
Project
Golden Quadrilateral
Dabhol Power Corporation
Bandra Terminus, Mumbai
Mumbai International Airport
Borivali-Virar Track Quadrupling
Chemical SEZ, Nandigram
POSCO steel plant
Tata Motors Small Car, Singur
Source: IDFC SSKI Research
Location Sector Status
All-India Infrastructure – Roads ~2% of the GQ still remains incomplete, with land
acquisition problems being one of the main reasons
Maharashtra Infrastructure – Power Though the project has been completed, use of force
in land acquisition was the subject of investigations
into human rights violations
Maharashtra Infrastructure – Railways Project delayed by many years due to encroachment
by slums on railway property
Maharashtra Infrastructure – Airports Process of clearing encroached land still not
complete
Maharashtra Infrastructure – Railways Project commissioned in July 2007, 12 years after
the project was first approved
West Bengal SEZ Project location proposed to be moved in the face of
violent protests by villagers
Orissa Industrial – Metals No work has commenced at the proposed site
West Bengal Industrial – Automobile Land acquisition completed, but project activity not
picking up due to continued protests

DECEMBER 2007 18
 IDFC - SSKI INDIA

Why is land acquisition a challenge?

Displacement of homes There are two key reasons for protests against land acquisition for infrastructure
and livelihood – key projects – the displacement of homes and of livelihood of project-affected-persons
hurdles to land acquisition (PAP). The problem is compounded in case of inadequate compensation and
rehabilitation and resettlement (R&R) measures by the implementing agency. In
the past, execution of large scale infrastructure projects has been delayed, mainly
because of the slow pace of work by state governments in providing alternative sites
for rehabilitation and poor basic infrastructure facilities at such identified sites. A
prominent example is the Sardar Sarovar project, which has been delayed by over
20 years mainly due to inadequate relief and rehabilitation measures.

Poor coordination between govt agencies compounds the problem

Land acquisition process a Land, in India, is a state subject with land records and dealings managed at the
long drawn one due to local level in each district of the state. Consequently, once a project concession is
involvement of multiple
departments awarded by a central government authority, surveys for land acquisition as also
legal and physical clearance of the land have to be done at the state/district level. As
a result, multiple agencies are involved in facilitating land acquisition for
infrastructure projects. Further, the administrative departments at the local level
(Tehsildar, Mamlatdar, Zilla, etc) do not share the same sense of urgency for
completing the land acquisition process as the private developer/ concessionaire or
the concession awarding agency. In general, developers have to practically
coordinate the land acquisition process on their own with limited support from
administrative agencies.

R&R policy notified to address land acquisition concerns

NRRP 2007 framed to The government has notified the National Rehabilitation and Resettlement Policy,
address interests of 2007 (NRRP 2007) to address the interests of landowners and others affected by
landowners and other
project-affected parties involuntary land acquisition for infrastructure and other projects. Some of the key
issues addressed by the policy include:

Minimizing displacement
One of the key objectives of the NRRP 2007 is to avoid, as far as possible, large
scale displacement of people when land is acquired for a project. According to the
policy, projects should be set up on wasteland, degraded land or un-irrigated land.
The policy also states that the acquisition of agricultural land must be kept to the
minimum and acquisition of irrigated and multi-cropped land must be avoided to
the extent possible.

Land for land

The policy follows the land-for-land principle and lays down that all PAPs must be
given homes/ land in return for their homes / land acquired as far as possible.

Making land owners stakeholders

PAPs given the option to Where land is acquired by a company, the PAPs are given the option to receive
receive 20% of 20% of the compensation due to them in the form of shares and/ or debentures of
compensation as shares such a company. This provision in the policy ensures that landowners are not just
and/ or debentures of that
company compensated on a one-time basis, but are also given the option to benefit from the
long-term prospects and profitability of the project.

DECEMBER 2007 19
 IDFC - SSKI INDIA

Jobs for land losers

Under the policy, preference in employment in the project must be given to at least
one person per family. In case necessary, training must also be given to the PAPs to
make them suitable for employment in the project or elsewhere.

The way forward…

NRRP 2007 – a few more NRRP 2007 is an attempt to align the need for speedy land acquisition for crucial
gaps need to be filled infrastructure development projects with the rights of landowners. While the policy
addresses some key issues in relation to land acquisition challenges for
infrastructure projects, we believe there are a few other issues which need to be
sorted out to facilitate speedy implementation of infrastructure projects. The basic
objective of land acquisition should be to ensure that the local communities and
the project exist in mutual harmony.

Consistent and comprehensive legislation

Related laws also need to A national level policy on R&R has undergone frequent changes in the past, with
be reformed to streamline the current NRRP 2007 replacing the last one notified only in 2003. Moreover, in
land acquisition process order to make the land acquisition process for infrastructure projects effective, the
government needs to reform all related laws also, including the Land Acquisition
Act and various state government laws.

Initiating the land acquisition process at an early stage

Project implementing bodies must initiate the land acquisition process at the
planning stage of a project rather than at the implementation stage. This will
ensure that the land acquisition process is properly planned and managed, and
delays are avoided at a later stage. Early commencement of land acquisition also
allows for sufficient time in case of negotiated land purchases from the landowners
directly.

Stressing income restoration

Focus should be on long- An R&R policy must ensure not only restoration of homes but more importantly,
term employment creation should stress on restoring livelihoods so that sustainable development of displaced
for PAPs rather than on communities is achieved. The current NRRP 2007 makes provisions only for
employment preference
giving employment ‘preference’ to PAPs in the project rather than stressing on job
and employment creation. In most cases of land acquisition, mere preference in
employing PAPs will render them unemployable as the local communities would,
in all likelihood, not be suitable for taking up jobs directly in the project. As a
result, the government must ensure proper training of the PAPs for industrial jobs.

Continued community development activities

Infrastructure projects must voluntarily adopt a corporate social responsibility code,
where community development initiatives are undertaken in the operational phase
of the project also. These initiatives are particularly relevant in power and port
projects, where support from local communities may be necessary for recurring
capacity expansion projects.

DECEMBER 2007 20
 IDFC - SSKI INDIA

MANPOWER SHORTAGE
Acute shortage of skilled human resources
Manpower shortage Shortage of manpower for construction, both skilled and unskilled, is one of the
leading to delayed project key risks to the huge infrastructure layout planned over the next five years. The
execution, low productivity
industry has been experiencing acute shortage of skilled workers and engineers over
and poor quality
the past few years, resulting in a relatively higher proportion of unskilled workers in
the manpower pool. This has, in turn, led to slow progress of projects, low
productivity and quality, and thus huge time and cost overruns.

Exhibit 12: Construction workforce changing in favour of unskilled workers

(‘000s) 1995 2005
Occupation Workforce % of total Workforce % of total
Engineers 687 4.71 822 2.65
Technicians & Foreman, etc 359 2.46 573 1.85
Clerical 646 4.40 738 2.38
Skilled Workers 2,241 15.34 3,267 10.57
Unskilled Workers 10,670 73.08 25,600 82.45
Total 14,600 100.00 31,000 100.00
Source: Planning Commission

Shortage led by inadequate capacity of education system

Rising demand for engineers / managers
Number of civil engineers The rapid rise in construction activity in the country in the last 2-4 years has
graduating every year lags resulted in higher demand for civil engineers vis-à-vis the number graduating each
construction GDP growth
year. Construction GDP has risen at a 12% CAGR over FY02-07, whereas the
number of graduating civil engineers every year has remained more or less stagnant
at about 22,000-23,000.

Exhibit 13: Construction GDP on the rise

Construction GDP at constant prices
(Rs bn)
2,000

1,500

1,000

500

0
FY00 FY01 FY02 FY03 FY04 FY05P FY06QE FY07RE
Source: RBI

DECEMBER 2007 21
 IDFC - SSKI INDIA

Lucrative options available for civil engineering graduates

The higher-paying IT Led by the boom in IT and software services in India, coupled with the shortage of
sector attracting civil computer and electronics engineers, a number of civil engineering graduates are
engineers in hordes opting to seek employment in the IT sector. The lucrative salaries offered and the
large number of jobs available has made a switch to the IT sector extremely
attractive for civil engineers. This further aggravates the skilled manpower shortage
in the construction sector.

Increasing attrition, led by opportunities overseas

Construction boom in In the last 3-4 years, the sharp increase in crude oil prices has been fuelling a
Middle East too adding to construction boom in the Middle East. This has led to a large number of middle
the demand
management personnel from the Indian construction sector seeking jobs in the
region. Consequently, Indian construction companies have experienced a jump in
attrition rates from 7-9% in the last 3-4 years to 12-14% currently. Moreover, with
attrition rates rising the fastest at the middle management level (5-10 years of
experience, and at or below the Project Manager grade), construction companies
have been faced with the daunting task of managing large projects with the desired
productivity and quality levels.

Shortage of manpower likely to worsen

With stagnant capacity at
engineering colleges, the
shortage set to worsen
The speed of the planned infrastructure rollout in India over the next five years,
coupled with the expected high growth in the real estate industry, are expected to
put additional pressure on human resources requirement of the construction sector.
A recent study by ASSOCHAM estimates that the construction industry will need
about 60m additional skilled and unskilled workers by 2010. With no announced
plans of increasing the capacity of the education system to train and graduate
sufficient civil engineers over the next 3-4 years, shortage of manpower will remain
one of the toughest challenges for achieving the infrastructure development targets
of the next five years.

The way forward...

Various institutes planning
to hike capacity to fill the
demand-supply gap
To meet the growing demand of infrastructure and construction sectors, there is an
urgent need for exponentially increasing the number of seats in colleges for civil
engineering and construction management graduates. Some key steps have been
taken in this regard; the All India Council for Technical Education (AICTE) has
also approved addition of about 3,000 civil engineering seats in 2008, and the seats
at the Indian Institute of Technology are being increased. NICMAR (National
Institute of Construction Management and Research) has also announced an
increase in its student intake over the next 2-3 years. In addition, the government
has also taken active steps in setting up new Industrial Training Institutes (ITIs)
and increasing the seats in existing ones.

DECEMBER 2007 22
 IDFC - SSKI INDIA

EQUIPMENT
Rising costs and extended delivery schedules
Industry facing time and The high growth in the construction sector witnessed in the past 2-3 years has been
cost related issues in fuelling demand for construction equipment and machinery. Consequently, the
procuring equipment
industry has been facing time and cost related issues in procuring equipment such
as hydraulic mobile cranes, mobile tower cranes, back hoe loaders, soil compactors,
etc from both domestic and foreign manufacturers. Lead times for deliveries have
increased by 2-3 months, while average costs have increased by 15-20% over the
past 2-3 years. Consequently, equipment shortages are proving to be a huge
challenge for infrastructure developers in completing projects on time and within
the estimated budgets.

