World Bank Document APPRAISAL REPORT I -ECONOMIC AND SECTORAL BACKGROUND ... 1.01 In mid-1991...

Document of

The World Bank

Report No. 15364-IN

STAFF APPRAISAL REPORT

INDIA

PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT

MARCH 7, 1996

Energy and Infrastructure Operations DivisionCountry Department IISouth Asia Region

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CURRENCY EQUIVALENTS(As of February 1996)

Currency Unit = India Rupees (Rs)Rs 1.00 = US$0.03US$1.00 = Rs 35.0

Guarantor's and Borrower's Financial Year

April I - March 31

MEASURES AND EQUIVALENTS

Metric British/US System

I meter (m) = 3.281 feetI square meter (m 2

) = 10.764 square feetI cubic meter (m2 ) = 35.3 15 cubit feetI kilometer (km) = 0.621 mileI metric ton = 2,205 poundsI tkm = ton-kilometer (0.621 ton-mile)I pkm = passenger-kilometer(0.621 passenger-mile)

ACRONYMS AND ABBREVIATIONS

ADB = Asian Development Bank IFP Infrastructure financing projectBOT = Build, operate and transfer IL&FS = Infrastructure Leasing and Financial Services

LimitedCARE = Credit Analysis and Research Ltd. IPO = Initial public offeringCAS = Country assistance strategy LIBOR = London interbank offered rateCBI = Central Bank of India MOST = Ministry of Surface TransportCEM Country economic memorandum NBFC Non-banking financial companyCOD = Committee of directors OD = Operational directiveCP = Commercial paper PRP = Performance-related payDEA = Department of Economic Affairs PWD = Public works department

(Ministry of Finance) R&R = Resettlement and rehabilitationED = Executive Director RBI = Reserve Bank of IndiaERR = Economic rate of return RMG = Risk management groupFYB = First-year benefits SEBI = Security Exchange Board of IndiaGDP = Gross domestic product SEC = Securities and Exchange CommissionGOI = Government of India SPV = Special purpose vehicleHDFC = Housing Development Finance USAID = US Agency for International Development

CorporationIFC = International Finance Corporation UTI = Unit Trust of India

INDIA



LOAN AND PROJECT SUMMARY

I - ECONOMIC AND SECTORAL BACKGROUND ........................ ....................... 2

* India's economic policies and performance ............................................................... 2* Evolving a policy and an institutional framework for private investment in

infrastructure ................................................................ 3* The Bank's assistance strategy in the infrastructure sector ....................................... 4

11- INFRASTRUCTURE LEASING AND FINANCIAL SERVICES LIMITED(IL&FS) ................................................................ 6

- The company ............................................................... 6* Regulations and operating policies ................................................................ 9* IL&FS's current operations ............................................................... 10* Future strategy and financial perfonnance ............................................................... 12

III - THE PROJECT ............................................................... 16

* Project objectives. ................... ............................................ 16* Project description ............................................................... 16* Indicative pipeline of subprojects .................................... ........................... 17* Project cost and financing plan ............................................................... 17* Project implementation and monitoring ............................................................... 19* Procurement ............................................................... 20* Security arrangements ............................................................... 21* Onlending and disbursement ...................... ......................................... 22* Environmental and social considerations ............................................................... 24

The project was prepared bv a team composed of Mmes. Joelle Chassard (Task manager, SA2EI),Susan Morse (Financial Consultant), Jelena Pantelic (SA2El), and E. Schaengold (ASTHR), andMessrs. Syed Ahmed (LEGSA), Raul Auzmendi (Transport Consultant), Chandra Godavitarne(SA2RS), Harald Hansen (SA2EI), P. Illangovan (ASTEN), and I. U.B. Reddy (SA2RS). Mmes. A.Armstrong, V. Scott and 0. Valladolid assisted in the production of the report. The peer reviewerswere Messrs. Hoon Mok Chung (ASTDR), John Flora (TWUTD), and Michael Klein (PSD). Thereport was endorsed by Messrs. Heinz Vergin, Director (SA2) and Jean-Fran,ois Bauer, Chief(SA2EI).

IV - PROJECT JUSTIFICATION ....................................... ......................... 26

* Project sustainability ............................................................... 26* Economic analysis ............................................................... 26* Benefits ............................................................... 27* Risks ............................................................... 27

V - AGREEMENTS AND RECOMMENDATION .................................................. 30

* Agreements ............................................................... 30* Recommendation ............................................................... 31

ANNEXES

2.1 IL&FS: composition of the Board of Directors .322.2 IL&FS: organization chart .332.3 Implementation of a cost accounting system .342.4 IL&FS: exposure limits for commercial infrastructure projects and limits to

investments in affiliates .352.5 IL&FS: income statements, cash flow statements, balance sheets, and

selected financial ratios (1991/92 - 2000-01 .36-422.6 IL&FS's financial forecast: sensitivity analysis .43-443.1 Subproject eligibility criteria .45-473.2 Subproject pipeline and implementation schedule .48-553.3 IL&FS's proposed training and technical assistance activities (summary) 56-583.4 IL,&FS's project ccle .59-613.5 Subproject evaluation report .62-643.6 Performance monitoring indicators .653.7 Supervision plan .66-673.8 Selection of BOT operators .68-703.9 IL&FS's pari passu security structure .71-733.10 IL&FS: foreign exchange risk management and treasury operations 74-753.11 Environmiient and social report (ESR) .76-90

INDIA


LOAN AND PROJECT SUMMARY

Borrowers: - India, acting by its President (for the IDA credit)- Infrastructure Leasing and Financial Services Limited

(IL&FS) (for the IBRD loan)

Guarantor: India, acting by its President (for the loan to IL&FS)

Beneficiaries: Public sector agencies; special purpose entities established forthe construction and operation of commercial infrastructureprojects

Poverty: Not applicable

Amounts: - SDR3.4 million (US$5 million equivalent) (for the credit toIndia)

- US$200 million (for the loan to IL&FS)

Terms: - For the credit to India: repayment over 35 years.- For the loan to IL&FS: repayment over a 20-year period,

including 5 years of grace. Standard interest rate for LIBOR-based single currency loans.

Commitment fee: - For the credit to India: 0.50% on undisbursed balances,beginning 60 days after signing, less any waiver.

- For the loan to IL&FS: 0.75% on undisbursed loan balances,beginning 60 days after signing, less any waiver.

Onlending terms: Proceeds of the Bank loan will be onlent either (i) in rupees at amarket-determined rate. In this case, IL&FS will bear theforeign exchange risk; or (ii) in US dollars at a variable market-determined rate. The tenor of the subloans will vary between17 and 20 years.

Proceeds of the IDA credit will be onlent on the standard termsand conditions for central assistance to the states applicable atthe time.

Financing plan: See para. 3.06.

Net Present Value: Not applicable

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INDIA



I - ECONOMIC AND SECTORAL BACKGROUND

India's economic policies and performance

1.01 In mid-1991 India's development strategy took a radical turn when, in response to asevere macroeconomic crisis, the new government launched an ambitious program ofeconomic reforms. The program did not limit itself to restoring macroeconomic stability. Italso reoriented structural policies governing the investment regime, foreign trade, thefinancial sector, taxation, and public enterprises. As a result, almost all areas of the economyhave been opened to domestic and foreign private investment. Import licensing restrictionson intermediate and capital goods have been virtually eliminated. Tariffs have beensignificantly reduced and full convertibility has been established for current accounttransactions. In the financial sector, prudential regulations that meet international standardshave been introduced; banks now have significantly more discretion in their lendingdecisions; financial markets have been liberalized; and entry restrictions have beeneliminated. The external accounts have strengthened considerably and, although still a majorobstacle to higher growth, central fiscal imbalances have been lowered. The result has been arebouncing of the economy, helped by an unprecedented sequence of good monsoons and astrong industrial recovery. GDP growth has been steadily increasing, from 1% p.a. in 1991-92 to an estimated 5.8% in the current financial year. The robust performance of the Indianeconomy is thus a testimony to the continuing favorable impacts of the liberalization andreform efforts.

1.02 There are daunting challenges ahead. Paramount among them is that of meeting theneeds of a rapidly-growing population while reducing the incidence of poverty, in a countrywith limited land and water resources, limited capital, and enormous social needs. In the next30 years, even taking into account ongoing family planning efforts, India's population isexpected to increase by another 450 million. This "third India" will put enormous additionalpressure on the country's natural resources, social programs, and already strainedinfrastructure. With the pace of urbanization accelerating, the consequences of populationgrowth will be particularly serious in urban areas where the provision of sanitation and publichealth services as well as infrastructure is already below standard, and the absolute number ofpoor is increasing.

1.03 The structural reforms introduced over the last four years have gone a long way inreorienting India's development strategy to meet these challenges. For example, the private

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sector now plays a much more important role in India's development process, and anincentive regime more conducive to a pattern of labor-intensive growth is being established.However, there still remains a large "unfinished" reform agenda which will take several moreyears to implement. Improving the fiscal situation, particularly with regard to states'finances, is of critical importance. Equally important is the need to conclude the process ofstructural reforms started in 1991 (e.g., in international trade, the financial system, the taxregime, and public enterprises). Finally, reforms need to be extended to key sectors of theeconomy, an issue where the participation of the states is critical because of their importantrole in formulating and implementing sector policies. This is the case in agriculture, thesocial sectors, and particularly infrastructure.

Evolving a policy and an institutionalframework/for private investment in infrastructure

1.04 The expansion and efficient use of infrastructure is fast becoming one of India's keydevelopment issues. Of grave concern today is the risk that poor infrastructure willundermine severely India's ability to achieve its medium- and long-term objectives of higherand sustainable economic growth. At the root of the problem is a severe absorptive capacityand implementation constraint which, combined with a financial constraint, has led tochronic underinvestment in the sector and a less than optimal use of the funds available.Implementation of public sector infrastructure projects has generally been slow, with frequentcost overruns and inadequate construction quality. Addressing the situation requires, aboveall, a redefinition of the role of the public sector in the provision of infrastructure and theestablishment of an appropriate legal, regulatory and administrative framework for privateinvestment so that the latter can assume a dynamic role in areas from which it has beenmostly excluded so far (telecommunications, power, ports, roads, urban infrastructure, watersupply). The impetus for change has to come primarily from the central and stategovernments. A number of legislative steps and policy announcements have already beenmade in that direction. In September 1991, the Electricity (Supply) Act of 1948 wasamended to permit private domestic and foreign investment in power. GOI's Telecom Policystatement of May 1994 launched the liberalization of the telecommunications sector. Finally,the May 1995 amendment to the National Highway Act, 1956 permits private sectorparticipation in the development and maintenance of national highways and expressways.The removal offormal barriers to private investment must now be followed by theestablishment of policy and institutional frameworks fully supportive of such investment.

