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GRIDLINESSharing knowledge, experiences, and innovations in public-private partnerships in inrastructure

PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY

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Helping to eliminate poverty and achieve sustainable development

through public-private partnerships in infrastructure

oTE no. 45 DEc 2008

Idia has see apid gth i ecet yeas i

its pgam iastcte pblic-pivate

pateships (PPPs). Despite the sge i

demad face, lcal facial makets

cped ell ve the peid t 2007ad eve

eed bette tems as they became me sedt the PPP mdel. Bt aeas pssible cce

have develped. Geaig has iceased sigif-

catly, ad facig tems mea that PPPs

ae me expsed t iteest ate vlatility

cases cce i a peid isig ates

ad edced liqidity. Fthe gth i PPPs

ill likely eqie a badeig the sces

facig ce the peset facial maket

tmil has lesseed. Addessig these

cces ill call plicy ems t capital

makets ad ccessi ameks.

India has seen a rapid increase in private invest-ment in inrastructure since 2003 (Harris 2008).Its PPP program has grown rapidly in the past veto six years; in 200206 more than 150 PPP dealsclosed, compared with 66 in the previous seven years (gure 1). This growth was mainly in thetransport and urban inrastructure sectors, withroad projects accounting or a large share o theincrease, particularly in the number o projects.1

Indias government had been concerned that localnancial markets would be unable to supportcontinued large growth in investment in PPPs. The

World Bank, with nancial support rom PPIAF,undertook a detailed review o nancing patternsand trends and the constraints to expanding PPPnancing as perceived by market participants.This exercise collected inormation on more than200 PPP projects, most o them in the transportand urban sectors, key areas or expanding PPPs.The analysis here covers a sample o 104 proj-

ects or which detailed nancial inormation wascollected. These account or 73 percent ($11.5billion) o the total project value.

H ee PPPs faced?

In 19952007 senior debt accounted or 68percent o project nancing on average. The resttook the orm o equity (25 percent), subordi-nated debt (3 percent), and government grants (4percent), typically viability gap grants providedduring construction to PPPs deemed economicallydesirable but not nancially viable.

O the senior debt, about 70 percent was providedby commercial banks, our-ths o this by publicsector banks. The rest o the total debt nanc-

ing came rom institutional lenders (around 23percent), with 5 percent provided by the Interna-tional Finance Corporation. Bond markets wereused sparingly. The use o subordinated debtalso remains limited. Its use has become morecommon, however, particularly in the road sector,which has the largest number o projects and thegreatest acceptance by nancial markets. But mosto the subordinated debt has been provided by thesenior lenders themselves.2

On the equity side, more than 80 percent camerom project developers, with the next largest

contributor being the public sector. Strategicinvestors made direct equity investments in the

Financing the boom in public-privatepartnerships in Indian infrastructureTrends and policy implications

Clive Harris and Sri Kumar Tadimalla

Clive Harris is the inrastructure policy advisor or East

Asia in the World Banks Sustainable Development Vice

Presidency, and Sri Kumar Tadimalla is a senior public-

private partnerships specialist or the transport unit in the

World Banks South Asia Region.

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special-purpose vehicles established to implementthe PPPs or only nine projects in the sample.These investments totaled almost $167 million(6 percent o the total equity), most o it in theairport sector. Equity investments by nancialinstitutions provided the rest.

Evlvig facial stctes

In recent years the role o senior debt has grownwhile the share o equity has declined, leading torising debt-equity ratios (gure 2). One explana-tion or this trend is that commercial banks havebecome more comortable with PPPs, particularlyin the road sector, and are thereore willing tohave senior debt make up a larger share o projectnancing.

There is also evidence suggesting that projects withviability gap grants have higher gearing than thosewithout them. While the evidence is inconclusive,there are some indications that lenders and devel-

opers view grants as substituting or the equityinusion needed during construction. The ewprojects involving a negative granta payment bythe PPP to the governmentalso have a higherratio o senior debt to equity, suggesting that thesepayments are being nanced by debt borrowed bythe PPP project.

Should high gearing and the replacement o equityby grants be a concern? Some observers (such asEhrhardt and Irwin 2004) have argued that greaterleverage means a higher likelihood o bankruptcy

and thus a higher likelihood o government bailoutto avoid the adverse consequences o bankruptcy,both actual and perceived. In addition, lowequity contributions make it easier or develop-ers to achieve a target return rom the margin onconstruction and reduce their long-term interestin the project.