The way forward…

Availability of equipment
likely to prevail
Given the time and capital expenditure required in creating the necessary
manufacturing capacities, shortage of equipment is an issue which cannot be
addressed in a short time frame. Moreover, with the construction boom in the
Middle East, and sustained and rapid infrastructure development in China, the
availability of imported machineries and equipment is expected to remain a major
challenge over the next few years. To alleviate the problems, some of the steps that
could be taken are:

Incentives to encourage leasing

Large-scale investments One inherent challenge a contractor faces in investing in heavy equipment is that
required to address the while project execution periods are short, the life of the equipment is substantially
shortage of equipment longer. Moreover, project flow may be sporadic and the equipment may lie idle
between projects. Also, in case projects are spread across geographies, the expenses
in transporting the equipment may be prohibitive. To enable use in specific
projects, there must exist a large and active equipment leasing market in the
country across different regions, thereby obviating the need for contractors to
invest in owned equipment in the face of rising costs and extended delivery
schedules. Moreover, availability of the equipment for use by multiple contractors
at different points in time will ensure full asset utilization. Consequently, the
government must, through a policy framework in the form of added incentives,
encourage investments in construction equipment and machinery for leasing to
contractors.

Private developers can explore setting up of ‘equipment pools’

One way to tide over the
problem is by sharing of
critical equipment
among developers
Driven by the nature of the infrastructure development business, it may not always
be prudent for construction contractors to own equipment. Hence, developers can
explore the option of jointly purchasing heavy equipment and maintaining it in a
pool for use by them as and when required. For example, a number of developers
are currently undertaking hydel power projects in North and North-east parts of
India. These developers could come together for acquiring critical equipment and
then using the same as and when required. Although this calls for coordinated
project planning so that no developer faces delays for want of equipment, there can
be substantial time and cost savings for all the projects. A similar model can be
followed for road projects, where developers executing adjoining stretches of
highways can share equipment.

DECEMBER 2007 23
 IDFC - SSKI INDIA

CENTRE-STATE COORDINATION
One of the most crucial aspects in infrastructure development has been the
coordination between administrative departments of different levels of government.
This becomes a critical issue when an infrastructure project is sponsored/ awarded
by a central government authority and needs the involvement of the state
government or district level administration.

Land acquisition – the biggest casualty

Involvement of various Land in India is a state subject, necessitating the involvement of state government
agencies in the process and the local administration for land acquisition. As discussed earlier, the
leads to delays in land
acquisition
multiplicity of administrative agencies involved and lack of active support from the
local administration only delay the land acquisition process rather than facilitate it.
The process becomes all the more challenging in case of BOT projects as the
developer has no locus standi on land acquisition for the project (unlike in BOO
projects, wherein the private developer continues to own the asset perpetually and
can buy the land on negotiated basis). In such cases, the complete onus of land
acquisition must rest with the relevant government authority and specific timelines
must be provided in the concession agreement for the same.

For example, in case of road BOTs, once the NHAI grants the minimum right of
way for commencement of construction, the MCA specifies that the right of way
for the balance will only be on a ‘best effort’ basis. This may lead to a situation (as
it happens currently, under the old MCA) where the developer has to coordinate
with various agencies for acquiring the right of way, with the NHAI just providing
peripheral support rather than playing an active part.

State Support Agreements (SSAs) not always honoured

States have sometimes In case of BOTs on national highways, the relevant state is required to sign an SSA
gone back on their allowing collection of toll, desisting from building alternative routes and providing
commitments all necessary support in executing the project. However, support from states is not
always forthcoming with some states refusing to sign SSAs (e.g., Kerala, till as
recently as November 2007; Delhi for Badarpur elevated highway). Moreover, even
after signing the SSA, many states have, taking advantage of loopholes therein,
announced construction of competing highways (e.g., Taj Expressway in Uttar
Pradesh).

DECEMBER 2007 24
 IDFC - SSKI INDIA

PRIVATE DEVELOPERS EXPECTED TO CREATE HUGE SHAREHOLDER VALUE

Maximum returns at the
pre-concession stage;
returns fall proportionately
as each risk is mitigated
Returns on infrastructure projects are proportional to risks
In an infrastructure project, returns are linked to the risks associated with the
project. The maximum returns made by players are at the pre-concession stage
(when the project has just been awarded), and when risk is also the maximum. This
stage entails many risks such as winning the concession with proper agreements,
financial closure, construction risk, timely completion, business risk, etc. However,
as each risk is mitigated, developers see a proportionate fall in returns. For example,
maximum returns (average equity IRR of 30-35%) are earned when the concession
has just been awarded. However, returns taper off as each risk is mitigated and the
project reaches maturity stage.

Exhibit 14: Project returns highest at concession stage led by higher risks

Project Pre-concession /
Construction Ramp-up Growth Maturity
Stage MOU (Promoter)

HIGH
25-28%
E
Q
U
I 20-22%
T
Y

R 15-18%
E
T
U 12-15%
R
N
S
8-10%
LOW

• Reputation Risk • Completion Risk • Execution Risk

• Operating Risk
Risks • Revenue Model Risk • Financing Risk • Competitive Risk Low risk
• Technology Risk
• Time Investment • Cost Overruns • Technology Risk

Source: SSKI Research

Value of project increases as it reaches commissioning stage

Once a project is
commissioned, its equity
value peaks out
Value accretion of the project accelerates as the project crosses major landmarks
such as financial closure, construction, etc. Once the project is commissioned and
after it attains maturity with an established revenue line and profits, the equity
value of the project reaches its peak. Thus, the incremental value for equity holders
gained through increased financial structuring is limited.

DECEMBER 2007 25
 IDFC - SSKI INDIA

Exhibit 15: Asset value at peak in the growth stage

Asset value

Cash flow

Greenfield Construction Ramp Up Growth Maturity

Source: SSKI Research

Value creation can be enhanced with the 4R framework

Globally, infrastructure development companies have created huge value by
following the “4R” framework, namely re-rating, renegotiation, rolling forward and
re-gearing.

Re-rating: As a concession makes progress on execution, risk premium for the

project falls and its value increases dramatically.
The “4R” framework
comprises re-rating,
renegotiation, rolling Renegotiation: Extension or renegotiation of the terms of the concession can create
forward and re-gearing value for investors.

Rolling forward: As a concession crosses the execution phase and enters the revenue
ramp up phase, value creation accelerates.

Re-gearing: After the construction phase of a concession, the concessionaire can

increase the leverage on the project, thereby creating significant value for investors.

DECEMBER 2007 26
 IDFC - SSKI INDIA

Exhibit 16: The “4R” framework for value creation of development companies

Rolling Forward Rerating

s
flow
ash
gc
a inin
m
f re Framework Agreement

Risk
V o
NP

Concession life Concession life

Regearing Renegotiation

Equity
Commitment

Revenues
Extension

Concession life

Source: SSKI Research

Private developers have exhibited strong risk mitigation capabilities

Despite the challenges in execution of infrastructure projects, infrastructure
developers have demonstrated strong execution capabilities in overcoming the
challenges and managing the risks by executing a number of large and complex
projects across sectors.

Exhibit 17: Private developers have successfully executed projects across sectors

Roads Ports Airport Railways Power

• Mumbai-Pune • Mundra Port • Mumbai • Kutch Railway • Baspa &

Expressway Vishnupravyag
• Pipavav Port • Delhi • Pipavav Railway
• Jaipur- • Sasan/Mundra
• Bangalore
Kishangarh UMPP
Expressway • Hyderabad
Source: IDFC – SSKI Research

India’s first 6-lane Roads – The Jaipur-Kishangarh Expressway was India’s first 6-lane expressway and
expressway completed despite an untested concession agreement for both the NHAI and the private
ahead of schedule by developers, the project was successfully executed as one of the earliest BOT projects
private developers
in the road sector. With the involvement of private sector participants such as GVK
Group and Larsen & Toubro, the expressway was completed in a record 24
months – six months ahead of schedule.

DECEMBER 2007 27
 IDFC - SSKI INDIA

Mundra port, developed by

Ports – With progressive policies of the Gujarat Maritime Board (GMB) and
a private player, has development capabilities of the Adani Group, the Mundra port has, in a relatively
emerged as a leading port short span of time, emerged as a leading port on India’s west coast, and in turn,
transforming the barren wasteland in Mundra in to a thriving port town.

Airports – Greenfield airports at Hyderabad and Bangalore are under successful

implementation following the PPP model and are ready to commence operations
in the next 6-9 months. Similarly, brownfield expansion projects at Mumbai and
Delhi, after initial hiccups, are on track and progressing smoothly.

Mundra and Pipavav ports
successfully linked to
national rail network
under PPP
Railways – The Mundra Port and the Pipavav Port have executed successful
projects in linking the respective ports to the national rail network, in partnership
with the Railways. Both the projects are operational and a prime example of
successful public-private partnership.

Power – A number of independent power projects (IPPs) have been implemented

across the country and are currently in the operating phase. A few hydel power
projects (Jaiprakash’s Baspa II and Vishnuprayag) have also been successfully
executed and are operating profitably.

Driving value creation for shareholders

Using the 4R framework,
many private developers
have adopted the PPP
model to create huge
shareholder value
A number of Indian private infrastructure developers have successfully adopted the
PPP model and have executed large and complex infrastructure projects across
sectors, in turn creating immense value for shareholders. GMR Infrastructure Ltd
(GMR), GVK Power and Infrastructure Ltd (GVK) and Mundra Port and SEZ
Ltd (MPSEZ) have successfully adopted the holding company model to emerge as
India’s leading private infrastructure developers.

These companies have effectively used the 4R framework for extracting maximum
value from concessions and in turn, driving shareholder returns. Be it re-gearing of
projects road annuity projects, or re-negotiating concession terms, rolling forward
projects on successful execution or re-rating driven by lower risk premiums on
achievement of execution milestones.

Exhibit 18: GVK – price performance GMR – price performance

(Rs) (Rs)
800 300

600 225

400 150

200 75

0
0
Feb-06 Apr-06 Jun-06 Aug-06 Oct-06 Dec-06 Feb-07 Apr-07 Jun-07 Aug-07 Oct-07 Aug-06 Oct-06 Dec-06 Feb-07 Apr-07 Jun-07 Aug-07 Oct-07

Source: IDFC – SSKI Research

DECEMBER 2007 28
 IDFC - SSKI INDIA

Infrastructure developers to create significant shareholder value

We are extremely bullish Indian private sector infrastructure developers have demonstrated strong risk
on private developers mitigation capabilities and financial acumen and have successfully executed a
number of challenging projets across sectors, in turn creating significant value for
shareholders. With the huge infrastructure development potential over the next five
years, an unprecedented opportunity exists for private infrastructure developers
with the scope to substantially create further shareholder value. The large
opportunity canvas and the development capabilities of developers make us
extremely positive on the private infrastructure development space and we believe
the private infrastructure developers can create significant shareholder value over
the medium term.

DECEMBER 2007 29
 IDFC - SSKI INDIA

SECTOR-WISE OPPORTUNITIES AND CHALLENGES

DECEMBER 2007 30
 IDFC - SSKI INDIA

ROADS: ON THE EXPRESSWAY

After the initial success of the Golden Quadrilateral (GQ), the scope of the
highway development programme has been extended significantly to cover
over 40,000kms of national highways. We estimate an investment potential of
Rs3,118bn in development of national highways, state highways and rural
roads over the next five years, with Rs1,125bn coming from the private sector.
The key challenges in realizing the potential are land acquisition and right of
way, shifting of utilities, absence of an independent regulator and alternative
routes on state highways.