1.05 The existing regulatory framework was formulated with the public sector in mind andis not appropriate to encourage the massive private investments India needs in these areas.Regulations governing entry, pricing in monopolistic conditions, the conduct of regulatoryauthorities, dispute resolution and arbitration are either aimed at preventing privateinvestment or, in cases where the private sector is allowed, lead to inefficient investment.The lack of finance on terms commensurate with the typical long gestation and revenue-earning capacity of infrastructure projects is also slowing down the pace of privateinvestment in the sector.

The Bank's assistance strategy in the infrastructure sector

1.06 Assistance on these policy issues has therefore received growing importance in theBank's work. The Bank group has pursued it through a variety of means. A substantialamount of technical assistance has been provided in the context of loans or through theadministration of bilateral grants. In power for example, through the combination of projectpreparation (e.g., proposed Orissa state power restructuring project, and similar operations inHaryana, Uttar Pradesh, Bihar and Rajasthan), bilaterally-funded technical assistanceprograms, the ongoing technical assistance project for private power development, and thepreparation of a guarantee framework for private investments in power, considerable progresshas been achieved towards fundamental power sector reforms and the removal of essentialbarriers to private investment. Similarly, in the telecoms sector, bilaterally-funded technicalassistance has enabled the Bank to assist in laying the ground for a regulatory frameworkconducive to private sector entry. A port sector report provided the basis for our policydialogue in this area. In its sequel, the Bank has extended technical advice on the preparationof international standard tender documents to induce private investment in new facilities andin the management of existing facilities.

1.07 By contrast, our involvement in assisting in the establishment of an enablingenvironment for private investment has been comparatively less intensive in the roads, watersupply and urban infrastructure sectors, partly because of the diversity of counterparts withwhom one needs to work (GOI, state governments, local governments, municipalauthorities). This is where the Bank's technical assistance is turning to now. A transportsector report as well as the specific review, in the 1995 Country Economic Memorandum(CEM), of bottlenecks to private investment in the roads sector have provided a valuableopening for a dialogue on these issues. An urban infrastructure review is now underpreparation. Discussions are also underway for putting in place a program of assistance tothe Ministry of Surface Transport (MOST) to help develop a comprehensive regulatory andadministrative framework for private investment in the national highway sector andproviding technical advice to GOI for facilitating such private investment. In this sector,however, as well as in water supply and urban infrastructure, much more needs to be done atthe state and local levels to enable efficient planning and implementation of privateinvestments.

1.08 In response to a request by Indian authorities, the Bank's latest country assistancestrategy (CAS) for FY96-98 proposes to increase the Bank's assistance in establishing anenvironment conducive to efficient private investment in infrastructure. Direct lendingcontinues to be envisaged to power, roads and urban infrastructure but all loans in these areaswould be policy-based investment operations. At the Government's request, in those sectorsas well as in telecommunications and ports where there is already considerable private sectorwillingness to invest, the Bank is considering providing private investors in infrastructurewith term financing through financial intermediaries. Such operations are designed tosupport the establishment of policies and regulations conducive to efficient privateinvestment in infrastructure, using the intermediaries' interest in getting the framework right(as tested in the telecoms sector). They are expected to play a catalytical role in mobilizing

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finance for private investment in infrastructure with more appropriate maturities than thosecurrently available. They will also assist financial intermediaries in developing appraisal andrisk evaluation procedures for large private infrastructure projects -- an area in which India'sfinancial sector has limited experience.

1.09 In this context, the first step was taken in September 1995 by restructuring theongoing Tamil Nadu Urban Development Project (Cr. 1923-IN) and promoting the entry of aprivate fund manager to commercially manage the mix of public and private sources offinance provided to the Municipal Development Fund. This is the first attempt made in onestate to establish a joint public-private partnership in the municipal infrastructure area. Thisproject is expected to provide a replicable regulatory and administrative environment forinvestment -- public, private or mixed -- in municipal infrastructure.

1.10 The proposed Project is the second initiative. It seizes upon a unique opportunityprovided by Infrastructure Leasing and Financial Services Ltd (IL&FS), a 51% privately-owned finance company with strong ties to the public sector. By supporting IL&FS'sexpansion in this area, the focus of the Bank is to assist first hand in the development ofprototype contractual arrangements for private investment in IL&FS's areas of involvement(urban bypasses and bridges, water supply and sewerage, effluent treatment, and othermunicipal infrastructure), thereby facilitating entry of the private sector on a much largerscale in areas heretofore dominated by the public sector. It is a "process" operation wherebythe Bank uses IL&FS as a vehicle to build up India's capacity to attract private investment ininfrastructure, pilot-test institutional and contractual arrangements in a variety of subprojectsunder various administrative and political conditions, and help establish a track record as apre-requisite for large-scale private investment in the sector. GOI has selected IL&FS as thefirst financial intermediary to receive the Bank's support given the pioneering role it isalready playing in promoting private investment in infrastructure, its exceptionalunderstanding of the synergy required between public and private interests for successfulinfrastructure development, its highly competent and innovative staff, and its high-qualityBoard.

1.11 The third and much larger operation is the proposed Infrastructure Financing Project(IFP) (FY98). With the removal of major policy and administrative barriers to privateinvestment in infrastructure through previous lending operations, sector work and TAprograms, financing on a much larger scale will then be possible. It is envisaged therefore toexpand the scope of the Bank's assistance significantly by involving several public financialinstitutions and use the IFP as a vehicle to promote financial policy reforms aimed atdeveloping a domestic long-term debt market. The proposed agenda of reforms contains thefollowing key elements: (i) changing the investment guidelines applicable to, and increasingcompetition among, contractual savings institutions; (ii) fostering the development ofbenchmark interest rates; (iii) encouraging active management by institutions of theirsecurities portfolios; (iv) reducing transaction taxes; (v) rationalizing debt market regulations;and (vi) establishing a secure clearing and settlement system for corporate debt services.The sequencing and pace of the reforms will influence the speed at which the proposedoperation can be processed.

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11- INFRASTRUCTRE LEASING AND FINANCIAL SERVICES LIMITED (IL&FS)

The company

2.01 Ownership. In 1983, the Banking Regulation Act of 1949 was amended to allowIndian commercial banks to enter the leasing business through separate subsidiaries. CentralBank of India (CBI), a major nationalized commercial bank, decided to promote its leasingactivities through a joint venture with Unit Trust of India (UTI), a public sector mutual fundmanagement, and Housing Development Finance Corporation Ltd. (HDFC), the country'sleading private housing finance institution. The result was the establishment of InfrastructureLeasing and Financial Services Limited (IL&FS) in 1987. Actual operations began in 1988with the owners contributing Rs.60 million (about US$2 million) in the followingproportions: CBI (50.5%), UTI (30.5%), and HDFC (19%).

2.02 IL&FS has since broadened its shareholder base not only to increase capital, but alsoto strengthen business relationships and develop strategic alliances. For example, theIntemational Finance Corporation (IFC) and, subsequently, ORIX Corporation, a Japanesefinancial services company, were inducted as new shareholders in 1993 when the originalpromoters diluted their equity stake in the company. More recently, in order to: (a) raisecapital, (b) broaden its name recognition in the public eye for further business development,and (c) establish a "market" price for its shares, IL&FS decided to proceed with an initialpublic offering (IPO) equivalent to 25% of its enlarged capital. Due to the poor performanceof the capital markets, this issue has been temporarily warehoused with UTI; its launching isnow expected to take place in mid-1996. Once the IPO is completed, the ownership structureof IL&FS will be as shown in Figure 2. 1.

Figure 2.1 - IL&FS's ownership structure(Shareholding of common stock)

HDFC IFC IL&FS

Orix 9% 9% employeesIS% _ 4%

Retail Investors25%

UTI18% CBI

20%

2.03 Board of Directors. The Board of Directors was initially constituted solely byrepresentatives of the three promoting institutions. In 1990, it was broadened to include anumber of prominent individuals from both the private and public sectors. It was again

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restructured in 1995 to create 4 executive directorships that were filled by senior managementof the company. Annex 2.1 provides the current composition of IL&FS's Board. The Boardmeets every two months; it takes all policy decisions for the company and considersapprovals of business transactions of a significant value. It is well structured, withrepresentatives of all shareholders, government, private sector and employees. As IL&FS'sbusiness expands into commercial infrastructure projects, and to enhance the Board'soversight function in this area, it might soon be desirable to appoint to the Board one or twoindividuals with a strong private sector background in infrastructure development, finance orconstruction. As a complement, IL&FS may expand the practice of setting up panels of localand international experts to assist Board members and senior management in decision-making and implementation'. Given the significant role the Board plays in the conduct ofIL&FS's operations, it would be beneficial to the Bank to be kept informed of the Board'sagenda of deliberations. Agreement was reached at negotiations that IL&FS will provide tothe Bank, within 30 days after any meeting of its Board, the agenda of such meeting,including all documents that were forwarded and considered at such meeting.

2.04 Management. Day-to-day management of the company, including major creditinvestment and underwriting proposals subject to Board-established guidelines, is entrustedto the Managing Director, who is assisted by four Executive Directors (EDs), who togetherform the Committee of Directors (COD). Annex 2.2 provides a summary of theorganizational structure of the company. IL&FS is managed in a flexible manner such thatassignments are often handled by ad hoc, interdisciplinary task groups. Considerable efforthas gone into corporate planning and management philosophy resulting in a well thought-outcorporate business plan and well-executed strategic plans (para. 2.14). The managementteam (which has virtually been intact since the founding of the company) is aware of thestrengths and weaknesses of the corporation and has formulated strategies to compete withmuch larger organizations both for new business and for human resources. One pillar ofIL&FS's development strategy has been to forge relationships with a wide array ofinternational partners, either through joint ventures or cooperation agreements, so that thecompany can position itself as a quality player in its mandated areas of operations and ensureit has access to international technology and training2.

2.05 Staff and training. IL&FS is a relatively lean organization; it employs a total of 189staff, of which 126 are professional. The company has tended to bring in professionals withsubstantial experience and has refrained from campus-based recruitment. Professionalcareers are managed to give individuals varied exposure to the company's activities; tofacilitate this, IL&FS has developed a modular organization structure with a high degree ofautonomy, and a work ethos which fosters independence and entrepreneurial behavior. To

Expert panels are already being established in the area of urban infrastructure and telecoms. Similar panels should beconsidered for roads and water supply projects for example.

2 One example of such relationship has been the appointment of IL&FS as country advisor to Oppenheimer &Company Inc. (USA) for their offshore country fund, the "India Fund Inc.". In that process, IL&FS has registeredwith the US Securities and Exchange Commission (SEC) as an "Investment Advisor", an impressive achievementgiven the rigorous SEC filing criteria.