In India the typical concession terms encour-age the use o debt over equity. In the highway

sector, or example, the contracting agency mustcompensate the contractor i the contract endsearly, even i the termination is due to a breacho the contractors own obligations or an evento orce majeure. In these cases the compensationis partial, with lenders typically being repaid inull or in large part while shareholders get noth-ing. Linking termination payments to debt, whilecommon around the world, can encourage highergearing, which in turn may increase projectsnancial vulnerability.

Some countries put limits on the ratio o debt

to equity. But restricting an investors ability tochoose its capital structure can increase the costo capital, prevent companies rom reaping taxadvantages associated with particular types onancing, and impose a monitoring burden on thegovernment. Alternatively, India could consider adierent basis or termination payments, reduc-ing the incentive to use debt embedded in thetermination clauses o its model concessions. Inthe United Kingdoms PPP program the govern-ment pays the market value o the asset (see U.K.Treasury 2007, section 21.2.5).

Debt-eqity

atis

Idia PPP

pjects have

bee isig

FIGurE 1

Idia has see PPP pjects climb i mbe ad valePPP projects by year of financial closure, 19952006

Source: PricewaterhouseCoopers 2007.

7

6

5

4

3

2

1

0

60

50

40

30

20

10

0

Value (total project cost) Number of projects

Value(US$billions)

Numberofprojects

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

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3Financing the boom in public-private partnerships in Indian inrastructure

Idia PPP

pjects ha

bee assm

me itee

ate isk

Debt facig became me

cmpetitive

Despite some volatility, average spreads on debt toPPP projects have declined signicantly in recent years (gure 3).3 This does not refect trends inIndian corporate bond spreads, which increasedin 2006 and 2007. While many actors may beinvolved, the decline in spreads is probably dueto the nancial markets growing acceptance andunderstanding o PPPs as more have come on lineand provided an operational track record, particu-larly in the road sector.

On the negative side, the tenor o debt has increasedlittle, averaging around 1415 years in the past ewyears. In addition, loans in India have shown atrend toward shorter reset periods. Although theloans are long term, rates are reset at predenedintervals. PPP projects generally do not have reve-nues that are linked to interest rates. There are

concerns that higher rates could aect some proj-ects, particularly those with higher gearing.

High eqity ets expected

Developers stated their expected equity returnsin only 22 cases. But among these, more than 70percent sought returns exceeding 16 percent. Anal-ysis suggests, as would be predicted, that projectswith higher gearing had higher expected rates oreturn. Calculations indicate that the asset beta

or these projects was around 0.60.75, dependingon the assumed equity risk premium. This is some- what higher than other estimates; or example,Alexander, Estache, and Oliveri (1999) estimatedasset betas or road projects in Latin America andthe Caribbean to be 0.310.48.

The dierence could refect the high-powered

regulatory regime or Indian road projectsbutit is also consistent with the aggressive biddingor road projects in 200607. Negative grant bidswere seen or some projects, driven by huge devel-oper interest in road PPPs.

Lesss gig ad

The trends in PPP nancing highlight several issues with implications or nancing the large-scalePPP program envisaged by Indias government.PPPs have relied heavily on commercial banks

or their debt nancing, and it is unclear howsustainableor how desirablethis dependence will be. Long-term nancing exposes the banksto the risk o asset-liability mismatch: the mainsource o unds or Indian banks is savings depositsand term deposits, whose maturity prole rangesrom less than six months to ve years. Over mucho the period developers were comortable withshorter reset periods, perhaps because this hadbeen a period o declining or low rates. But asinterest rates began to increase, concerns aroseabout the impact on PPPs, because the concession

FIGurE 2

Debt-eqity atis isig Idias PPP pjectsFinancing by type for selected PPP projects, 19982007

Source: PricewaterhouseCoopers 2007.

80

70

60

50

40

30

20

10

01998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Percentage

oftotal

Senior debt Equity Subordinated debt Government grants

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contracts have no provisions or passing on higherinterest charges. Continued increases in rates aswell as a tightening o credit could have adverseeects on some projects.