THE OPPORTUNITY
With the government’s continued focus on road development, we assess potential
road orders of Rs3,118bn over FY08-12. Apart from the NHDP programme, the
main drivers include construction/ development of state and rural roads, which are
funded by central government and multilateral funding agencies.

Exhibit 19: Total road investments – Rs3,118bn

Road Spend
Project Project description Length Public PPP Total
National Highways 715 827 1,542
NHDP I Golden Quadrilateral 1,738 58 4 62
NHDP II North-South & East-West Corridors 6,736 249 55 304
NHDP III 4-laning of balance highways 10,000 227 227 454
NHDP IV 2-laning of stretches 20,000 - 196 196
NHDP V 6-laning of select stretches 6,500 131 160 291
NHDP VI Access controlled expressways 1,000 - 118 118
NHDP VII Ring roads, by-passes, service roads etc. - 51 67 118
State Highways - 862 298 1,160
Rural roads - 368 - 368
North East roads Special Accelerated Road Development Program - 48 - 48
Total 1,993 1,125 3,118
Source: IDFC – SSKI Research; NHAI; Plan documents

• The Golden Quadrilateral (GQ) project is close to 95% complete, while

We assess potential road
orders of Rs3,118bn
over FY08-12
contracts have already been awarded for the remaining work. The entire project
is now expected to be completed by December 2007.
• The North East West South (NEWS) corridor is under implementation, with
about 20% of the project complete and contracts for 66% of the project already
awarded. The orders for the remaining 14% (821kms) are likely to be awarded
over the next one year.
• Work has also started on the first phase of NHDP III with about 261kms of the
total 4,000kms already completed, while contracts for 1,731kms have been
awarded and are under implementation. We expect contracts for the remaining
work to be awarded over the next 12-18 months and the project to be
completed by December 2009.
• The government has planned NHDP IV for upgrading the highway network
further. NHDP IV will entail converting an additional 20,000km of highways
(which are not covered under GQ, NEWS or NHDP III) into four-lanes.

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• NHDP V would cover select stretches of 6,500kms on GQ and NEWS, which

would be converted into six-lane highways over the next 6-7 years. The total
cost of the project is Rs291bn. NHAI has already identified stretches on the
GQ and contracts for 148kms are under implementation with contracts for
another 6-8 stretches likely to be awarded by December 2007.
• The government has also planned NHDP VI under which 1,000kms of access-
controlled expressways of 4-6 lanes will be built in high-traffic density parts of
the country. The project is estimated to cost Rs118bn.

Apart from the NHDP • Under NHDP VII, NHAI has also planned development of ring roads, bye-
programme, the main passes, service roads, etc to enhance the utilization of the highway network. The
drivers include the state entire project is expected to be completed by December 2014 at a cost of
roads and rural roads
Rs118bn.
• Road improvement programmes in various states such as Rajasthan, Madhya
Pradesh, Gujarat, etc are picking up pace. These roads would be mainly funded
by multilateral agencies or through private participation.

• The government also plans to invest Rs368bn over the next five years,
exclusively in developing rural roads, with the aim to connect all villages.

• Additionally, Rs48bn is expected to be spent under the Special Accelerated

Road Development Program for the North East.

FINANCIAL/ CONCESSION STRUCTURE

Financial structure
Road projects extremely Traffic growth, and therefore revenue growth in a BOT road project, is fairly
attractive to lenders; hence predictable. With relatively fixed operating costs, and a fair degree of certainty of
gearing in such projects
tends to be high
rise in toll rates in line with inflation, cash flows from road projects can be
predicted with reasonable accuracy. Moreover, with a legally enforceable concession
agreement, road projects represent a steady stream of revenues with relatively low
risk. This makes road projects extremely attractive to lenders; and hence gearing in
such projects tends to be high.

BOT projects relating to In recent experience, BOT projects relating to roads in India have been funded at a
roads in India typically gearing between 2.5-4.0x. In case of roads with heavy traffic, the gearing has been
have a gearing of 2.5-4.0x as high as 8x also. In case of annuities, gearing has gone up to even 9x, as there is
no risk of traffic with NHAI receivables being the only risk.

With high gearing, the equity contribution in BOT road projects is limited.
Capital grants received by the developer as part of the viability gap funding reduce
the developer’s equity investments even further.

IRRs in the range of 15-18%

Equity IRRs in BOT road projects have been in the range of 18-20% in the past.
Going forward, we expect equity IRRs to stabilise at 15-18%.

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Bidding variable to be the grant expected from NHAI

Project parameters such The selection of the concessionaire, under the new Model Concession Agreement
as concession period, toll (MCA), will be based on open competitive bidding. All project parameters such as
rates, price indexation and
technical parameters the concession period, toll rates, price indexation and technical parameters are
clearly stated upfront clearly stated upfront, and short-listed bidders are required to specify only the
amount of grant sought by them. The bidder which then seeks the lowest grant
wins the contract. In some cases, instead of seeking a grant, a bidder may offer to
share project revenues with the NHAI. And in that case, the bidder offering the
highest revenue share would win the contract.

20% of project cost The maximum grant provided shall be 20% of the project cost. In case the grant is
provided as maximum inadequate for making a project commercially viable, an additional grant up to a
grant; additional grant of
20% of project cost for
maximum of 20% of the project cost may be given for O&M support after the
O&M support highway has been commissioned.

Concession structure
To encourage and sustain private investments in roads, the government has
formulated an MCA, which spells out the policy and regulatory framework for
development of roads through the BOT route. The key features of the MCA are:

Concession period
The concession period is generally expected to be 20 years, but may vary depending
on the volume of existing and projected traffic for specific projects.

6-laning of highways
The standard 20-year The standard 20-year concession period entails construction of a 4-lane highway
concession period entails and subsequently 6-laning it. However, if within eight years of commissioning of
construction of a 4-lane
the highway, the NHAI is satisfied that the traffic volume and growth does not
highway and subsequently
6-laning it warrant expansion to 6-lanes, it may restrict the period of concession to 12 years.
Similarly, after the 8-year period, the concessionaire has the option to give up its
right to 6-laning the highway, which reduces the concession period to 12 years.

Extension / Reduction in concession period

The MCA provides for an extension of the concession period in case of lower than
expected growth in traffic and a reduction in the event of higher than expected
traffic rise. The MCA sets a targeted traffic growth and allows for a change in the
concession period as under:

Exhibit 20: Extension and reduction in concession period

Variation in traffic vis-à-vis Variation in Remarks
target traffic concession period
(-) 2.5% – 2.5% No change
< (-) 2.5% Every 1% shortfall increases Maximum increase in
concession concession period by 1.5% period capped at 20%
< 2.5% Every 1% excess reduces Maximum reduction in
concession concession period by 0.75% period capped at 20%
Source: NHAI

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Exhibit 21: Illustration of traffic variance and impact on concession period

Traffic (base 1000) Change in Revised concession
concession period period (over 20 years)
1020 No change 20.00
1050 (-) 3.75% 19.25
960 6% 21.20
Source: NHAI

The time required for
construction (typically 24-
30 months) included in the
concession period
The technical parameters
in MCA focus on output,
rather than construction,
specifications
Construction period
The time required for construction (typically 24-30 months) is included in the
concession period. A concessionaire starts earning revenues from the completion
date, which gives it an incentive for early completion of construction.
Focus on output parameters
The technical parameters in the MCA focus on output, rather than construction,
specifications. Given that only the core requirements of design, construction,
operation and maintenance of the highway are specified, the concessionaire has the
requisite flexibility to evolve and adopt cost-effective designs without
compromising on the quality of service.

Concession fee
The concession fee, given in the exhibit below, is fixed on an ascending revenue-
sharing basis, in line with the cash flow pattern of the project where debt service
obligations would entail substantial outflows in the initial years.

Exhibit 22: Concession fee details

Particulars Revenue share
First 9 years Re1 p.a.
10th year 1% of project revenues
11th year onwards Additional 1% each year
Source: NHAI, SSKI Research

Financial closure
A time limit of 180 days is set for achieving financial closure by the concessionaire.
In the event of failure, the bid security is forfeited.

Toll charges
Toll charges, based on • The toll charges are based on the rates notified by the government.
government-notified rates,
revised to the extent of • The toll charges are revised to the extent of 40% of the variation in the
40% of variation in WPI wholesale price index (WPI).

Obligations of NHAI
• Acquire and hand over possession of at least 40% of the land required for the
project to the concessionaire before financial closure is achieved.
• Obtain all environmental clearances for the project before financial closure is
achieved.

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Substitution
The MCA provides for the concession to be transferred to another company in the
event of failure of the concessionaire to operate the project successfully.

Termination
In the event of termination, the MCA provides for a compulsory buyout by the
NHAI.

RISKS
Traffic
Lower than expected growth in traffic is the key risk borne by the concessionaire.
Given that investments in building the road have to be recovered from toll
revenues, any shortfall in traffic impacts the profitability of the project.

Financial closure risk

Lower than expected traffic Given that the new MCA puts a time limit on achieving financial closure, any
growth, delay in achieving delays in the same will impact profitability of the project. Moreover, with the
financial closure and
delayed completion of construction period now a part of the concession period, a delay in achieving
project –the key risks financial closure and completing construction shortens the effective period available
for toll collection.

Execution risk
While the new MCA includes the construction period as part of the total
concession period, completing a construction within or before time is a key to
achieving higher profitability.

CHALLENGES
Land acquisition and right of way issues tend to delay projects
Many projects have had Land acquisition and right of way are extremely critical for timely completion of
been affected by delays or road projects. Typically, at the time of a road project award to a private operator,
inability to acquire land
the land acquisition is not 100% complete. If there is any delay in land acquisition,
the project typically gets delayed, which leads to cost escalations. Moreover, if it is
not technically possible to get the land, then the project may get cancelled
altogether. The land delay issues have had delayed completion of NHAI’s marquee
project – the Golden Quadrilateral project, which was 98% complete over 24
months ago and has not yet achieved 100% completion, primarily due to problems
in land acquisitions.

Though MCAs now In order to address the land and right of way issues for road projects, NHAI has
stipulate that projects inserted a clause in the Model Concession Agreement (MCA), which states that a
cannot start before 40% of
project cannot be awarded unless 40% of the land is acquired. However, the MCA
the land is acquired,
delays cannot be ruled out states that the right of way for the balance land will be only on a ‘best effort basis’
by NHAI, and practically the developers may have to co-ordinate the process
themselves, with limited support from the NHAI. In BOT projects, the private
developers do not have any locus standi on land acquisition and with NHAI playing
only a supporting role in acquisition of the balance land, there might be delays in
projects.