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motivate and retain competent professionals in a highly-competitive job market, the companyhas evolved a variety of forward-looking remuneration strategies such as stock options, aperformance-related pay (PRP) program involving an appropriation of 5% of yearly netprofits -- the first such program to be offered in India by a financial institution -- and careergrowth through joint ventures. As the company recruits only experienced staff, it does nothave a systematic training program for new entrants. However, it does provide training onan ad hoc basis. Until now, training expenditures have remained relatively low. As IL&FSis embarking on a major move into the infrastructure business where little experience has yetbeen gathered in India, it is building up its institutional capacity and plans to provide itsProjects staff with structured training programs to help them in the delivery of theirresponsibilities, particularly in identification, evaluation, implementation monitoring, andquality assurance functions (para. 3.07).

2.06 Systems and controls. financial reporting and audit. IL&FS has in place well-developed, high-quality accounting systems and internal auditing arrangements. Theprincipal instrument for management control is a budget which is approved by the Board.IL&FS uses a reputable firm of chartered accountants as external auditor. A formal systemhas been in place since January 1993 to ensure compliance with: (i) the covenants andinvestment agreements entered into with creditors and shareholders; (ii) the company's creditpolicies and procedures, including those stipulated in its Operating Framework (para. 2.10);and (iii) statutory and regulatory requirements. Following the establishment of regionaloffices in Delhi and Bangalore, the company has further strengthened its accounting systemto better monitor the operations of its various profit centers from a geographical perspective.It now needs to build up its capacity to carefully monitor the profitability of individualproducts marketed by the company. This has clearly not been a problem until now: thecompany has remained of a manageable size, thus enabling its senior management to keepgood track of the various business activities and their relative profitability. As the companygrows rapidly and the number of product lines multiplies -- as is currently anticipated -- suchmonitoring will become increasingly difficult and therefore needs to be cast within a moresystematic framework. A comprehensive cost accounting system by product line thus needsto be put in place (Annex 2.3 provides details on the general purpose of such a system).During negotiations, agreement was reached that IL&FS will establish and implement acomprehensive cost accounting system by product line no later than March 31, 1997.

2.07 IL&FS follows internationally accepted commercial accounting standards inpreparing its financial statements. The latter are presented in a format that meets therequirements of the Indian Companies Act, 1956. These requirements, however, are bettersuited for manufacturing companies than for financial institutions such as IL&FS and make itmore difficult to interpret the company's financial situation. The reports submitted to theBoard for the annual budget provide a more comprehensible picture of IL&FS's financialperformance. Agreement was reached at negotiations that IL&FS will submit to the Bank byJune 30 of each year its annual audited accounts in the format required by the Companies Actas well as its financial statements presented in the budget format and duly certified by theauditor.

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Regulations and operating policies

2.08 IL&FS is a non-banking financial company (NBFC) regulated by the Reserve Bankof India (RBI) under its NBFC (Reserve Bank) Directions, 1977, as amended (theDirections). In addition, it is a company incorporated under the Indian Companies Act, 1956.IL&FS is recognized as a Category I Merchant Banker under the Security Exchange Board ofIndia (SEBI) Act. Its activities are monitored by the Department of Financial Companies ofthe RBI, which performs inspections and reviews the portfolio and quarterly reportssubmitted by IL&FS for capital adequacy, asset quality, etc. IL&FS is in general compliancewith all the applicable regulations.

2.09 Under the Directions, IL&FS has been historically classified as an equipment leasingcompany. In November 1994 it applied to RBI seeking a new NBFC classification given itsunique positioning in the infrastructure sector. This initiative was taken by IL&FS as thecompany is not currently meeting the RBI standards applicable to equipment leasingcompanies3 . In January 1996, RBI informed IL&FS of its decision to retain the existingclassification of the company as an equipment leasing company until March 31, 1997 whileacknowledging IL&FS's intention to make leasing and infrastructure finance its principalbusiness4 . During negotiations, agreement was reached that any material modification to theexisting regulatory framework applicable to IL&FS, that adversely affects the operations ofthe company, will be an event of default under the loan.

2.10 In addition to the guidelines contained in the above-mentioned regulations, IL&FShas developed a comprehensive Operating Framework that spells out (i) the company'soperating policy, (ii) its risk management framework and policies, and (iii) guidelines andframework of operations. The Framework was updated in July 1995 to reflect the company'splanned expanded involvement in commercial infrastructure projects. In particular, its riskmanagement framework and policies now set out in an extensive manner IL&FS's riskmanagement philosophy and process, provides a detailed analysis of the types of risksassociated with its various activities, and proposes an array of risk mitigation measures to becarefully monitored internally through a well-defined allocation of responsibilities5 . Ingeneral, the Operating Framework sets sound management principles. However, in someinstances, investment exposure limits are presented more as guidelines than strict ceilingsbeyond which no further exposure should be taken. In these cases, the language of the

3 Such companies are required to have at least 50% of their assets in equipment leasing and hire-purchase businesstaken together and earn at least 50% of their income from such business activities. IL&FS does not wish to undertakehire-purchase activities to meet the 50% requirement as the corporate sector (its main client base) is not amenable tosuch activity. Given applicable fiscal and accounting norms, it is also not feasible ordinarily for an NBFC to haveleased assets equivalent to 50% of its portfolio.

4 As a result. leasing and infrastructure assets will be considered together in the calculation of the applicable standards.

5 Because of the increasing complexity of risk management. IL&FS is planning to institute a "Risk ManagementSystem" that would be entrusted to a Risk Management Group (RMG). The responsibility of the RMG, inter alia,would include assisting IL&FS's business managers in evaluating various risks in their business areas, initiate riskmitigation steps. reporting risks to the various management levels for corrective actions, and ensuring compliance ofdirectives laid by the Board or the COD.

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Framework needs to be tightened accordingly. Furthermore, three specific aspects related tothe company's investment in commercial infrastructure projects need to be revised: (i)because of the inherent risks associated with this type of projects, particularly with India'sand IL&FS's limited track record in this area, it is considered more prudent that IL&FS limitits credit exposure to infrastructure projects to one third of the company's total creditexposure (instead of the 40% of total assets currently provided for in the Framework). Thiswould ensure a careful balance between leaving enough room for IL&FS to develop itsinfrastructure business and ensuring that, as a result, it does not take excessive risks thatcould threaten its fundamentally sound financial position; (ii) it is important to preserve theintegrity of lending decisions in those cases where IL&FS may be both a significant equityinvestor in and a lender to the same commercial infrastructure project entities; thus the sumtotal of investments (including equity, loans and guarantees) in affiliates of the companyshould not exceed 30% of IL&FS's net worth; and (iii) when considering IL&FS's totalequity investments -- which should not exceed its net worth -- all expenditures incurred byIL&FS on commercial infrastructure projects prior to financial closure should be treated asequity. In close consultation with IFC, the Bank discussed with IL&FS a proposal forrevising the related sections of the risk management framework that reflects the specificconditions under which these projects will be implemented and the risks they will entail. Theagreed version is presented in Annex 2.4. During negotiations, agreement was reached that,as a condition of loan effectiveness, IL&FS will revise its Operating Framework to (i) setdefinite investment exposure limits instead of guidelines, (ii) limit to one third of its totalcredit exposure, IL&FS's credit exposure to infrastructure projects, as calculated inaccordance with a methodology satisfactory to the Bank, (iii) limit to 30% of the company'snet worth its aggregate investments in entities in which its share in the paid-in capital is morethan 33 1/3%, and (iv) treat as equity all expenditures incurred by IL&FS on infrastructureprojects prior to financial closure. In addition, agreement was reached that (i) IL&FS willcontinue to conduct its operations in accordance with the principles and proceduresenunciated in its revised Operating Framework, and (ii) any material modification to theOperating Framework, without prior approval of the Bank, will be an event of default underthe loan.

IL&FS's current operations

2.11 Assets. IL&FS is engaged in lease and loan financing -- which constitutes its corebusiness -- as well as merchant banking and other financial activities. It is today one of the 5largest and best regarded non-bank finance companies (NBFCs) in India; it is currently rated"AAA" by Credit Analysis and Research Ltd. (CARE), one of the 3 Indian credit ratingagencies. Since the company was founded, revenues and net profit after tax have increased atan average annual rate of 56% and 57%, respectively. Its assets have grown from Rs.734million (US$44 million) in its first year of operation (FY88/89) to Rs. 13.2 billion (US$418million) in FY94/95 -- an impressive growth rate of over 50% per year in local currency andover 40% in US$ dollar terms. It has successfully built up its balance sheet with a safe, butnot overly profitable, lending and leasing business. As of March 31, 1995, loans and leasesaccounted for 77% of the company's total assets and 76% of its income. The leasingbusiness is attractive to IL&FS as the company benefits from accelerated tax depreciation on

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its leased assets6. The core lending and leasing business is restricted to the country's top 60corporate groups as well as creditworthy public sector agencies, which has meant that,although risks are low, competition in this segment has limited profitability. IL&FS tries todifferentiate itself from its competitors by providing products which are customized to clientneeds. The quality of the lease and loan portfolio is good and has seen a markedimprovement over the last three years; it reflects not only the large, high-quality client base,but also the company's tight credit control and portfolio management.7 In parallel with thecore business of lending and leasing, an investment banking business has evolved sinceIL&FS's inception. Asset-based investment banking activities are mainly securitiesinvestment and trading, and property development. A growing area of business for IL&FS isnow its fee-based investment banking activities: asset management, corporate and projectadvisory work, and underwriting and issue management. To date, the contribution of thebottom line of these activities has been modest, but its growth is a key component ofIL&FS's business strategy (para. 2.15). IL&FS is also engaged in the development ofvarious new businesses -- through the establishment of joint ventures -- most of which are alogical extension of current activities that will give rise to new financial products or willincrease investment banking services that IL&FS can offer. The breakdown of IL&FS'sassets as of March 31, 1995 is presented in Figure 2.2 below.

Figure 2.2 - Breakdown of IL&FS's assets(as of March 31, 1995)

Investment Infrast. devt Jointbanking & financing ventures

assets 1% 4% Others16l 7%

Leasing Loans &25% debentures

47%

2.12 Funding. Historically, IL&FS has sourced its resource requirements through theinduction of new shareholders, and through its credit lines from commercial banks, Indianfinancial institutions and multilateral agencies. Over the past few years, it has dramaticallychanged its resource base. IL&FS began as a subsidiary of a bank (CBI), which, along with

6 The volume of leasing in each year is set in order to bring IL&FS's taxable income to zero.

7 As of March 3 I. 1995, arrears on leases over 90 days represented 0.3% of total lease receivables; arrears on loansover 90 days accounted for 0. 1% of total loan receivables. Loans and leases affected by arrears over 90 daysrepresented 2.2% and 1.5% of total loan and leasing assets respectively.