An active bond market can increase the fow olong-term unds and reduce reliance on banks. TheIndian corporate bond market, though one o thelargest in Asia, is still at an early stage o develop-ment, and its growth is hampered by institutional,legal, and regulatory constraints that make bonds amore expensive way o nancing debt. These prob-lems, as well as potential solutions, are highlightedby the Patil Committee (2005), established bythe government. Following the suggestions o thecommittee, the government has set up reportingand trading platorms or corporate bonds. Manyother important suggestions still await implemen-

tation. But implementing bond market reorms isa dicult challenge in the best o times, and inthe light o the current global nancial crisis thegovernment would have to explore other innova-tive ways to ensure adequate fows o (private)nancing to inrastructure PPPs.

On the equity side, participation by oreign play-ers, particularly strategic investors, has been loweven though PPP projects in the sectors studied areallowed to have 100 percent oreign direct invest-ment. Foreign direct investment accounted or only11 percent ($322 million) o the total investment.

The port sector had the largest share (51 percent)o this oreign investment, ollowed by airports(32 percent) and roads (16 percent). Only nineprojects were reported to have strategic investorparticipation: our in ports, three in airports, andone each in water supply and railways. Few pureequity providers are willing to invest directly inspecial-purpose vehicles because many concessionagreements put restrictions on the sale o develop-ers equity. Encouraging pure equity providers to

do so will require more liberal norms allowingthem to participate at the time o bidding

or to enter later with a majority stake.

Notes

This note draws on PricewaterhouseCoopers (2007) and work byIan Alexander.

1. These gures are based on data rom PricewaterhouseCoopers(2007), which may dier rom data rom the World Bank andPPIAFs Private Participation in Inrastructure (PPI) ProjectDatabase.

2. Discussions with nancial investors suggested that subordinateddebt is a way to help developers put less equity into the projects.In return or conserving the developers equity, the banks chargea higher rate o interest on the subordinated debt, improving theoverall yield on the project debt.

3. The spread is measured by comparing the interest rate on the

loan against the average yield to maturity on Indian governmentborrowing during the year in which the loan was taken and ismeasured in basis points.

Reerences

Alexander, Ian, Antonio Estache, and Adele Oliveri. 1999. A FewThings Transport Regulators Should Know about Risk and the Costo Capital. Policy Research Working Paper 2151, World Bank,Washington, DC.

Ehrhardt, David, and Timothy Irwin. 2004. Avoiding Customerand Taxpayer Bailouts in Private Inrastructure Projects: Policytoward Leverage, Risk Allocation, and Bankruptcy. Policy ResearchWorking Paper 3274, World Bank, Washington, DC.

Harris, Clive. 2008. India Leads Developing Nations in PrivateSector Investment. Gridlines series, no. 30, PPIAF, Washington,DC.

Patil Committee. 2005.Report of the High Level Expert Committee onCorporate Bonds and Securitization. New Delhi: Ministry o Finance.http://www.sebi.gov.in/debt/expertreport.pd.

PricewaterhouseCoopers. 2007. Inrastructure Public-PrivatePartnership (PPP) Financing in India. Drat report prepared orthe World Bank with support rom PPIAF, Washington, DC.

U.K. Treasury. 2007. Standardisation of PFI Contracts, Version 4.London. http://www.hm-treasury.gov.uk/media/3/5/p_sopc4pu101_210307.pd.

GRIDLINESGridlines share emerging knowledge

on public-private partnership and give an

overview o a wide selection o projects rom

various regions o the world. Past notes can be

ound at www.ppia.org/gridlines. Gridlines are a

publication o PPIAF (Public-Private Inrastructure

Advisory Facility), a multidonor technical assistance

acility. Through technical assistance and knowledge

dissemination PPIAF supports the eorts o policy

makers, nongovernmental organizations, research

institutions, and others in designing and implementing

strategies to tap the ull potential o private involvement in

inrastructure. The views are those o the authors and do

not necessarily reect the views or the policy o PPIAF,

the World Bank, or any other afliated organization.

FIGurE 3

PPP speads ell shaply ve the peid200407Average spread over government borrowing, 200207

Source: Bloomberg; PricewaterhouseCoopers 2007.

600

500

400

300

200

100

0

Selected PPP projects AAA bonds

AA bonds BBB bonds

2002 2003 2004 2005 2006 2007

Basispoints