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Utilities’ shifting is quite cumbersome

Shifting of utilities quite
complicated due to need to
seek permission from
various departments
Post the award of the project and land acquisition, certain utilities (telecom towers,
power lines, water pipes, etc) need to be shifted to accommodate the expansion of a
road network. Currently, the process is quite cumbersome as the private player has
to deal with separate entities in each department, including NHAI, for clearing the
land to expand and build the road. For speedier implementation of projects, we
believe a central coordinating agency should handle all the relevant departments
involved in shifting of all the utilities.

New MCA likely to delay financial closure

The new MCA states that once the traffic crosses a certain threshold level, the road
needs to be expanded from four lanes to six lanes. As per the MCA, upon the
expansion of the road, the project life will be extended so as to enable the private
developer to earn returns on the increased project cost. As a result, private
developers are likely to find it difficult to financially close projects due to the
uncertainty on project costs and possible changes in the concession period as
lenders may not be ready to take open-ended risks.

Absence of an independent regulator

Currently, NHAI awards the projects on BOT and EPC basis to various
contractors and private developers. Also, NHAI sets the toll rate and gives annuity
payments or grants to the developers for certain projects. Consequently, there is no
independent regulator if any arbitration is required between a private developer and
NHAI.

State highways should not have alternative routes

Alternative routes affect Apart from the central authority of highways (NHAI), private greenfield or
the viability of a project brownfield road projects are also awarded by state governments to enhance the state
infrastructure. At times, these roads are alternative routes to the existing routes,
which may not make the project viable. However, as per the current MCA, no
alternative roads can be developed unless existing routes cannot be developed
further. Moreover, to protect the viability of the existing route, the toll rates on
competing roads have to be higher by 33% than the existing routes. As a result,
there should be coordination between NHAI and state governments while planning
expansion of existing roads or development of new roads.

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POWER: GENERATION LEAP

The power sector is expected to receive the largest chunk of infrastructure
investments over the next five years – Rs6.17tn or 36% of total investments.
The major investments in the power sector are expected towards adding large
generating capacity and in creating the related transmission and distribution
networks. The private sector is likely to invest Rs1.6tn in the sector over the
next five years, mainly in generation. The major challenges in implementing
power projects are delays in securing environmental clearances, R&R issues
in case of hydel projects, pressure on delivery schedules of equipment, and
risks in fuel availability and pricing.

THE OPPORTUNITY
The focus on T&D loss reduction and generating-capacity augmentation would
lead to investments of Rs6,165bn in the segments over the next five years. The
investments would be divided in the ratio of 55:45 between generating-capacity
addition and T&D loss reduction led initiatives.

Exhibit 23: Huge power investments led by increased focus on power reforms
MW Public PPP Total
Generation
Thermal 50,124 1,126 152 1,278
Hydel 15,585 524 139 662
Nuclear 3,160 188 - 188
Sub-total 68,869 1,838 291 2,129
Transmission
National Grid 20,700 524 156 680
Intra-state transmission 472 141 613
Sub-total 20,700 995 298 1,293
Distribution
Sub-transmission & distribution 680 85 765
RGGVY 255 - 255
APDRP 255 - 255
Decentralised Distributed Gen 168 - 168.3
Sub-total 1,358 85 1,443
th
Generation (12 Plan investments)
Thermal 47,225 31 450 482
Hydel 31,734 38 502 539
Nuclear 12,800 279 - 279
Sub-total 91,759 349 952 1,301
Total 4,540 1,625 6,165
Source: IDFC – SSKI Research; Plan Documents

Power reforms, capacity
additions and measures to
reduce cash losses in
distribution to drive orders
h
• The 11 5-year Plan (2008-2012) targets generation capacity addition of
68,869MW across thermal, hydel and nuclear plants.
• We estimate majority of the capacity addition to be from thermal power plants
(50,124MW over the next five years).
• Additions from hydel power plants are picking up pace and are estimated at
15,585MW (Rs662bn) over the next five years.
• The nuclear power plant capacity addition is estimated at 3,160MW, which
would involve an outlay of Rs188bn.

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• There are plans to create a National Grid with a transmission capacity of

Investments of Rs6,165bn
planned across segments
over the next 5-8 years
37,000MW over the next 5-7 years at an estimated outlay of Rs680bn. Power
Grid Corporation of India Ltd (PGCIL) is expected to invest Rs500bn towards
this while private players are expected to mobilise the remaining.
• Distribution capex is also expected to ramp up in the next five years, with
schemes such as APDRP (Accelerated Power Reforms and Development
Program), RGGVY (Rajiv Gandhi Gramen Vidyutikaran Yojana). We expect
investments of Rs1,443bn in distribution capex over the next five years.
th
• In the 11 Plan, the power sector is also expected to see investments related to
th
capacity additions which will materialise in the 12 Plan. A total of Rs1,301bn
is expected to be invested in generation, and T&D.

CONCESSION / PROJECT STRUCTURES

PPA based thermal power projects
Power purchase agreements (PPAs) are typically signed between the developer of a
power plant and the entity buying the power. PPAs ensure a fixed guaranteed
return to the developer, while giving the buyer a regular supply of power.

Some of the key details of PPA based projects are mentioned below:

Financial and return structure

• Gearing of the project is to be as per the CERC norms, which peg the debt to
equity ratio at 70:30.
• In cases where equity is in excess of the norm, the excess equity should be
treated as loans at a weighted average rate of interest.
Gearing of the project is to • For equity below the normative level, actual equity to be used for RoE
be as per the CERC norms, calculation purposes.
which peg the debt to
equity ratio at 70:30 • The rate of return is capped at 14% RoE for the developer. However, further
incentive is provided for efficient operations.
• Incentives are based on higher returns for PLF greater than 80%.
• Same rates of depreciation to be notified for tariff as well as accounting based
on SLM depreciation.
• Forex variations shall not be a pass through in tariff. However, hedging and
swapping costs would be allowed as costs for tariff calculation.
The concession period is • Operating parameters for tariff calculations should be at “normative levels”.
generally for a period of
20 years • Fuel costs, tax, interest and other key costs are pass-through to the customer by
way of tariffs.
• The concession period is generally for 20 years.

Equity IRRs in the range of 16-18%

Despite a cap of 14%, equity IRRs in thermal based PPA projects have been in the
range of 16-18% owing to higher operating efficiencies such as higher gearing,
higher PLFs, etc.

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Merchant thermal power plants

Merchant power plants are power plants without any provision for guaranteed
offtake, which implies that returns are not assured for the developer. However, the
developer typically ties with a trading company or enters into an agreement with a
utility for part offtake of the output, which covers the fixed costs of the plant and
protects the developer to some extent.

Some of the key details of a merchant power based plant are mentioned below:

Financial and returns structure

Lenders typically gear the
project based on PPA
based norms, i.e. at a debt
to equity ratio of 70:30
• The gearing of the project is not based on any fixed norms. Developers prefer
higher gearing to reduce their equity contribution and enhance returns.
However, lenders typically gear the project based on PPA based norms, i.e. at a
debt to equity ratio of 70:30.
• There is no cap on the rate of return for the developer. The return varies on the
offtake of power, operational efficiencies, gearing, etc.
• Unlike in PPA based power plants, costs like fuel, interest costs, depreciation,
forex, etc are not a pass-through.
• There is no fixed concession period for the power plant as there is no long-term
agreement with a utility.

Equity IRRs in the range of 22-25%

Equity IRRs boosted by Equity IRRs in thermal based merchant projects have been in the range of 22-25%
better operating in the past led by better operating efficiencies, higher gearing, higher PLFs, cheaper
efficiencies, higher cost of fuel, etc. Some power plants have witnessed higher equity IRRs due to
gearing, higher PLFs,
cheaper cost of fuel, etc higher efficiencies of the power plant.

PPA based hydel power plants

Considering the uncertainty of water availability, hydel plants are typically PPA
(power purchase agreement) based. There are two types of hydel power generation
– run of the river and storage based power plants. The projects are typically
awarded by NHPC or individual state electricity boards.

Some of the key details of hydel based PPA power plants are mentioned below:

Financial and returns structure

• The gearing levels of the project are as per the CERC norms (at a debt to equity
ratio of 70:30).
• The rate of return is capped at 14% RoE for the developer.
70:30 gearing levels as per
the CERC norms; rate of • However, further incentive is provided for higher Plant Availability Factor
return capped at 14% RoE
(PAF), which is capped at 2%.
for the developer
• A hydel power plant capacity is typically designed based on 90% dependable
water flow in the river. As a result, the secondary energy due to higher water
availability can potentially give an incremental 10% RoE to the developer.
Overall, hydel power generation can give the developer RoE of 26%.
• The developer of the hydel power plant has to give 12% free power to the state
electricity board.

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The developer of the hydel
power plant has to give
12% free power to the state
electricity board
• All key costs such as interest costs, O&M costs, etc are a pass-through to
customers by way of tariffs.
• The concession period for the power plant is generally for 30-40 years.
• The upfront premium paid to the respective state electricity boards for the
rights to set up the plants is the bidding variable. Typically, the premium is paid
in the form of Rs 5m/MW.

Equity IRRs in the range of 20-22%

Despite a cap of 14%, the average equity IRRs in hydel based PPA projects have
been in the range of 20-22% in the past owing to higher operating efficiencies such
as secondary energy and higher PAFs.

Merchant hydel power plants

Developers have no guarantee of offtake or returns in a merchant based power
plant as no agreements or tie-ups are in place with any utility. However, being a
peak load form of power, the operator can maximise realisations by selling power at
peak hours.

Zero cost of fuel – key advantage

Zero fuel costs enable the Hydel power plants have zero cost of fuel, as they generate power from water.
developer to sell power at Therefore, power generated from a hydel power plant is extremely cheap compared
competitive prices and to that from thermal plants. This enables a merchant hydel power developer to sell
boost returns
power at competitive prices and boost returns.

Equity IRRs in the range of 25-30%

The merchant hydel power plants have an average equity IRR in the range of 25-
30% led by higher sale of power at peak hours, which results in better realisations
and returns.

Offtake – the key risk

No agreement with any Merchant based power plants face an offtake risk, as there is no agreement with any
utility for assured utility for assured purchase of power. Considering the huge fixed costs of a power
purchase of power
plant, any shortfall in offtake that covers the fixed costs will sharply deteriorate the
returns of a merchant power plant developer.

Transmission lines
There are plans to create a National Grid with a transmission capacity of
37,000MW over the next 5-7 years, at an estimated outlay of Rs600bn. The
private sector is expected to invest Rs200bn towards this while Power Grid
Corporation (PGCIL) is expected to mobilise the remaining.

Bidding variable
The lowest bidder of the Developers have to bid for the exact transmission charges explicitly for each of the
transmission charges wins years in the concession. The lowest bidder of the transmission charges wins the
the concession
concession.

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Some of the key details of transmission concessions are mentioned below.

Financial and returns structure

Project gearing likely to be
at a debt to equity ratio of
70:30; can go higher as
project is low risk in nature
Gearing levels of the project are likely to be at a debt to equity ratio of 70:30.
However, considering the low risk nature of the project, gearing can increase
substantially.

The returns of the projects are not fixed or capped for a developer.