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the company's other major shareholders, served as the main source of funds. The opening ofits capital to new strategic shareholders (IFC and ORIX) not only broadened its equity basebut also facilitated the company's access to a wider range of debt funds. At present, IL&FSborrows from multilaterals8 (IFC and the Asian Development Bank), local banks (it hasobtained renewable credit lines from a consortium of 19 banks), domestic financial andinvestmnent institutions and insurance companies (an important source of medium- to long-term fimds9 ). IL&FS has also been successful in mobilizing funds through the placement ofcommercial paper (CP) and issue of debentures to select corporate groups in an attempt todiversify its resource base. Figure 2.3 presents IL&FS's liability profile as of March 31,1995.

Figure 2.3 -- IL&FS's liability profile(as of March 31, 1995)

Short-term OthersBorrowings 5%

33% Equity Capital5%

Reservs &Surplus

16%

Long-termBorrowings

41%

Future strategy andfinancial performance

2.13 One of IL&FS 's primary mandates was to establish itself as a premier institution tostructure and finance, both directly and through syndication, private infrastructure projects.The fulfilment of this objective was deferred to allow the company to build up its balancesheet to a size sufficient to enable it to take on the requisite risks associated with lumpyinfrastructure investments. With total assets estimated to reach Rs. 16,307 million (US$470million) at the end of the current financial year and a net worth of Rs.3,732 million (US$110million), it is now in a position to start financing infrastructure projects. To reinforce thisstate of readiness is the strength derived from a unique combination of public and privatesector influences that have defined the company's development until now. IL&FS hasconsistently built upon the special position it has enjoyed from having been promoted bypublic-sector institutions and being overseen by an influential Board of Directors. At thesame time, its management and professional staff, having been recruited largely from the

8 The average tenor of these borrowings, which are mainly for lending towards import of capital assets, is 10 years.

9 The tenor of these facilities is typically between 5 and 8 years.

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private sector rather than the promoting institutions, have left the company with a distinctlyprivate sector culture. This unique characteristic is seen as a key strength to enable IL&FS toenter the commercial infrastructure business in a major way. It has started to position itselfas the leader in developing the concept for commercializing infrastructure projects, theassociated legal framework as well as financing alternatives. Over the last few years, IL&FShas been actively engaged in creating and developing frameworks to enable suchcommercialization, and has been in continuous dialogue with the relevant authorities in orderto develop policy as well as the recommended legislative changes that promote such intent.The sectors chosen by IL&FS for initial development were power and telecommunications,surface transport and transportation systems. As explained earlier (para. 1.06), power andtelecommunications are somewhat better positioned for commercial implementation;IL&FS's initial focus in these sectors has therefore been towards providing investmentbanking services. The surface transport sector has been far different in that IL&FS has had todevelop models which are sought to be replicable across the sector and structured to facilitatemarket borrowings. Thus, in these areas, IL&FS has been required to undertake amultiplicity of roles in a project, including initial conceptualization, development, financing,implementation and management. Its record to date in this area is limited to the successfulimplementation of a small toll road in Madhya Pradesh (the 11.5-km Rau-Pithampur bypass);it has also advanced significantly the preparation of three additional projects, two of which(Delhi-NOIDA bridge and Panvel bypass) are in the final stages of development.

2.14 Corporate business plan. IL&FS has developed a comprehensive corporate businessplan for the next five years to manage a successful move into infrastructure. The plan hasbeen conceived in the light of the prevailing economic environment in India, and IL&FS'sperception that the changes over the last few years would continue into the foreseeable future.It reflects IL&FS's keen interest in preserving its position in the market as a prudentlymanaged, commercially oriented and profitable institution, and maintaining its track recordof innovation and delivery. A summary of IL&FS's projected financial performance ispresented in Table 2.1 below. Past and projected income statements, cash flow statementsand balance sheets are provided in Annex 2.5.

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Table 2.1 - Summary of IL&FS's projectedfinancial performance 1995/96-2000/01(Rs. million, unless otherwise indicated)

1995-96 1996-97 1997-98 1998-99 1999-000 2000-01

Total Assets 16,307 19,619 26,640 33,860 39,599 44,866Infr. Project Assets 275 1,331 3,108 6,239 8,313 9,863of which: - debt 51 980 2,383 5,135 6,935 8,207

- equity 224 351 724 1,104 1,378 1,656Long-tenn debt 8,807 10,062 15,005 18,775 22,210 24,573Net worth 3,742 4,283 4,944 6,944 8,420 10,178of which: - share capital 894 894 863 949 949 949

- reserves and surplus 2,848 3,389 4,081 5,995 7,471 9,229

Total Income 2,439 3,191 4,063 5,417 6,668 7,593of which: - interest income 1,344 1,474 2,028 2,965 3,746 4,333

- lease income 946 1,315 1,528 1,805 2,144 2,378- fee income 125 230 278 333 400 488

Interest and finance charges 1,472 1,740 2,319 3,056 3,606 4,048

Ratios:

Project Assets as a % of total assets 1.69 6.78 11.67 18.43 20.99 21.98Debt: equity ratio 3.06 3.09 3.72 3.16 3.01 2.74Debt service coverage ratio 1.47 2.14 2.00 2.10 2.24 2.45Retumnonnetworth(%) 12.71 18.18 19.08 19.55 21.91 21.12Return on total assets (%) 3.09 3.99 3.74 4.10 4.54 4.61

2.15 The main thrust of IL&FS's growth over the next 5 years will be the dramaticexpansion of its commercial infrastructure project portfolio, which, for the moment, islimited to the Rau-Pithampur toll road'". Commercial infrastructure assets are projected toamount to about Rs.9.863 million (US$280 million) by the end of 2000/01 as compared toRs.275 million (US$8 million) as of March 31, 1995. To sustain this growth, IL&FS hasforecasted a robust expansion of its core loan and leasing business that would increase byabout 24% p.a. over the period, a pace considered achievable in light of the projected overalleconomic and industrial growth in India. Another important feature of IL&FS's corporateplan is the significant growth in non-fund based business derived from a conscious effort atdeveloping a wide range of advisory services". The impact of such development would be

0 The Rau-Pithampur toll road, being the first commercial infrastructure project arranged by IL&FS, was actuallyimplemented by the company acting as project developer; the total cost of the project appears therefore as an asset onIL&FS's balance sheet. IL&FS has just received approval to domicile the asset into a special purpose vehicle inwhich the Government of Madhya Pradesh will take a 20% stake. The SPV will then issue toll revenue bonds, a firstfor India.

l IL&FS plans to offer a range of advisory services encompassing: (i) corporate advisory services (structured finance,capital markets, project financing), (ii) securities management, and (iii) infrastructure advisory services. For example,with the experience gained as country advisor to the Oppenheimer "India Fund", is now spearheading the

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reflected in a relatively rapid growth in fee income (28% p.a.). Finally, the plan assumesthat the existing fiscal regime applicable to leasing activities would be maintained. In theevent the prevailing incentives are either reduced or eliminated, IL&FS could, to a certainextent, pass on the associated additional costs through an increase in its spread. However, itwould also likely face stiffer competition and see a slower growth in its leasing assets. Toevaluate the impact of possible events on IL&FS's financial performance, a sensitivityanalysis was carried out using different scenarios (Annex2..6). If IL&FS's growth in assetswere significantly curtailed as compared to the base case scenario presented above, and and ifthere were no income from capital gains and no growth in fee income -- a worst case scenario-- the company's return on net worth would basically remain at its present level (about 14-15%), while its debt service capability, as measured by its debt service coverage ratio, wouldactually improve as a result of lower funding requirements.

2.16 The company's move into the infrastructure sector means that the average maturityof its assets will grow. In order to manage its liquidity risk, the average maturity of itsborrowings must also be increased. IL&FS is therefore looking to take up more medium-and long-term debt. Although it is already raising medium-term funding from domesticcommercial banks, their capacity to provide longer maturity debt is limited. In the absence ofa well-functioning long-term debt market in India, IL&FS has no other option but tap foreignsources for long-term funds. IFC is not in a position to provide additional funds withmaturities and on the substantially-increased scale that is now being sought by the company -- IL&FS is already the largest exposure of IFC's Asia Capital Markets Department. TheBank is thus considered to be the main source of funds to meet the pressing needs for long-term financing. In addition to the Bank loan, USAID has approved a US$25 million line ofcredit to IL&FS in support of one of the projects in the pipeline (Tirupur integrated areadevelopment program). The company is discussing further non-rupee lines with otherforeign agencies (DEG of Germany, USEximbank, FMO of Holland) as well as a number ofinternational commercial banks interested in the Indian market (ING Bank, Bank of America,Chase Manhattan, Societe Generale, Fuji Bank and Deutsche Bank). While the potentialsources of foreign funding are wide and numerous, a significant constraint may be the abilityto swap these funds into rupees.

2.17 The development of IL&FS's infrastructure business will modify the risk profile ofwhat is currently a very prudently managed enterprise. The prudential guidelines embeddedin RBI's Directions are certainly appropriate for IL&FS's current set of activities, essentiallylow-risk lending and leasing to top Indian corporates, but they are insufficient for higher-riskand lumpier infrastructure development and financing. IL&FS's risk managementframework addresses by and large this concern (para. 2. 10). As a complement, agreementwas reached during negotiations on the following two financial performance targets forIL&FS: (i) maintain at all times a debt service coverage ratio of not less than 1.25; and (ii)maintain at all times a debt to equity ratio of not more than 6:1.

development of specialty funds for the infrastructure sector, the first of which is being established with AmericanInsurance Group (AIG) (USA). The first tranche of US$70 million was closed on January 10, 1996 and includedanchor investors such as ADB, Orix and Tata Industries; the second, of US$80 million, is expected to close in April1996.

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III - THE PROJECT

Project objectives

3.01 The Project aims to develop prototype contractual arrangements for privateinvestment in IL&FS's areas of involvement, thereby facilitating entry of the private sectoron a much larger scale in areas heretore dominated by the public sector. In the process, itwould build up India's capacity to attract private investment in infrastructure, pilot-testinstitutional and contractual arrangements in a variety of subprojects under variousadministrative and political conditions, and help establish a track record as a prerequisite forlarge scale private investment in the sector. The Project would also meet the pressing needsof commercial infrastructure project entities for long-term rupee financing. pending theimplementation of financial sector reforms for the development of a domestic long-term debtmarket, currently under preparation. Equally important, it would foster efficiency in thedelivery and use of selected infrastructure services, encourage the establishment of moreefficient practices in the construction and operation of infrastructure project, and assist inalleviating the severe financial and institutional constraints to the expansion of infrastructurein India.