The developer bears the O&M cost as also the interest cost of the transmission
Returns of projects not line project. The cash surplus is the return to the developer.
fixed or capped for a
developer
The developer will transfer the project to PGCIL at zero cost at the end of the
concession period.

The concession is generally for a period of 25 years.

Transmission charges are paid by PGCIL.

Owing to lower risk, equity IRRs in transmission projects are likely to be 16-
20%.

RISKS
Receivables risk
Receivables risk, fuel- This is the key risk for a power plant developer. Typically, state utilities buy out the
availability and execution power from the developer. However, the huge T&D losses may lead to non-
delays – the key risks
payment of the power purchased from the developer.

Availability of fuel
The PPA and returns are based on the premise that the power plant will be always
available for power production. In case the power plant is not available for
production due to lack of availability of fuel, the developer will be unable to
generate returns on the investment of the power plant for that period.

Execution risk
Any delay in timely completion of the project or cost overruns could result in lower
returns for the developer. Execution risk is higher in case of hydel power plant as
the construction period is long and projects are typically located in difficult terrain.

Offtake risk
Offtake of power is the key risk in case of merchant power plants, as there is no
pre-signed agreement with any utility. Consequently, the risk of both offtake and
tariffs is very high. However, considering the huge shortage of power in India, we
do not see merchant power plants saddled with surplus power.

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CHALLENGES
Securing environment clearances – a time-consuming process
A single window clearance Considering the high amount of pollution from thermal power plants, power
with a time bound projects need to secure environmental clearances before commencement. The
schedule needed to process is quite cumbersome as it requires coordinated effort among various
simplify the process
agencies and government departments. As a result, the time taken to get
environmental clearances can be quite long and can delay project execution. We
believe the process can be simplified and can be made less time consuming by
setting up a single window clearance with a time bound schedule.

R&R issues for hydel power plants

A proper policy should be Rehabilitation & Resettlement issues (R&R) arise largely in hydel power plants as
formulated to tackle they require large tracts of land compared to thermal power plants. Against other
rehabilitation and
resettlement issues
types of power plants, hydel power plants sometimes lead to submergence of
villages or forests, which implies displacement of many villages. Rehabilitation and
shifting of villages to other locations can take time due to the approvals required
from various local, state and central authorities.

At times, before the project is approved or awarded, these issues are not resolved,
which results in delays in implementation of the project as witnessed in the Sardar
Sarovar project, which has been delayed for over a decade due to R&R issues. The
step ahead would require the government to formulate a proper policy on the R&R
issues, which protects the interests of landowners as well as enable speedy
implementation of the project.

Equipment shortage drives execution delays

Shortage of equipment Equipment shortages have been another key reason for delays in setting up power
leading to inability to meet plants or improving systems and efficiencies in power distribution. Equipment
power capacity addition manufacturers have failed to keep pace with the growing demand for equipment
targets
due to rising cost of raw materials and lack of capacity. The shortage and delays in
deliveries of equipment have further led to shortages in power generation and
distribution. Similarly, while transmission capacity is limited, regional connectivity
has aggravated inefficiency in the system as surplus power generation cannot be
sold in power deficit regions.

Accordingly, we believe power utilities and distribution companies should try to

place the orders at an earlier stage as well as share their expansion plans with the
equipment manufacturer so as to enable the latter to expand its capacities in line
with the demand growth. Moreover, the government has taken steps to encourage
utilities to improve their T&D network by introducing programmes such as the
rural electrification program, APDRP, etc.

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Fuel supply and pricing uncertainties lead to implementation issues

Fuel unavailability Easy availability of raw material at reasonable prices is a critical factor for running
preventing production power plants at a higher utilization level. The issue of raw material availability
commencement at certain
arises primarily in thermal power plants.
completed power projects

The availability and pricing of coal and gas has, in the past, been an issue. Certain
power plants, despite being completed, have failed to commence power production
due to fuel unavailability. For example, some gas based power plants in Andhra
Pradesh such as Gautami Power, Vemagiri Power, etc have been non-operational
due to lack of gas supplies. Similarly, despite receiving all the required clearances,
construction of Reliance Power’s Dadri gas plant and NTPC’s Kawas and Gandhar
power plants has not started due to uncertainty on pricing and availability of gas.
Also, coal based power plants witness delays due to coal unavailability.

In order to address the issues of power supply, the government is allotting

coalmines to power companies to ensure steady supply of coal. Moreover, the gas
supplies are being allotted to power companies on a preferential basis compared to
other user industries. These steps are likely to ensure timely production of power
and reduce power supply shortages.

Selling risk and financial closure

Though assuring offtake, Power producers typically enter into PPAs with state distribution companies so as
PPAs run the risk of to enable an assured return on power plants. The tying up of power purchase
entailing high cost
enables a speedy financial closure as it gives lenders to the project comfort on
of power
receivables of the power plant. However, a PPA signed with an assured offtake
agreement may not always be feasible as the cost of the power may be high. Also,
power producers would also want to run merchant power plants, wherein they can
sell power in the spot market. In this backdrop, lenders and power producers
should work closely together for ensuring speedy financial closure for merchant
power projects.

DECEMBER 2007 43
 IDFC - SSKI INDIA

PORTS: RISING TIDE

With India’s rising share in international trade, port capacity augmentation is
likely to be a key focus area in infrastructure development over the next five
years. We estimate investments of Rs740bn over the next five years in
developing new ports along with related infrastructure. However, the absence
of a full service regulator, lack of clarity on tariff setting by TAMP and rail-road
connectivity of ports remain key challenges in realizing the large investment
potential. In spite of these challenges, we estimate the private sector to invest
Rs545bn over FY08-12 and successfully execute projects in the ports sector.

THE OPPORTUNITY
Ports – one of the attractive destinations for private players – are likely to attract
investments worth Rs740bn over the next five years. The investments would go
into augmenting existing port capacities as well as developing greenfield ports. We
believe the majority of the investments for port infrastructure would come from
private players.

Exhibit 24: Port capacity to double over next five years

(mn tons)
POL Containers Iron ore Coal Others
1,050

Ports likely to attract 700

investments worth
Rs740bn over the next
five years…

350

0
Current Mar-12

Source: Ministry of Shipping

…of which ~Rs470bn will
be towards construction of
new berths, deepening
channels, rail-road
connectivity etc. At major
ports
• Indian ports are facing huge bottlenecks and require capacity expansion on a
war footing. The current capacity of about 500m tonnes across various ports is
required to ramp up to 1,000m tonnes by 2012 to meet the potential demand.
• The government has rechristened the old Sagarmala project as National
Maritime Development Programme (NMDP), which will execute the entire
development of the port infrastructure.
• Of the total investments of Rs740bn in the ports sector, major ports are
expected to invest Rs470bn in construction of new berths (both bulk and
container ports), deepening channels at select ports, equipment and rail and
road connectivity to major ports.

DECEMBER 2007 44

We estimate the private
sector to invest Rs270bn in
the ports sector
The MCA spells out policy
and regulatory framework
for development of ports
through the BOT route
Concession period
extended in case of lower
than expected growth in
traffic and vice versa
When bidders seek capital
grant from the government
or Port Trust, they have to
share revenues with
the latter
DECEMBER 2007
IDFC - SSKI INDIA
• The government of India is using privatization as a tool to expand the existing
port infrastructure. The privatization of existing and new berths and
development of greenfield ports will be the drivers for investments in ports over
the next five years. Towards this, minor and other ports are expected to invest a
total of Rs270bn over FY08-12.
CONCESSION STRUCTURE
To encourage and sustain private investments in ports, the government has
formulated a model concession agreement (MCA), which spells out the policy and
regulatory framework for development of ports through the BOT route.
The framework contained in the MCA is applicable to PPPs in building new port
terminals at the existing ports. With some modifications, it can be applied to
transfer of existing port terminals from the government/ Port Trust to private
entities. Similarly, with some modifications, it can also be applied to PPPs for
building new ports on BOT basis. The key features of the MCA are:
Concession period
The concession period for BOT projects in ports is generally 30 years but may be
changed in specific projects.
Construction period
The time required for construction (about two years) is included in the concession
period, so as to incentivise early completion.
Flexible concession period
The MCA provides for an extension of the concession period in case of a lower
than expected growth in traffic. Conversely, a higher than expected growth in
traffic may entail reduction of the concession period. The MCA provides for a
target traffic growth and stipulates an increase of up to seven years in the
concession period if the growth rate is lower than projected.
For example, a shortfall of 10% in the target traffic after 20 years will lead to
extension of the concession period by five years. On the other hand, a reduction of
up to three years is stipulated in the event of higher than expected growth. An
increase of, say, 6% in the target traffic will reduce the concession period by 18
months.
Concession fee
The concession fee is fixed at a nominal Re1 per annum for the entire concession
period. However, where bidders seek a capital grant from the government / Port
Trust, they are required to share a portion of revenues with the government / Port
Trust. The revenue share quoted for the initial year is then increased by an
additional 1% for each subsequent year of the concession.
The rationale for an ascending revenue-sharing basis is in line with the cash flow
pattern of the project, where debt service obligations entail substantial outflows in
the initial years.
45
 IDFC - SSKI INDIA

Focus on output parameters

Technical parameters The technical parameters in the MCA focus on output, rather than construction,
focus on output, rather specifications. Only the core requirements of design, construction, operation and
than construction, maintenance of the highway are specified, leaving the concessionaire with the
specifications
requisite flexibility to evolve and adopt cost-effective designs without
compromising on the quality of service.
Financial closure
A time limit of 180 days is set for achieving financial closure by the concessionaire.
In the event of failure, the bid security is forfeited.
Toll charges
Port tariffs based on the • Port tariffs are based on the rates notified by the TAMP.
rates notified by the TAMP
• Toll charges are revised to the extent of 40% of the variation in the wholesale
price index (WPI).
Obligations of the government / Port Trust
• Acquire and hand over possession of at least 40% of the land required for the
project to the concessionaire before financial closure is achieved.
• Obtain all environmental clearances for the project before financial closure is
achieved.

Substitution
The MCA provides for the concession to be transferred to another company in the
event of failure of the concessionaire to operate the project successfully.

Termination
In the event of termination, the MCA provides for a compulsory buyout by the
Port Trust/ government.

RISKS
Traffic risk
Lower than expected In all BOT projects, the concessionaire bears the risk of lower than expected
traffic, inability to achieve growth in cargo traffic. Given that investments in building the port have to be
financial closure and recovered from port related revenues, any shortfall in cargo traffic impacts the
delayed execution – the profitability of the project. A shortfall in cargo traffic growth becomes all the more
key risks
critical as the new MCA provides for a reduced concession period in case of a lower
than projected growth in cargo traffic.

Financial closure risk

As the new MCA puts a time limit on achieving financial closure, any delays on the
same impacts profitability of the project. Moreover, with the construction period
now a part of the concession period, a delay in achieving financial closure and
completing construction shortens the effective period available for collecting tariffs.

Execution risk
The new MCA includes the construction period as part of the total concession
period. Hence, completing the construction within or before the stipulated time is
a key to achieving higher profitability.

DECEMBER 2007 46
 IDFC - SSKI INDIA

CHALLENGES
Full-service regulator
A central regulatory body Similar to other infrastructure segments, the port sector too lacks an independent
would ensure similar regulator. Currently, the port authority gives out EPC contracts or concessions and
regulations across ports is also the regulating body for resolving any disputes or overcoming problems.
However, to ensure fair decision making, it is quite necessary to have an
independent regulator. Moreover, minor ports are not regulated by the central
government, but by the respective state governments or authorities. Therefore, a
central regulatory authority governing all ports in the country, ensuring similar
regulations across Indian ports, would aid port development and port users.

TAMP issues in tariff setting

A fixed formula for setting
tariffs would impart clarity
on charges for various
services
The major ports in India (those owned by the central government) are governed by
TAMP for tariff related issues, while minor ports are free to set their own tariffs
without any cap or governance by TAMP. Consequently, different ports have
different charges for various services offered by them. Moreover, there have been
issues in the past on the way the TAMP sets tariffs, which results in disputes
between the port terminal operator and TAMP (e.g., PSA – Sical terminal operator
at Tuticorin port for allowing royalty expenses as costs). However, TAMP has
disallowed these expenses to be reimbursed as part of the tariff, resulting in disputes
between TAMP and terminal operators. If there were to be a set formula for setting
tariffs across ports, the users and various operators would have clarity on how to
charge for various services.

A port’s success depends
on its rail and road
connectivity to hinterland
Rail-road connectivity
Good connectivity of a port to the hinterland, through both rail and road for
movement of cargo, enhances the benefits to users, and hence success of a port. As
rail and road connectivity falls under the ambit of different ministries, i.e. Ministry
of Surface Transport and the Indian Railways respectively, as well as with the
central and the respective state governments, there are quite a few approvals and
sanctions required from various entities. Consequently, getting the requisite
approvals is quite cumbersome and a time consuming process.

In order to ensure that ports are well connected to the hinterland, companies form
a separate SPV for rail and road connectivity, as witnessed in Mundra and Pipavav
ports wherein rail connectivity was done through an SPV with the port operator
and the railways jointly investing in improving the port connectivity by rail. The
initiative of forming JV companies with the central authorities ensures timely
connectivity of the port to the hinterland.

Dredging – responsibility of port authority or terminal operator?

Lack of clarity on who All the ports in India do not have a natural deep draft to service large vessels, and
would carry out dredging therefore require dredging (both capital and maintenance). At the time of award of
sometimes leads to
project delays
the contract for developing terminals at a port, the contract may remain silent on
the dredging aspect or outline the dredging responsibility as that of the port
authority or the terminal operator.

DECEMBER 2007 47
 IDFC - SSKI INDIA

However, dredging by the port authority may not be in the same timeline of the
terminal commissioning or there may be delays, which may result in low
profitability (unattractive as large vessels may not berth at the terminal) for the
terminal operator. However, if dredging responsibility lies with the terminal
operator, other terminal operators also benefit from using the same infrastructure.

The problem of common infrastructure was witnessed by Vizag Seaport

(concession of GIPL), which had to dredge the channel to facilitate larger ships,
whereas the agreement stated that the port authority would dredge the channel.
The lack of clarity on the issue and a delay in dredging resulted in delayed
commissioning of the project. Consequently, it is better that the dredging work of
the terminal begins or is in progress at the time of the award of the contract as well
as the contract clearly lays down the responsibility of the dredging on one party. In
case there are delays, the terminal operators should be suitably compensated.

DECEMBER 2007 48
 IDFC - SSKI INDIA

AIRPORTS: TAKING OFF

Increasing domestic and international air travel is pushing existing airports in
the country to peak capacity utilization. To handle the growing passenger
traffic, investments of Rs349bn are envisaged in building new airports and
expanding existing airports across the country. Though absence of a model
concession agreement and an independent regulator remain two of the key
challenges in the airports sector, we believe, the success of PPP in the
Bangalore, Hyderabad, Mumbai and Delhi airports will drive private sector
investments of Rs257bn over the next five years in the sector.

THE OPPORTUNITY
In its effort to upgrade Indian airports to world-class standards, the government is
inviting private participation for the task. After successfully awarding greenfield
airports at Hyderabad and Bangalore and brownfield expansions at Mumbai and
Delhi to private players, the government is expected to increase the pace of PPP
projects in the airports sector over the next five years.

Exhibit 25: Investments planned in airports

(Rs bn)
400

300
Total investment of
Rs349bn proposed in
airports over the next 200
five years

100

0
Metro Airports Greenfield airports * Non-metro Airports North East airports Total

Source: Ministry of Civil Aviation, SSKI Research; * Navi Mumbai, Gr. Noida, Goa, Nagpur and Pune

• In India, the number of people travelling by air is estimated to show a 25%

CAGR over the next five years, driven by the ongoing deregulation of the
aviation sector.
• Greenfield airports are under development at Bangalore and Hyderabad, at a
While work has
commenced on a few total investment of Rs30bn. The Hyderabad airport is expected to commence
projects, many more are operations from March 2008 while the Bangalore airport is expected to be
planned to be developed commissioned by April 2008.
• The government is also planning to develop greenfield airports at Greater
Noida, Navi Mumbai, Goa, Pune and Nagpur, at an estimated investment of
Rs43bn over the next five years.
• Among metro city airports, the Mumbai and Delhi airports are being upgraded
and modernized under the BOT route, involving investments of Rs133bn. The
Chennai and Kolkata airports are planned to be modernized and upgraded by
the Airports Authority of India (AAI) at an estimated cost of ~Rs86bn.

DECEMBER 2007 49
 IDFC - SSKI INDIA

• Upgradation and modernization of 35 more non-metro airports will be taken

up by the AAI at a total cost of Rs52bn and airports in the North East are
proposed to be developed at a cost of Rs5bn.

CONCESSION STRUCTURE
The government has taken the following initiatives to improve the Indian aviation
infrastructure:
• Amendment of the AAI Act, 1994 to create an effective legal framework for
restructuring existing airports under the AAI and for encouraging private sector
participation in the sector
• Formulation of Airport Infrastructure Policy 1997, including policy for
greenfield airports
A favourable framework • Announcement of various initiatives for private sector participation in airports
being created to promote in the Union Budget
private sector participation
in the aviation sector • Hike in FDI to 49% for Mumbai and Delhi airports, while allowing 74% FDI
in greenfield airports through the automatic route and 100% with permission
• Extended the limited open-sky policy to all foreign airlines
• Private airlines allowed to fly to international destinations

Overall, a favourable framework has been created to progressively reduce the

government and AAI’s control over the airport sector in the country and promote
private sector participation.

Concessions for greenfield airports

Concession period
Initial concession term of Greenfield airport concessions in India are structured on a BOOT basis with an
30 years extendable by initial concession term of 30 years, extendable by another 30 years at the option of
another 30 years subject to
fulfilment of certain terms
the concessionaire and subject to fulfilment of certain terms and condition. The
and condition project is extendable beyond 60 years subject to mutual agreement.

Exclusivity
All existing airports in the city have to be closed as soon as the new greenfield
airport starts commercial operations. Moreover, no new or existing airport will be
allowed to be developed within 150km aerial distance before the 25th anniversary
of the project.

The concession fee for
airports fixed at 4% of the
annual gross revenues of
the airport
Concession fee
The concession fee for airports has been fixed at 4% of the annual gross revenues of
the airport. However, the fee has been deferred for the first 10 years and becomes
payable in 20 semi-annual instalments from the 11th year of the concession
agreement.

DECEMBER 2007 50

Aeronautical revenues
based on the cost-recovery
principle; aimed at
providing stable revenues
Concessionaires allowed
use of certain area of the
airport land for real estate
development
The concessionaire has to
take over the existing
airport infrastructure by
paying a fee to the AAI
DECEMBER 2007
IDFC - SSKI INDIA
Commissioning
Commercial operations must begin within 33 months from the date of financial
closure.
Land lease
Land lease payments are decided upfront before the bidding. Typically, the land
lease payments are nominal and there is no upside sharing for government from the
development of the land.
Aeronautical revenues
Aeronautical revenues are based on the cost-recovery principle and aimed at
providing stable revenue streams. Landing and parking charges are collected from
airlines based on the size and load of each aircraft. Landing charges are collected as
per AAI-defined rates.
The passenger service fees (PSF) are escalated at a certain rate every year.
Moreover, the greenfield airport will charge a user development fee (UDF) per
departing passenger to recover the cost of building the airport. The amount of
UDF is decided upfront by negotiating with the government given that the airport
is a greenfield one.
Commercial revenues
As per the concession agreement, the concessionaires will be allowed to use a
certain area of the airport land for real estate development such as hotels and
business parks. The real estate development has to conform to the local authority
development norms.
Concessions for brownfield airports
Concession period
Concessions for brownfield expansion of airports are structured on BOOT basis
with an initial concession term of 30 years, which is extendable by another 30 years
at the option of the concessionaire.
The project is extendable beyond 60 years subject to mutual agreement between
the concessionaire and the government.
Commissioning
The concessionaire has to take over the existing airport infrastructure by paying a
fee to the AAI. The concessionaire, after gaining control of the airport, has to
complete the master plan for its expansion and refurbishment within six months
and the same has to be approved by the AAI. Commercial operations must begin
within 33 months from the date of financial closure.
Exclusivity
Under the concession agreement, if a new airport is to be awarded within a 150km
radius of the airport during the concession period, the concessionaire would have
the first right of refusal for the airport in a competitive bidding process provided its
bid is in the range of 10% of the winning bid.
51

AAI will transfer the IGIA
to DIAL in three months
after upfront fee payment
After two years, and
completion if mandatory
capital projects are, a
nominal 10% increase in
landing charges allowed
Formula for calculating
landing charges is a price
cap formula
Concessionaires allowed
using up to 5-10% of the
total land of the airport for
real estate development
DECEMBER 2007
IDFC - SSKI INDIA
Transition phase of three months for transfer of airport
The transition phase of transferring the existing airport from AAI to the
concessionaire is three months (extendable by another three months). The
concessionaire will be required to pay an upfront fee to the AAI for taking charge
of the existing infrastructure at the airport.
AAI has a 26% stake
In all the brownfield airports, the AAI mandatorily has a 26% stake in the venture.
Determination of Aeronautical revenues
For the first two years after the transition, the aeronautical charges will be in line
with AAI’s existing charges to all the airlines. After two years, if mandatory capital
projects are complete, a nominal 10% increase in landing charges will be allowed.
After another two years, the government’s Aero Economic Regulatory Authority
will decide the charges with a cap of a maximum 10% increase in any year.
Landing charges are calculated based on a price cap formula, where the target
revenues are determined by applying an 11.6% weighted average cost of capital
(WACC) to the regulatory base (capex or assets) used for aero activities. Further,
operations and maintenance costs pertaining to aero services are added to the target
revenues. The depreciation for regulatory asset base for aero services and the tax is
also added to the target revenues.
In order to arrive at the final target revenues for aero services, 30% of the gross
revenues generated from non-aero assets are subtracted. The resulting revenues are
divided by the projected aircraft movements to arrive at the final landing charges.
The AAI gets 65% of the passenger service fees (PSF) for security expenses and the
remaining 35% goes to the concessionaire.
Exhibit 26: Target aero revenue calculations
Aero Assets (Capex / regulatory base) * 11.6% WACC
Add: Aero O&M expenses
Add: Depreciation
Add: Tax
Less: 30% revenues from non aero
Total revenues (A)
Aircraft movements (B)
Landing charges = Target aero revenues (A ÷ B)
Source: AAI, IDFC – SSKI Research
Commercial revenues
As per the concession agreement, the concessionaires will be allowed to use up to 5-
10% of the total land of the airport for real estate development. The real estate
development has to conform to the relevant development authority rules. For
example, the development norms of DDA have to be followed for the Delhi
Airport.
52
 IDFC - SSKI INDIA

Concessionaire to share a
certain proportion of
annual projected revenues
with AAI in 12 EMIs
Bidding variable
The bidding variable for the brownfield airport concessions is the revenue share
between the concessionaire and AAI.
Revenue sharing details
The concessionaire will be required to share a certain proportion of the annual
projected revenues with the AAI. The revenue share is to be paid in 12 equal
monthly instalments on the first day of each month. If the actual revenue is higher,
then the differential is to be paid on a quarterly basis. Moreover, if the difference is
more than 10%, then an interest at SBI PLR plus 300bp will need to be given to
the government. On the other hand, if the actual revenues are lower, the
government will repay the concessionaire.