Project description

3.02 The Project will assist IL&FS in financing infrastructure subprojects such as majorbridges, urban bypasses, port facilities, water supply and effluent treatment schemes, andintegrated area development projects, to be implemented on a build-operate-and-transfer(BOT) basis (or a variation thereof) and expected to be started within the next three years. Itconsists of three interrelated components:

+ an investment component in the forn of a line of credit to IL&FS, the proceeds of whichwill be used to provide long-term finance to special purpose entities established for theconstruction and operation of commercial infrastructure projects in IL&FS's pipeline(para. 3.04);

* a subproject preparation component to cover specialized consultancy services to advisethe public authorities granting the subproject concessions or to assist project developersin preparing their subprojects (para. 3.05); and

* a training and technical assistance component to cover (i) IL&FS's staff development forits staff, (ii) specific studies that IL&FS is undertaking to facilitate the evaluation andimplementation of commercial infrastructure projects (e.g., legal and regulatoryframework applicable to BOT projects in sectors of IL&FS's interest, innovativefinancing for environmental infrastructure in medium-sized cities and townships, trafficforecasting, willingness to pay and fixation of user charges for water supply and roadprojects) (para. 3.07).

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Indicative pipeline of subprojects

3.03 IL&FS has identified a long list of subprojects which it may eventually consider forfinancing and which provides valuable information on the potential size of the market.However, it is clear that some of the projects in that list may either slip or not be executed atall, while new subprojects may be incorporated at a later date. In the course of preparing theProject, the Bank and IL&FS agreed that, to achieve the maximum results, it would be best tofocus on certain priority sectors and establish a track record in India, that would thenfacilitate replicability in future. A set of eligibility criteria for the line of credit has thus beendeveloped and is presented in Annex 3.1. Agreement was reached at negotiations that theseeligibility criteria will be applicable to all subprojects to be funded under the line of creditunless otherwise agreed by the Bank on a case-by-case basis.

3.04 Given the above criteria and after reviewing the state of preparedness of eachsubproject, IL&FS has drawn up an indicative pipeline of subprojects (Annex 3.2)tentatively considered for financing under the Project. It is a scaled-down version of theabove-mentioned list, bearing in mind that (i) commercial infrastructure projects take aconsiderable time to develop, and (ii) IL&FS can only gradually build up its capacity tohandle the correspondingly large volume of appraisal work. The pipeline includes 18geographically dispersed subprojects, distributed as follows: (i) 10 are in transport (urbanbypasses and bridges, roads and highways, railways), (ii) 6 are area development projects(including a combination of water supply, effluent treatment, power supply and roaddevelopment schemes). (iii) one is a port facility, and (iv) the last one is a large areadevelopment project to be developed in stages (Bay of Cambay). Some of the subprojects areat a relatively advanced stage of preparation and have a high probability of beingimplemented under the Project, they are expected to start construction within the next 18months. By contrast, others are only at the preliminary development stage and theprobability that they will be ready for implementation within the next three years is, at themoment, somewhat lower. Any slippage on these projects is expected to be made up by otherprojects currently under development and not included in the pipeline.

Project cost and financing plan

3.05 The aggregate cost of the subprojects in the pipeline (including development costs) isestimated at about Rs.58,000 million (US$1.6 billion). The figures indicated above providean order of magnitude of the investments envisaged. Out of this aggregate cost, developmentexpenses for projects still at their initial stage of development and envisaged to be financedunder the Project are estimated at about US$19 million, US$5 million of which wouldcorrespond to the cost of advisory services (including computer hardware and software)which public sector authorities (e.g., GOI, state governments, municipalities) could avail ofto select BOT operators and negotiate concession agreements. It is proposed to finance thislatter subcomponent through an IDA credit to GOI, the proceeds of which would be utilizedby the concerned GOI or state government agencies. Agreement was reached at negotiationsthat the IDA credit will become effective only once the loan to IL&FS has been made

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effective. It is still too early to provide a reasonable estimate of the breakdown of costsbetween local and direct or indirect foreign currrency expenditures; this will likely varyconsiderably from subproject to subproject, depending on the nature of the subproject, theBOT operator, and the extent to which the contractor imports construction equipment. Giventhe experience gathered so far on the first two subprojects in the pipeline, the foreign costcomponent is likely to be higher than for public sector projects as great emphasis is placed inintroducing best international practices through a careful selection of consortium membersfor the special purpose entities. It has thus been assumed that about 40% of the subprojectcosts would be in foreign currency.

3.06 The subprojects would be developed with a mix of financing comprising: equity fromproject sponsors and other partners such as institutional investors (through specialty equityfunds), debt financing from contractors or suppliers, term financing from other domesticfinancial institutions, banks and the domestic markets (e.g., through the offering of "tollrevenue bonds"), and long-term financing from multilateral agencies such as the proposedBank loan and bilateral funds such as the US$25 million line of credit from USAID. As partof its review of each individual subproject (paras. 3.08 and 3.13), the Bank will also assesswhether a World Bank guarantee might be an appropriate vehicle for Bank support to thesubproject, either as a complement to or a substitute for a subloan from IL&FS. The amnountof the Bank loan has been deliberately set at a relatively conservative level to reflectuncertainties as to the pace of implementation of the subprojects and hence of disbursementfrom the loan. However, should the subprojects materialize more rapidly than anticipated,additional commitments could be envisaged through guarantees and/or a second line of creditto IL&FS. Bringing the subprojects to financial closure will require a mix of projectdevelopment expertise and relatively novel and complex financial engineering. IL&FS isexpected to play a key catalytic role in the process. It will build on its proven record ofsuccess in investment banking and financial services, and the strategic alliances it hasestablished with foreign institutional investors'2 . For all subprojects in its pipeline, IL&FS isalso laying great emphasis on aligning the interests of the major stakeholders and the localgovernments in the success of the projects. Table 3.1 below provides an indicative projectcost and financing plan.

12 For example, IL&FS will offer to the AIG equity fund all the infrastructure projects it is aware of. It has also been indiscussion with General Electric Capital Corporation (GECC) for a relationship for infrastructure deal referrals forwhich IL&FS would receive a fee.

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Table 3.1 - Indicative project cost andfinancing plan(millions of US dollars)

Cost Foreign Local Total

Investment 675 905 1,555Subproject preparation 1 0 9 19Training and tech. assist. I - 1

Total 686 914 1,600

Financing

IBRD 200 - 200IDA 5 - 5IL&FS - 44 44Indian fin. institutions/banks - 430 430Capital markets 150 150State governments & agencies - 100 100Export credit agencies 200 - 200Bilateral funds 75 - 75Project sponsors & others 206 190 396

Total 686 914 1,600

Project implementation and monitoring

3.07 The Project will be implemented by IL&FS, acting as equity investor and lender tothe special purpose entities. During project preparation, the Bank reviewed in detail IL&FS'sproject appraisal procedures and capabilities and suggested a number of adjustments to bemade in the company's organizational structure, staffing and processes so that it would bebetter equipped to handle the anticipated large volume of infrastructure business. Keyreassignment and recruitment decisions were subsequently made by IL&FS's management,internal processes and procedures have since been clearly formulated, and greater recourse isbeing made to outside expertise to assist in project appraisal. In addition, a comprehensiveplanning exercise has been carried out by IL&FS to assess the manpower requirements --both internal and external -- of its infrastructure business, evaluate training needs andestimate the cost of consultancy services. A summary of the training program and technicalassistance activities envisaged by IL&FS is provided in Annex 3.3.

3.08 IL&FS has designed a comprehensive system of steps and procedures to be followedby its staff for appraising subprojects and evaluating subloan applications. The resultingproject cycle is an elaborate and well-thought out project evaluation system (Annx3.4).However, for IL&FS, some of the subproject appraisal activities will be undertaken for the

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first time in a structured format. Systems must therefore be in place that are of a standardand quality that can withstand the scrutiny of all potential financiers. Because of the size,relative complexity and novelty of the subprojects which the proposed loan will finance, it ishighly desirable that all subproject appraisal activities be carried out in close consultationwith the Bank. It has been agreed with IL&FS that, for the first two subprojects in eachsector category (e.g., roads, water supply, integrated area development)'3 , there would beclose interaction with the Bank as appraisal of infrastructure projects is still an area where thecompany has least experience and where the Bank can contribute most. In particular, the fulldocumentation on the contractual framework for the subprojects (e.g., concession agreement,construction contract, O&M contract, lenders' agreement, shareholders' agreement) will bereviewed in detail by the Bank for their risk mitigation aspects. This is critical as IL&FS isbreaking new grounds in India and is thereby setting precedents that may potentially becomegovernment policies. For all subprojects, IL&FS will prepare a detailed subprojectevaluation report, an outline of which is provided in Annex 3.5. These arrangements wereconfirmed during loan negotiations.

3.09 Performance monitoring indicators have been established that will provide tools formonitoring progress of the Project and the extent to which it is meeting its developmentobjectives (Annex 3.6). A comprehensive management review of all aspects of the Project,including IL&FS's operations, financial performance and annual budget, will be carried outbefore April 30 of each year. In addition, a mid-term review of the Project will be heldbefore April 30, 1998 to take stock of the progress to date and identify any appropriatemeasures to improve implementation of the Project, as the need may arise. Thesearrangements were confirmed during loan negotiations. Given the Bank's expected intensiveinvolvement throughout the life of the Project, and especially in the first two years whereconsiderable efforts will be deployed to put in place an appropriate contractual frameworkthat would be replicated for subsequent projects, unusually large supervision resources willbe required to monitor project implementation. An indicative supervision plan is provided inAnnex 3.7; it may be reviewed and updated as appropriate during project implementation.

Procurement

3.10 In line with the Bank's revised procurement guidelines, two courses of action areenvisaged for the procurement of goods and services under the Project. Whenever possible,and particularly for those subprojects in which IL&FS's involvement is identified at an earlystage, it is envisaged that BOT operators will be selected through international competitivebidding, following which the selected operator will be free to procure goods, works andservices required for the facility using its own procedures. As part of the advisory servicesIL&FS is providing to state and local governments for the preparation of subprojects, IL&FShas sought consultants' advice to develop the basic documentation for selecting a BOToperator. It is also looking to the Bank for assistance in developing acceptable procedures for

13 Namely, the Panvel bypass, the Delhi-NOIDA bridge, the Tirupur area development program and the Dewas watersupply scheme.

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inviting and evaluating proposals. During project preparation, the Bank already providedsome inputs. General guidelines were discussed with IL&FS which, in some instances, isacting as advisor to state governments or other public agencies that will eventually managethe competitive bidding process (Annex 3.8). Given the diversity of subprojects, the lack ofexperience with competitive selection of private infrastructure operators in India and thelimited availability of reference documents in the Bank to guide IL&FS in carrying out suchprocurement, it is anticipated that extensive work will be required in this area in the earlystage of project implementation. In those cases where the BOT operator will not be selectedon a competitive basis, construction contracts or supply of construction materials andequipment will be procured following normal World Bank ICB procedures, unless otherwiseagreed with the Bank on a case-by-case basis. During project preparation, the Bank reviewedthe procurement and contracting activities for two of such cases and suggested a number ofimprovements to be made in the area of procurement procedures and bid documentation toensure that IL&FS adopts international best practices. Technical assistance and consultancyservices would be procured in accordance with the provisions of the Bank's guidelines for theuse of consultants. Table 3.2 below provides a summary of the procurement arrangementsenvisaged under the project.