RISKS
Traffic risk
Lower-than-expected In all BOT projects, lower than expected growth in traffic is the key risk borne by
traffic and any delay in the concessionaire. As investments in building airports have to be recovered partly
execution of project – the
from the aeronautical revenues, any shortfall in traffic growth will impact the
key risks
profitability of the project.

Execution risk
The concession agreement for airports puts a time limit of 33 months for
commencement of commercial operations of the airport. Consequently,
completing the construction within or before the stipulated time is a key to
achieving higher profitability.

CHALLENGES
Absence of a Model Concession Agreement
The five airports awarded Five airports have been awarded to private players on BOT basis. However, all the
to private players have five airports (Cochin, Bangalore, Hyderabad, Delhi and Mumbai) have a different
different concession
concession structure. Due to lack of standardization, the process for getting
structures
approvals, clearances, processes, etc for each of the project has been longer. In order
to enable faster award and execution of projects, the government has initiated work
on making a model concession agreement for airports.

Need for an independent regulator

Projects awarded by AAI to
private operators compete
with airports owned by AAI
The pricing of aero services run by private operators in the case of Delhi, Mumbai,
Hyderabad, etc are regulated and governed by the AAI. On the other hand, AAI
itself runs all the airports across various cities in India, which compete with other
cities where AAI has the control of the assets. Consequently, an independent
regulator or body is required to set prices for various aero services. The government
is in the process of setting up an independent regulatory body, ‘AERA’ (Aero
Economic Regulatory Authority), to address the conflict issues.

DECEMBER 2007 53
 IDFC - SSKI INDIA

Land clearances and access road issues

Facilitating better Some of the airports require the land to be cleared of slum dwellers or additional
accessibility to an airport land acquisition is required for expanding and modernizing the airport operations.
would enable smooth At times, the concessions have remained silent or laid the responsibility of these
running of the project
land related issues on the private operator, which results in delays. This has been
witnessed in the case of Mumbai airport, which has recently awarded the slum
clearance to a third party real estate developer.

Moreover, the new greenfield airports, specifically in Hyderabad and Bangalore,

wherein the location of the new airports is away from the heart of the cities, require
access to be created such as roads or metros. The creation of better accessibility
enhances the airport operations as well as drives faster evacuation of passengers in
the airport. Consequently, the state government and other regulatory bodies have
to aid and expedite the process for facilitating the access, so as to enable smooth
running of the airport.

ATC functions controlled by AAI need to be enhanced

ATC division, key to The government has kept the Air Traffic Control (ATC) division of the airports
efficient running of the under its own control even after the award of the project to the private developer.
airport, needs to be
The ATC division of an airport is key to the efficient running of the airport as the
beefed up
capacity of the airport can be operationally enhanced by improving the ATMs /
hour by reducing the time slots between two aircraft at the runway, peak and off
peak hour pricing, reduction in aeronautical distance of aircraft, etc. As the ATC is
not in the hands of the private developer, the ATC operations need to be enhanced
and improved so as to improve efficiencies of the airport after the expansion and
modernization of these airports.

DECEMBER 2007 54
 IDFC - SSKI INDIA

WATER SUPPLY, SANITATION: STRONG FLOWS

Adequacy and equitable distribution of water supply and sanitation services in
both urban and rural areas is expected to be a key focus area of the
government over the next five years. We estimate investments of Rs1.99tn in
the sector over the next five years, with a limited role for the private sector.

THE OPPORTUNITY
th
The 11 5-year Plan seeks to address three main issues in provision of water supply,
sanitation & sewerage services in urban and rural areas – i) adequacy ii) equitable
distribution, and iii) per capita provision. The problem of adequacy is particularly
relevant in rural areas and in slums in urban areas. We estimate the government
and private players to spend Rs1,991bn on drinking water supply, sewage
treatment, etc over the next five years.

Exhibit 27: Investments planned in water supply and sanitation (Rs bn)

Water Supply, 449

Rs1,991bn to be spent over

the next 5 years on mass
rapid transport systems, Rural, 907 Urban, 1,084
drinking water supply,
sewage treatments, etc Sewerage, 447

Drainage, 166

Solid Waste Mngt ,22

Source: IDFC – SSKI Research; Plan documents

th
• The 11 Plan aims to provide 100% of the population in urban areas with
water supply and has made provisions for spending Rs449bn for the same over
FY08-12. Approximately 50% of the funds required are expected from
budgetary allocations while the remaining will be from a combination of market
and multilateral borrowings.
• The government has also set a target for providing 70% of the urban population
with sewerage and sewage treatment facilities and 30% of the urban population
with low cost sanitation, septic tanks, etc by 31 March 2012. The total
investments envisaged for the purpose are Rs447bn, to be funded out of
budgetary grants of Rs217bn, multilateral borrowings of Rs130bn and market
JNNURM set up to step up
development and borrowings of Rs87bn. The private sector is expected to invest Rs13bn in
expansion of physical sewerage and sewage treatment in urban areas over the next five years.
infrastructure in 63
identified cities • Targets for solid waste management and drainage systems have been set at
100% population coverage in urban areas, with estimated investments of
Rs18bn and Rs166bn respectively.

DECEMBER 2007 55
 IDFC - SSKI INDIA

• The Jawaharlal National Urban Renewal Mission (JNURM) is also expected to

give a fillip to investments in urban water supply and sanitation. Under
JNURM, a monetary assistance of Rs500bn has been earmarked over the next
seven years, to be paid out as grants of up to 35-90% of the project cost, with
an additional Rs500bn to be contributed by state governments and urban local
bodies.
• Investments in rural water supply and sanitation are estimated at Rs907bn,
expected to be funded almost entirely out of budgetary allocations.

CONCESSION STRUCTURE
Water supply
A retail distributor typically A wholesale distribution agreement is normally between the retail distributor
enters into a 20-25 year (municipal corporations or water boards) and a private player for supplying water.
agreement with the The agreement typically ranges from 20-25 years after construction. The project
concerned body
involves building infrastructure for sourcing water from a far off location and
transporting it to the city. The charges are levied on per gallon or kilolitre basis.
Any cost increases, arising from electricity charges and other variables, are typically
passed on to customers. Gearing in such projects is usually pegged at around 2x.

Some form of escrow arrangements is in place for concessions involving municipal

bodies.

These projects offer equity IRRs in the range of 15-20%.

Waste management
Segment offers huge Waste management has been a neglected subject in India with limited policy focus.
potential with Rs50bn Consequently, private participation in the sector has been extremely low with one-
investments proposed
over the next five years off agreements for waste management in only a few states. However, the segment
offers huge potential with investments of Rs50bn proposed over the next five years
across three segments of waste management:

Hazardous waste management: This involves the management of industrial and

chemical waste through treatment (for chemical neutrality) and disposal of the
Three types of waste
same.
required to be handled –
hazardous, medical and Medical waste management: The management of medical waste emanating from
municipal hospitals, clinics, etc involves sterlization, incineration and disposal of the waste.

Municipal waste management: Collection, transportation, sorting and disposal

are the various stages of management of household and commercial waste.

DECEMBER 2007 56
 IDFC - SSKI INDIA

Structure
• The concession agreement is normally with industries, hospitals and municipal
bodies.
• The agreement typically ranges from 5-25 years based on the type of waste to be
managed. Municipal waste management concession periods are typically longer
with an average duration of 20-25 years, while medical waste management
concession periods are shorter at 5-7 years.
• The agreement involves pick up, transportation, processing and disposal of the
Gearing in waste
management projects waste.
stands at 2.0-2.5x • The charges for hazardous and municipal waste management are levied on per
tonne of waste handled, while medical waste management is charged based on
per bed per day basis.
• Key costs such as diesel, chemicals and power are a pass through to clients.
• The charges per tonne or per bed of waste handled are the bidding variable for
winning the project.
• Gearing in such waste management projects stands at 2.0-2.5x.
• Some form of escrow arrangements is in place for concessions involving
municipal bodies.
• Equity IRRs for these projects range from 15-20%.

RISKS
Receivables risk
Developers run the risk of receivables from the municipal bodies, water boards and
Receivables and corporate users. The financial ratings of the municipal bodies and water boards
regulations –the key risk
areas
may not be healthy, and hence developers can run into huge receivables risk.

Regulation risk
Water being a basic necessity, the developer is always at a risk of a change in
regulation in favour of consumers. This can put the developer’s entire investments
at risk.

Residual liability risk

Receivables and residual The concessionaire of the waste management is liable for any environmental
liability – risk factors damage during the waste management process. The liability from environment
damage can be significantly higher than the revenues earned from the concession.