Table 3.2 - Summary of Procurement Arrangements'4

(indicative) (in millions of US dollars)

ICB Others Total

Subprojects 110 75 185

Technical assistance- Implementation support - 19 19- Policy support - 0.5 0.5- Capacity building - 0.5 0.5

Total 110 95 205

Security arrangements

3.11 The Bank loan will be a US$ LIBOR-based loan. It will be extended directly toIL&FS and guaranteed by GOI. The provision of GOI guarantees in support ofinfrastructure development in general is under active consideration by a high-poweredworking group within the Ministry of Finance. Its recommendations are expected to besubmitted before the end of March 1996. At that time only will the detailed terms andconditions of GOI's guarantee of the Bank loan to IL&FS be finalized. However, agreementwas reached at negotiations that GOI will levy a guarantee fee of not less than 1.2% on the

4 The amounts shown correspond to IBRD/IDA financing; as of the appraisal date the respective total cost of theindividual subprojects is not known and therefore not shown in the procurement table.

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amounts outstanding and disbursed, a level considered appropriate considering the pioneeringrole IL&FS is expected to play in establishing a track record for India in the area of privateinvestment in infrastructure. Agreement was also reached that, as a condition of loaneffectiveness, GOI and IL&FS will enter into an indemnity agreement on terms andconditions satisfactory to the Bank. In addition to the GOI guarantee, the Bank will take apari passu interest in the security structure currently in force in respect of the present lendersto IL&FS (Annex 3.9). To complete the security package, an inter-creditor agreement needsto be in place. IL&FS has finalized the agreement to the satisfaction of the Bank and willcirculate it shortly to all the other lenders for their comments. Agreement was reached atnegotiations that, as a condition of loan effectiveness, the security arrangements for theWorld Bank loan will be completed, including the placement of the loan under the mortgageshared equally with other lenders and the execution of the inter-creditor agreement.

Onlending and disbursement

3.12 The proposed loan to IL&FS is meant to meet the pressing needs of commercialinfrastructure project entities for long-term rupee financing, pending the implementation offinancial sector reforms for the development of a domestic long-term debt market (para.1. 11). Furthermore, given the intrinsic risks of infrastructure projects and the fact that costrecovery will, in most if not all cases, be in local currency, it is considered more prudent notto pass on the foreign exchange risk to the final beneficiaries of the loan so as to preserve thefinancial viability of the subprojects. Proceeds of the loan to IL&FS will therefore be onlentto the subproject entities, mainly in the form of rupee term loans with maturities matchingthat of the original loan to IL&FS as closely as possible (17-20 years) and a market-determined rate'5 . Only in exceptional cases will IL&FS onlend in US dollars in which caseit will charge a market-determined variable rate'6 . These onlending arrangements wereconfirmed at negotiations. For subloans made in rupees, IL&FS will bear the foreignexchange risk. The company plans to hedge the currency risk by swapping the proceeds ofthe Bank loan into back-to-back rupee-denominated loans with the same repaymentstructures as the Bank loan. For this to be cost-effective in the absence of a swap market inIndia, IL&FS will need to do it in amounts of at least US$25 million at the minimum. Toenable IL&FS to arrange these swap transactions, a Special Account, with an authorizedallocation of US$25 million, will be established in a commercial bank, on terms andconditions satisfactory to the Bank. The amounts deposited in the Special Account will beused exclusively for executing the swap transactions, and the rupees obtained therefrom willbe deposited into a Swap Account, to be used for eligible expenditures. Annex 3.1 0 providesfurther details on such arrangements. They were confirmed at negotiations. Depending onthe terms of the swap agreement, IL&FS may onlend the proceeds of the loan at a fixed orvariable rate. In either event IL&FS will not bear the interest rate risk. The IDA credit will

5 IL&FS estimates that, under prevailing conditions, it would onlend at a spread of 400 basis points over the lendingrate obtained from the swap counterparty.

16 Under present conditions and given the cost of the funds to IL&FS, the company reckons that it would onlend at aspread of 400 basis points over LIBOR.

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be onlent on the standard terms and conditions applicable to central assistance to the states atthe time.

3.13 As indicated earlier, subprojects financed by the line of credit will need to meetspecific eligibility criteria (para. 3.03). In particular, subprojects will need to comply withthe following financial performance benchmarks:

* a capital structure for the SPV of no more than 75% debt, with the promoter'scontribution representing at least 25% of the paid-in capital;

* a project debt service coverage ratio of no less than 1.25 on an annual cash-flow basis;and

* the entire financing package to have been finalized (committed or raised) or promoterguarantees of high quality to have been provided prior to the finalization of the financialpackage.

These will need to be fully documented in the subproject evaluation report prepared byIL&FS, which will form the basis for the Bank's review of individual subprojects.Agreement was reached at negotiations that, as conditions of disbursement for the investmentcomponent, (i) IL&FS will submit to the Bank, for its review and approval, the final projectevaluation report, including the environmental and social (EA/SA) assessment reports, and(ii) the contracts for the financing of the subproject will have been executed together with allthe other contracts associated with the implementation of the subproject.

3.14 Drawdowns from each subloan will be contingent on the SPV meeting conditionsprecedent relative to progress of construction. Such conditions would be specified in thelender's agreement between IL&FS and the SPV and would be spelled out in the evaluationreport submitted by IL&FS to the Bank. Disbursements under the loan will be made for100% of the amounts paid by IL&FS for expenditures incurred under eligible subloans;disbursements for consultancy services and training will be for 100% of expenditures.Disbursements under the credit will be for: (i) 100% of expenditures for consultancy services,and (ii) for equipment and software, 100% of foreign expenditures, 100% of localexpenditures (ex-factory cost) and 80% of local expenditures for other items procured locally.As indicated in the eligibility criteria, proceeds of the Bank loan would not cover more than25% of the total cost of individual subprojects. The loan is expected to disburse over a five-year period. An indicative schedule of disbursements has been assumed in the financialprojections for IL&FS (Annex 2.5). The cut-off date for new loan commitments to befinanced under the Project would be December 31, 1998. The Project would be completedby March 31, 2001 and the closing date for the loan would be September 30, 2001.

- 24 -

Environmental and social considerations

3.15 IL&FS, with assistance from an NGO, has prepared an Environmental and SocialReport (ESR), the objective of which was to put in place an environmental and socialassessment process which adequately responds to GOI requirements and, for subprojectsinvolving Bank financing, the Bank's operational directives (ODs). Organized in 3volumes'7 , the ESR: (a) states the company's environmental and social goals; (b) providesthe contextual setting for the environmental and social assessment process; (c) identifies themajor issues in the priority sectors; (d) details the environmental assessment and socialassessment (EA/SA) process that IL&FS will follow when appraising suprojects; (e) outlinesmethods to moderate risks and liabilities due to environmental and social factors; (f) specifiesthe organizational arrangements in IL&FS to manage the environmental and socialassessment process; and (g) spells out the staff development plan. Relevant regulations,guidelines (including the Bank's relevant operational directives), checklists and protocols areprovided as an attachment to the report. Land acquisition and resettlement proceduresdescribed in the ESR will apply only to land acquired, whether by public or private sectoragencies, on or after June 15, 1995 (the date of commencement of preparation of the ESR).During project preparation, the Bank "field-tested" the ESR approach in the context of onesubproject (para. 3.17) and met with various government officials and NGOs to assess theirconcurrence with the approach proposed in the ESR. The Executive Summary of the ESR ispresented in Annex 3.1 1.

3.16 In the process of preparing the document, IL&FS's management has demonstrated astrong commitment to implement the ESR and taken a proactive stand for tacklingenvironmental and social issues. IL&FS clearly sees the EA/SA process as an integral part ofits risk management framework: specific environmental and social risks are identified upfrontand mitigation measures fully integrated into the project design, thereby reducing the risks ofdelays during contruction and operation that could threaten the project's financial viability.It also enables IL&FS to screen projects and avoid financing investments for which, forexample, land acquisition may result in costly resettlement and rehabilitation (R&R). IL&FShas brought a few innovative features into the environmental and social assessment process,such as the establishment of neighbourhood committees or the preparation of annualenvironmental and social audits for the company. It has set an example of best practice thatmight well be considered for other operations supported by the Bank in India and elsewhere.

3.17 IL&FS, with the assistance of local consultants, prepared an environmental and socialassessment for the proposed Delhi-NOIDA link bridge subproject. The draft report wasreviewed by the Bank and the final version incorporates all the comments. The DelhiAdministration, NOIDA and the project SPV have all committed to implement the mitigationactions. Air pollution and noise have emerged as the major environmental issues in certainlocalities adjacent to the project location. A greenbelt, noise barriers and air quality

7 Volunie I is the Executive Summary; Volume 11 is the main report; and Volume 111 is a compilation of referencedocuments.

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monitoring are included in the project design. Five per cent of the total landfall area is underdispute, the remaining is unencumbered land. A negotiated settlement with the affectedpeople is being pursued by the Delhi Administration. The compensation will be based on theentitlement framework contained in the ESR.

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IV - PROJECT JUSTIFICATION

Project sustainability

4.01 In this particular case, project sustainability must be looked at from three inter-relatedangles: (i) from the point of the individual subprojects; (ii) from the institutional IL&FSviewpoint; and (iii) from a broad sectoral perspective. The proposed project will support theimplementation of commercial infrastructure projects which IL&FS is and will continue to becarefully screening for their financial, economic, technical, environmental and social merits.Among the eligibility criteria agreed with the Bank, IL&FS has set a minimum real financialrate of return of 14% which it considers to be the minimum for attracting private finance.The subprojects are structured to generate sufficient revenues to recover capital as well asoperating and maintenance costs through the duration of the concessions. Particular attentionis also given by IL&FS for establishing an appropriate institutional framework for theimplementation of the individual projects, through a pro-active dialogue with GOI onregulatory and legal issues and by encouraging public/private partnerships with stategovernments and their agencies. Since the financial viability of the proposed investmentsdepends on the cost-effective design, implementation and operation of individual projects,the incentives for sustainability are greater than in the case of similar investmentsimplemented by the public sector. The agreed procedures for Bank review of subprojects(paras. 3.08, 3.09 and 3.13) should also enhance the likelihood of sustainability of thesubprojects.

4.02 With regard to IL&FS's sustainability, the company has developed an OperatingFramework which inter alia sets out a risk management framework and related policies aswell as the company's guidelines and framework of operations (para. 2. 10). To ensure thatIL&FS's expanded involvement in infrastructure is sustainable in the long run, the Projectincludes the following safeguards: (i) IL&FS's risk management framework, as revised, willset prudent limits to the company's exposure to infrastructure projects; (ii) financialcovenants will provide additional prudential guidelines for IL&FS's overall operations; and(iii) the agreed financial eligibility criteria for onlending to individual subprojects areexpected to contain the credit risks of individual subprojects.

4.03 By supporting IL&FS' efforts in the development of private infrastructureinvestments, in collaboration with the concerned agencies of GOI and individual states, theproject will assist in defining an improved regulatory and institutional framework for thesector and hence establishing the sustainability of private infrastructure investments in India.

Economic analysis

4.04 The economic analysis of the Project will be carried out at the subproject level, on aninvestment-by-investment basis. As indicated earlier, each subproject will be subject to botha detailed financial analysis and a conventional economic evaluation by IL&FS, assisted, asnecessary, by specialized consultants. During project preparation, the Bank reviewed thepreliminary economic evaluations carried out by IL&FS for a sample of subprojects in the

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transport and water supply sectors. While IL&FS's staff demonstrated extensive knowledgeof the principles of economic analysis of projects, some improvements were suggested toenhance the coverage, thoroughness and rigor of the evaluations. The Bank agreed withIL&FS a methodology to be followed for investments in each sector, including: (i) a cleararticulation of the underlying rationale for the choice of each subproject, (ii) the consistencyof the subproject within future sectoral development plans, (iii) the identification of theexpected beneficiary groups, (iv) the valuation of economic benefits and costs usingappropriate shadow prices, (vi) the identification of the risks of the subproject and theassociated mitigation measures, (vii) the establishment of a minimum economic rate of return(ERR), (viii) the test of first-year benefits (FYB) to check appropriate timing of theinvestment, and (ix) the use of incremental analysis in the context of a phased project.During loan negotiations IL&FS confirmed that it will follow an acceptable methodologywhen carrying out the economic evaluation of subprojects and that it will fully documentsuch analysis in the evaluation report to be submitted to the Bank for each subproject.

Benefits

4.05 At the subproject level, the project will achieve the benefits normally attributed tospecific infrastructure projects; these will be clearly identified and measured on a case-by-case basis in the economic evaluation of individual subprojects. At the macroeconomic level,the Project should be seen as a precursor for greater involvement of domestic financialinstitutions and the capital markets in the infrastructure sector. It will help overcome one ofthe major obstacles to a satisfactory market response to GOI's economic reform efforts andpromote increased capital availability for infrastructure, improved efficiency in the use ofthese resources and overall faster economic growth. The Project will enable IL&FS topromote commercially-viable infrastructure projects on a much wider scale than heretofore.By giving such investments a clear commercial orientation, the concept adopted by IL&FSfor their implementation is expected to induce better cost recovery, faster construction, theapplication of improved maintenance policies, the introduction of technologicalimprovements, better utilization of the infrastructure capacity, and better interaction betweenusers and providers of services. The project will also provide the company with theappropriate institution-building and technical assistance support required to develop it into asuccessful infrastructure company. IL&FS will thus have become a rare institution in thedeveloping world, achieving what it does as a purely indigenous enterprise.

Risks

4.06 The Project -- innovative in its concept and design -- entails certain risks which areproposed to be mitigated in the following manner:

* first, the Project is breaking new grounds. The pioneering of commercial infrastructureprojects in India in itself constitutes a key risk, particularly in the absence of a well-established administrative, legal and regulatory regime. To mitigate this risk, IL&FS isusing great care in selecting ("cherry-picking") only those projects which it considers

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commercially viable, in establishing close partnerships with local authorities and otherstakeholders, and spending significant resources in developing appropriate contractualframeworks (e.g., concession agreements) for these projects. The Project will alsoensure that the public contracting parties will have access, whenever required, to expertadvisory services to ensure that the subprojects supported under the operation are theresult of a fair and responsible contracting and negotiating process;

secondly, BOT-type infrastructure projects are still relatively new to IL&FS and raisecredit risk issues quite different from the more traditional corporate finance andinvestment banking business in which IL&FS has so far excelled. IL&FS is building up acore team of professional staff and has agreed to build into its appraisal process a greaterdegree of reliance on outside consultants to complement its own resources. Systems arebeing put in place to ensure careful and comprehensive appraisal of projects which willbe reinforced by a close interaction with the Bank and specific financial eligibilitycriteria;

thirdly, there is a risk that IL&FS may have set excessively optimistic targets forimplementation of the subprojects in its pipeline. Thus, embedded in the project is also arisk of delays in disbursing the proposed loan. This could in turn induce IL&FS to eithershift towards simpler and less productive projects or rush the procedures and deviate froma proper contractual framework. A reasonable degree of conservatism has been built intothe financial projections discussed in Chapter 11. The close working relationshipbetween the Bank and IL&FS, the proposed covenants and onlending arrangements,including milestone provisions for disbursements, and Bank reviews and approvals ofindividual subprojects should also minimize the risk of IL&FS deviating from the prioritysector and project types as well as the agreed procedures. In addition, to secure aneffective role for the Bank in monitoring progress of implementation of the project, thesupervision plan provides for a significantly enhanced supervision effort by the Bank,particularly during the first two years of project implementation. (para. 3.09);

fourthly, IL&FS's involvement in a number of large and relatively complex projects,raises the risk of too rapid an expansion of its infrastructure operations. While it hasfollowed until now prudent management practices, it must continue to maintain a properbalance between growth and sound investments. The financial covenants proposed forthis project should provide appropriate checks on IL&FS's growth in infrastructure assetsand future exposure to infrastructure projects;

finally, the loan to IL&FS includes a new feature whereby the company will be allowedto use proceeds from the loan account and immediately swap them into Rupees in orderto protect itself from the foreign exchange risk on repayment of the loan. Appropriatesafeguards have been built into the terms and conditions of such Special Account and theassociated Swap Account so that the funds disbursed from the loan account are usedexclusively for the Project.

- 29 -

4.07 It is also worth noting that IL&FS itself, as a commercial entity, is well aware of theissues related to risks and risk management; this has been extensively reflected in itsOperating Framework (para. 2.09). The risk management framework and policies set out indetail (i) IL&FS' risk management philosophy; (ii) the objectives of risk management; (iii)the company's risk management process; (iv) the internal allocation of responsibilities; and(v) definition and types of risks incurred in IL&FS's various business activities.

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V - AGREEMENTS AND RECOMMENDATIONS

Agreements

5.01 Agreement has been reached with IL&FS that:

(i) it will provide to the Bank, on a timely basis, all important documents andinformation submitted to the Board for its consideration (para. 2.03);

(ii) it will implement a comprehensive cost accounting system by product line to befully operational by March 31, 1997 (para. 2.06);

(iii) it will submit its annual audited accounts to the Bank by June 30 of each year (para.2.07);

(iv) any material modification to the existing regulatory framework applicable toIL&FS, that adversely affects the operations of the company, will be an event ofdefault under the loan (para. 2.09);

(v) it will continue to conduct its operations in accordance with the principles andprocedures enunciated in its Operating Framework, as suitably revised, and that anymaterial modification to the Operating Framework, without prior approval of theBank, will be an event of default under the loan (para. 2.10);

(vi) it will maintain at all times a debt service coverage ratio of not less than 1.25 (para.2.17);

(vii) it will maintain at all times a debt to equity ratio of not more than 6:1 (para. 2.17);

(viii) it will apply eligibility criteria, acceptable to the Bank, to all subprojects to befinanced under the loan (para. 3.03);

(ix) it will onlend the proceeds of the loan on terms and conditions acceptable to theBank (para. 3.12);

(x) it will use the amounts deposited in the Special Account exclusively for executingswap transactions, on terms and conditions acceptable to the Bank, and it willdeposit the rupees obtained thereby in a Swap Account, payments out of which willbe used exclusively for eligible expenditures under the Project (para. 3.12); and

(xi) it will follow a methodology acceptable to the Bank for the economic analysis ofsubprojects (para. 4.04).

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5.02 Agreement has been reached with GOI that it will guarantee the proposed loan toIL&FS under terms and conditions satisfactory to the Bank, including the levy of a guaranteefee of not less than 1.2% on amounts outstanding and disbursed (para. 3.11).

5.03 Agreement has been reached with GOI and IL&FS that annual management reviewsof the Project will be carried out by April 30 of each year and that a mid-term review of theProject will be carried out no later than April 30, 1998 (para. 3.09).

5.04 Conditions of effectiveness of the loan to IL&FS will be that:

(i) IL&FS's Operating Framework has been revised to (a) set definite investmentexposure limits instead of guidelines, (b) limit to one third of its total creditexposure, IL&FS's credit exposure to infrastructure projects, as suitably defined, (c)limit to 30% of the company's net worth its aggregate investments in affiliates, assuitably defined, and (d) treat as equity all expenditures incurred by IL&FS oninfrastructure projects prior to their financial closure (para. 2.10);

(ii) GOI and IL&FS have entered into an indemnity agreement on terms and conditionssatisfactory to the Bank (para. 3.1 1); and

(iii) the security arrangements for the loan have been completed by IL&FS, includingthe placement of the loan under the mortgage shared equally with other lenders andthe execution of the intercreditor agreement (para. 3.1 1).

5.05 A condition of effectiveness of the development credit will be that the loan to IL&FShas been made effective (para. 3.05).

5.06 Conditions of disbursement for the investment component of the loan to IL&FS willbe, with respect to all subprojects, that the Bank will have reviewed and approved eachsubproject and that all contracts associated with the implementation of the subproject willhave been executed (para. 3.13).

Recommendation

5.06 With the above assurances, agreements and conditions, the proposed Project would besuitable for a Bank loan of US$200 million to IL&FS, to be repaid over a period of 20 years(including 5 years of grace) at the Bank's standard interest rate for LIBOR-based singlecurrency loans, and an IDA credit of SDR3.4 million (US$5 million equivalent) to India, tobe repaid over 35 years.

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ANNEX 2.1

INDIA


IL&FS: Composition of the Board of Directors

The Board of Directors has 18 members comprising the Chairman, the ViceChairman and Managing Director, I I non-executive directors and 4 executive directors.The present Chairman is also Chairman of HDFC. Other than the Chairman, 6 of thenon-executive directors are shareholder representatives including 2 from CBI, I fromUTI, 2 from ORIX Corporation, and I from IFC. Two other non-executive directors areprominent Indian industrialists, including the chairman of the Mahindra group. Theremaining three are current or former GOI secretaries.