DECEMBER 2007 57

As urban projects are not
subsidized, they require
budgetary allocation or
viability gap funding
Acquisition or availability
of land for urban projects –
a difficult task
In basic infrastructure
services, tariff escalations
are a tough proposition
DECEMBER 2007
IDFC - SSKI INDIA
CHALLENGES
The key challenges for the urban infrastructure sector, including water supply and
sanitation and other sub-segments such as MRTS, are discussed below.
Funding issues not streamlined for urban infrastructure projects
The projects under urban infrastructure tend to have viability issues as user charges
for sewage, water supply, sanitation services, water treatment, MRTS, metros, etc
are normally subsidized by the government. Consequently, the projects under
urban infrastructure require budgetary allocation or viability gap funding. In order
to ensure that the projects are completed within the stipulated timeline (and
thereby in a cost effective manner), the aim should be to tie up funding for the
project at an earlier stage.
Implementation – city centre land acquisitions
In the past, urban infrastructure projects have witnessed considerable execution
delays due to issues on acquisition and availability of land in city centers. As urban
areas are highly populated, availability of large land tracts for execution of projects
may pose a problem. Moreover, the land clearance process involves approvals from
the local taluka, local municipal body as well as state governments. Moreover,
environmental clearances may also be required. Therefore, it is quite critical that
when a project is identified and the DPR is being conducted, the possible problems
in land acquisition be taken into account. For example, there were serious issues on
land acquisition for the Versova-Ghatkopar MRTS project in Mumbai.
User charges escalation and collection issues
Once the project is implemented, the collection of user charges is an issue in
projects such as water treatment and usage, as the collection agency is the local
municipal body. Moreover, the tariff escalations may not be permitted despite cost
increases as some of these services are basic infrastructure provided by the state
governments. Consequently, user charges escalations as well as collection issues
should be clearly stated in the agreement at the time of the award.
58
 IDFC - SSKI INDIA

RAILWAYS: CHUGGING ALONG

The Indian Railways (IR) is expected to make large investments over the next
five years in improving its dated network and augmenting capacity, especially
for freight movement. We estimate total investments of Rs2.55tn by the
railways in acquiring rolling stock, capacity augmentation, improving safety
standards etc, of which the private sector is expected to contribute Rs434bn.
The need for an independent regulator and the absence of a clear PPP policy
remain the key challenges in realizing the potential investments in the sector.

THE OPPORTUNITY
Poor infrastructure and inadequate safety measures mandate huge investments in
rail infrastructure in terms of laying new tracks, building a dedicated freight
corridor, upgrading the existing tracks and improving safety in rail transportation.
We expect railways to attract investments of Rs2,550bn over FY08-12 from both
budgetary and private resources.

Exhibit 28: Break up of investments in rail safety funds & Rail Vikas Yojana
Metro Rail Projects
7% Rolling stock
DFC
10% 18%
Investment in PSUs
Investment of Rs2,550bn 4%
estimated to flow into
railways sector over
FY08-12

Capacity augmentation
24%

Safety & other works

37%
Source: IDFC – SKKI Research; Plan documents

• In the next five years, bulk of the investments in the railways sector would be
made towards improving safety standards. The Railways have created a non-
lapsable Special Railway Safety Fund (SRSF) of Rs300bn for this purpose and
the total investments are expected to be Rs951bn, which will be met from
budgetary allocations, market borrowings and multilateral borrowings.
Upgradation and • The Indian Railways’ (IR) main focus is upgradation and modernization of the
modernization of existing existing network along the Golden Quadrilateral (GQ) by electrification, and
network along the GQ a doubling its existing line and passenger terminals. It is also planning to ramp up
priority area
network along the roads, and increase connectivity to ports by doubling lines.
The total investments in capacity augmentation and development over the next
five years are expected to be ~Rs617bn.
Large investments • To meet the growing demand for railway carriages and wagons, large
required for procuring
rolling stock of railway
investments are required in procuring rolling stock. The Indian Railways is
carriages and wagons expected to invest Rs463bn towards the same over the next five years.

DECEMBER 2007 59
 IDFC - SSKI INDIA

• The IR is planning to build dedicated freight corridors, i.e. rail lines dedicated
to freight movement, between the four metros over the next 10 years. The
Delhi-Mumbai leg of the DFC has been approved by the government and is
expected to be developed with an investment of Rs255bn over the next five
years.
• In addition to the Indian Railways, various state governments and city
administrations are expected to make investments of Rs170bn in building
metro rails in cities such as Mumbai, Delhi, Hyderabad, Chennai, etc.

FINANCIAL / CONCESSION STRUCTURE

Financing
Gearing
PPP projects in railways The revenue stream from railway projects is in the form of semi-annual annuities
have historically managed from the Indian Railways. Considering the fixed revenue stream and almost non-
to receive funding at a
gearing of 2.00-2.33x
existent receivables risk, PPP projects in railways have historically managed to
receive funding at a gearing of about 2.00-2.33x.

We expect future projects to get funded at higher gearing levels of 6-8x (similar to
road annuities).

IRRs
With fixed and stable cash flows and high gearing levels, equity IRRs in railway
projects tend to be in the range of 15-20%.

Bidding variable
The bidding variable is the revenue the concessionaire needs from the Indian
Railways every six months in order to build and maintain the rail tracks for the
latter’s use.

Concession structure
PPP projects in railways have so far been limited and only two concessions have
been awarded. The broad concession structure in these projects is outlined below:

• Concession period is fixed at 12 years after completion of construction

• The concessionaire is allowed six months for achieving financial closure
Concession period fixed at
12 years after project • All projects are based on an annuity model, and concessionaires are paid semi-
completion; projects based annual annuities by the IR.
on annuity model,
concessionaires paid • The concessionaire is paid a bonus for early completion based on extra annuity
semi- annual annuities amount depending on the number of days of early completion.
• The design of bridges and structures is to be done by the concessionaire and
approved by the IR.

DECEMBER 2007 60
 IDFC - SSKI INDIA

RISKS
Regulatory risk
Regulatory issues and The Indian Railways is the policy maker and regulator as well as the monopoly
single user risk – key
concerns operator. Consequently, in cases of disputes, there is no independent body the
private sector developer can approach for resolution.

Single user risk

In India, the running of wagons and passenger trains is the sole monopoly of the
Indian Railways. As a result, in case of default or dispute with the entity, the
concessionaire cannot lease out the tracks to any other party.

CHALLENGES
Requirement of an independent regulator – a must
IR, the monopoly service Railway services is a monopoly of the IR owned by the central government, with all
provider, also the regulator operations and expansions in the possession of the IR. The IR itself plans and
and decision-maker for
awarding segmental
develops the programmes for expansion and builds out the infrastructure for
projects expanding the reach as well as enhancing the capacity of the railways. However, all
the issues of pricing, operations, ownership, expansion, etc are with the IR.
Moreover, when a rail freight corridor is being set up, all the decisions regarding
the same (such as award of contracts, operations, etc) are done by the IR, which
means that there is no independent regulator for the entire process.

No clear policy on public private partnership

As the Indian Railways expands and enhances its infrastructure, projects are being
given out on a piecemeal basis on EPC basis. Efforts are also being made to give
out certain parts on a private basis. However, there is no clear policy on the same
which outlines the structure or the involvement of the private developer for the
build out of railway infrastructure.

DECEMBER 2007 61
 IDFC - SSKI INDIA

IRRIGATION: CHANNELLING GROWTH

India, one of the least irrigated farmlands in the world, has started focusing on
irrigation projects through the Bharat Nirman programme (25m acres). The
total outlay on irrigation over the next five years is estimated to be Rs2,172bn,
with the central government likely to invest Rs1,706bn and the state
governments the remaining Rs466bn. State government investments are
expected to be driven mainly by Andhra Pradesh, which has initiated a
massive drive to push irrigation projects of Rs450bn in the state, of which
Rs250bn has already been deployed and Rs200bn is to be spent over the next
five years. Similarly, Maharashtra is pushing to complete its unfinished
irrigation projects by investing Rs180bn over the next five years.

Exhibit 29: Investments of Rs786bn in irrigation by 2010

Project (Rs bn)
Investments of Rs2,172bn Major and Medium Irrigation 1,544
envisaged in the irrigation
Minor Irrigation 255
sector over FY08-12
Command Area Development 77
Flood Control 90
Watershed Development 205
Source: IDFC – SSKI Research; Plan documents

• India has one of the least irrigated farmlands in the world, mainly due to lack of
irrigation facilities. As a result, the government, under the Bharat Nirman
programme, has set a target of creating additional irrigation potential of 10m
hectares by 2012.
• The government, through various Major and Medium Irrigation (MMI)
th
projects, is planning to create irrigation potential of 9m hectares in the 11 Plan
at a total cost of Rs1,544bn. Bulk of these investments are likely to be funded
from budgetary grants while the remaining will come from market borrowings.
• Additionally, a number of Minor Irrigation projects are planned across the
country to create an irrigation potential of 7m hectares with an investment of
Rs255bn.
• Under the Command Area Development (CAD) schemes, the government
targets to cover about 10m hectares, including development of CCAs
(culturable command areas) and reclamation of waterlogged, saline and alkaline
lands. The total investments under the CAD schemes are expected to be
Rs77bn, to be funded mainly out of budgetary grants of Rs54m.
• Watershed Development is another major focus area of the government over the
next five years, with a proposed investment of Rs205bn.

DECEMBER 2007 62
 IDFC - SSKI INDIA

GAS: STEPPING ON IT
The outlook for India’s gas distribution infrastructure has improved
considerably in the recent past in the wake of offshore gas discoveries on the
East Coast. These discoveries necessitate laying down of pipelines, which are
the only means of transporting gas, and then creating the last mile
connectivity in the form of city gas distribution networks. The total
investments in the sector are likely to be Rs205bn, expected to be funded
almost entirely by private sector players.

Exhibit 30: National Gas Grid – segment-wise details

Sector Length (km) States covered
Kakinada-Kolkata 1140 Andhra Pradesh, Orissa, West Bengal
Haldia-Jagdishpur 887 West Bengal, Bihar, Uttar Pradesh
Kakinada-Chennai 584 Andhra Pradesh, Tamilnadu
Uran-Hyderabad-Kakinada 955 Andhra Pradesh, Karnataka, Maharashtra
Bangalore-Chennai 300 Karnataka, Tamilnadu
Kochi-Kayamkulam-Bangalore 927 Kerala, Karnataka
Dabhol-Bangalore 700 Maharashtra, Karnataka
Panvel-Dabhol 187 Maharashtra, Karnataka
Kota-Mathania 301 Rajasthan
Vijaipur-Kota 245 Madhya Pradesh, Rajasthan
Dadri-Bhatinda 427 Punjab, Uttar Pradesh
Dahej-Vijaipur 610 Gujarat, Madhya Pradesh
Dahej-Hazira-Uran 504 Gujarat, Maharashtra
Thulendi-Phulpur 139 Uttar Pradesh
Dadri-Panipat 114 Haryana, Uttar Pradesh
Total 8,020
Source: SSKI Research, GAIL

Large gas finds off India’s The total investment towards oil and gas pipelines, LNG terminals and city gas
eastern coast to propel distribution networks is likely to be Rs205bn over the next five years.
investments in gas
distribution • There have been significant discoveries of natural gas on the eastern coast of
India in the past 3-4 years. One of the key discoveries has been by Reliance
Industries (Krishna Godavari Basin), where production is quite distant from the
main consuming centers – the northern and western regions.
• Accordingly, a National Gas Pipeline Grid has been proposed to transfer natural
gas across India from the ports and the production centres to the consumption
points. The total length of the National Grid is likely to be 8,000kms at a cost
of Rs210bn, of which Rs151bn will be invested over FY08-12.
• For last mile connectivity of gas to end users, large investments in developing
city gas distribution networks in various cities is expected to attract investments
of Rs18bn over the next five years.
• On the LNG front, expansion of terminals at Dahej, Dabhol and Kochi is
expected to involve investments of Rs36bn over the next five years.

DECEMBER 2007 63
 SSKI INDIA

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