Current members of the board are:

Messrs. - Deepak Parekh ChairmanChairman, HDFC

- Yoshihiko Miyauchi President, ORIX Corporation- Yoshiaki Ishida Managing Director, ORIX Corporation- Irving Kuczynski Director, IFC- Keshub Mahindra Chairman, Mahindra Group- K.M. Birla Chairman, Birla Group- RK Bhargava Secretary (Ret'd), GOI- RC Bhargava Chairman & Managing Director, Maruti

Udyog Ltd.- K Padmanabhiah Secretary, Ministry of Home Affairs- C Ramachandran Secretary, Ministry of Urban Affairs and

Employment- DK Contractor Executive Director (Ret'd) CBI- KC Chowdhary Executive Director, CBI- BG Daga Chief General Manager, UTI- Ravi Parthasarathy Vice Chairman & Managing Director,

IL&FS- Vimal Bhandari Executive Director- Ashok Totlani Executive Director - Infrastructure- Arun K Saha Executive Director & Company Secretary- Gopal Rajagopalan Executive Director - New Initiatives

INDIA


IL&FS organization chart

C.d l- W.

M.,m'' , m .

I an |~~~~~~~~;~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~02 $BMM MM 9" W3 X ff

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ANNEX 2.3

INDIA

PROPOSED PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT

Implementation of a cost accounting system

1. IL&FS has in place well-developed high-quality accounting systems and internalauditing arrangements. Following the establishment of regional offices in Delhi andBangalore, the company has further strengthened its accounting system to better monitorthe operations of its various profit centers from a geographical perspective. What isneeded however is the capacity to carefully monitor the profitability of individualproducts marketed by the company. This has clearly not been a problem until now as thecompany has remained of a manageable size, thus enabling its senior management tokeep good track of the various business activities and their relative profitability, but notyet in a systematic manner. As the company grows rapidly and the number of productlines multiplies -- as is currently anticipated -- such monitoring will become increasinglydifficult. It is therefore necessary that, in anticipation of future growth, IL&FS startimplementing a comprehensive cost accounting system by product line so that it is fullyoperational by 3/31/97.

2. On an annual basis, the company's statutory auditor should certify to the Bankthat an adequate system of accounting for costs per product line is in place (to be certifiedas of 3/31/97). Such system shall be throughout the company for all major product linesand shall make available to senior management, division managers and the Board (as wellas the Bank) sufficient information to determine "gross" and "net" spreads per majorproduct line. Such a system shall take into account overhead costs, including marketing,product and project development, finanncing costs and other administrative burdens andshall require the development of a transfer pricing model or other formula for appropriateallocations. The "gross" spreads shall be before the allocation of overhead expenditures.If appropriate, IL&FS shall work with its statutory auditor or others to develop anappropriate transfer pricing model to determine such spreads.

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ANNEX 2.4

INDIA


IL&FS: exposure limits for commercial infrastructure projectsand

limits to investments in affiliates

* With regard to infrastructure investments, credits extended to infrastructure projectswill not exceed one third (33 1/3%) of the Company's total credit exposure.Infrastructure investments are those projects of a utility nature (e.g., powergeneration, power distribution; water supply, water distribution, transport facilitiesincluding roads, bridges, tunnels; airports, port facilities, water and air transportoperators or systems, passenger and freight handling facilities, rail systems andrailway operators; telecommunication operators, equipment and systems) which beara greenfield startup/major expansion risk or where the pricing of output or services issubject to Government approval. Excluded from this list will be infrastructureinvestments extended to creditworthy industrial houses where the infrastructureinvestment constitutes no more than 25% of the assets of the industrial house, or forwhich full and unconditional guarantees have been given by such industrial houses.Total credit exposure will include all forms of investment which are made by meansof instruments (including loans', lease contracts, guarantees, debt underwritings andother similar financial obligations) which are not counted as equity (as definedelsewhere in the risk management framework). Appropriate adjustments to a creditexposure will be made to reflect the proportion of debt service coverage met by a firmofftake contract of a creditworthy industrial house. Compliance with this covenantwill be reviewed in its entirety annually.

* Aggregate investments (including total credit exposure and equity as referred toabove) in affiliates of IL&FS will not exceed 30% of IL&FS's paid-in share capitaland unimpaired reserves. For purposes of this section, an IL&FS affiliate is to bedefined as an entity where IL&FS's share of the paid in equity capital is more than 331/3%. Excluded from this limit are long-term strategic investments made by IL&FSin developing its business activities2 .

including subordinated loans.

2 These include investments in the share capital of its stock-broking venture, asset management venture, autofinance venture, Kampsax India, Transroute.

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ANNEX 2.5Page 1 of 7

INDIA

PRIVATE INFRASTRUCTRE FINANCE (IL&FS) PROJECT

IL&FS: income statements, cash-flow statements,balance sheets, and selected financial ratios

(1991/92-2000/01)

INDIAPRIVATE INFRASTRUCTURE FINANCING (IL&FS) PROJECT

IL&FS: Income Statement(Rs. Million)

1991-92 1992-94 1994-95 1995-96 1996-97 1997-98 1998-99 199910 200-01

L Income

Interest IncomeLiquid Investments 99 28 80 126 89 97 104 112 119Current Maturities 200 314 260 372 396 444 607 717 853Corporate Bonds 208 448 181 222 244 241 216 212 210

Loans & AdvancesInfrastructure 15 78 55 153 290 425 560 670 760Others 53 81 371 414 344 413 574 741 888

Investment in Venture Capital 0 0 7 38 38 38 38 38 38

Dividend on Corp Investments 0 0 0 18 27 27 27 27 27ifrastructureIncomeProject 0 9 6 0 46 306 725 1,153 1,361

Bandra Kurla Complex 0 138 0 0 0 39 113 76 76

Total Interest Income 575 1,094 961 1,344 1,474 2,028 2,965 3,746 4,333

Lease IncomeLease Advance - Infrastructure

Interest 18 15 32 141 144 160 179 207 222

Lease Management Fee 5 4 3 9 12 15 17 20 21Lease Advance - Others

Interest 33 32 7 23 23 26 29 34 36

Lease Management Fee 10 6 6 2 2 2 3 3 3Lease Rentals 411 1,120 721 730 1,055 1,226 1,396 1,618 1,793Lease Rentals -Panvel 0 0 0 0 0 0 61 122 122Toll Income 0 2 3 2 3 3 4 4 4OperatingAssets 0 0 0 38 76 96 116 136 176

Total Lease Income 477 1,179 771 946 1,315 1,528 1,805 2,144 2,378

Fee Income toAdvisory Fees 84 90 113 125 230 278 333 400 488Project Management Fees 0 0 4 0 7 17 26 12 2 t Project Merchant Banking Fees 0 0 0 0 0 0 22 39 0

Total 84 90 118 125 237 295 380 450 490

Profit on Sale of InvestmentsQuoted Investments 139 137 158 0 166 213 266 328 393

Liquid Investments 0 0 0 24 0 0 0 0 0Total Profit on Sale of Investments 139 137 158 24 166 213 266 328 393

Total Income 1,275 2,499 2,008 2,439 3,191 4,063 5,417 6,668 7,593

IL&FS: Income Statement

1991-92 1992-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01

IL Expenses

Interest and Finance ChargesExisting Borrowings 997 1,623 1,161 1,290 1,054 929 901 768 610

New Borrowings 0 0 0 291 854 1,498 2,188 2,838 3,438

Less: Interest Capitalized -96 -101 -73 -109 -168 -109 -32 0 0

Net Interest Expenses 901 1,523 1,088 1,472 1,740 2,319 3,056 3,606 4,048

Administrative & General Expenses 54 119 154 167 195 234 281 337 404

DepreciationLeased Assets 234 577 345 303 469 566 669 798 922

Toll Road 0 0 1 1 1 1 62 123 123

Fixed Assets (Own) 13 29 23 32 42 46 72 97 96

Operating Assets 0 0 0 14 27 32 36 41 51

Total Depreciation 247 606 369 350 539 646 840 1,059 1,193

Total Expenses 1,202 2,247 1,611 1,988 2,474 3,199 4,177 5,002 5,645

Profit 73 251 397 451 717 865 1,240 1,666 1,948

H0

TINIALPRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT

HAFS: Cash Flow Statement (Rs. Million)

1991-92 1992-94 1994-95 1995-96 199697. s:1.997-9" 1998-9q9 199IM00O

Sources of Funds

Profit for the year- 7 3 251 397 451 717 865 1,240 1,666 198 ~ 3

Depreciation 247 606 369 350 539 6.46 840 1,059 1,193 4fLease Termunal A/C 0 2 3 4 1 90 286 491 517 727 913

Lease Rent Suspense -152 -240 2 1 3 3 112 90 103 113 5 947

Increase in Share Capital 102 217 98 176 0 0 86 0 0

Share Premiuum 0 600 980 510 0 0 863 0 0

New Borrowings 4,069 2,867 3,257 4,998 4,179 7,198 6,276 6,800 6,092 $4

Repayment of Bridge Finance 431 1,335 1,879 1,098 2,270 1,710 3,032 3,530 4,220 14762:

Repayment ofbLoanis &Advances 350 774 2,056 1,894 1,054 965 1,371 2,1482,6

Sale of Corporate Bonds 0 906 228 196 275 594 568 512 562: Z$

Sale of hinvestmnents 0 22 1,053 362 0 0 0 00

Panvel SPC Deposit 0 0 0 0 388 500 1,184 -104 -104:::...165

Working Capital 210 -82 169 168 139 -51 -367 -139 -23 -.44..

5,331 7,278 10,548 10,324 9,960 13,007 15,714 16,311 17,528

Application of Funds

Bridge Finance Disbursement 141 1,706 2,369 2,050 1,500 2,960 3,530 4,220 5,000::::.'"

Loans & Advances Disbursement 840 1,569 3,401 2,000 1,700 2,650 3,050 3,600 3,900 1,0

Marketable Securities HI1 136 242 236 210 235 260 285 285 1,7

Corporate Bonds 913 93 870 300 350 400 450 500 500:.:,:,::

Lease Disbursemecnt 859 1,178 1,078 1,200 1,400 1,600 1,800 2,100 2,200::.

Own Assets 171 154 45 336 264 296 133 92 75:.

Rau Piaiampur 0 68 0 1 7 0 0 0 0 0 (

Operating Assets 0 0 59 550 0 250 0 250 250:,

Repayment of Borrowings (Old) 1,828 1,681 586 3,003 1,849 393 694 1,027 1,016 47

Repayment of Borrowings (New) 0 0 0 0 575 1,613 2,063 2,338 2,563

Redeinption of Preference Shares 0 21 0 0 0 31 0 0 0_

hivestment in Projects 0 0 6 1 0 1,056 1,777 3,131 2,074 1,550:'...

Investments 371 496 1,552 363 0 0 0 0 0. 0......

Institutional Complex 0 191 0 261 260 129 -522 -359 0.42

Panvel Bypass 0 0 0 0 620 500 952 00

Dividend 26 27 132 132 176 176 173 19019

Cash 71 -41 152 -124 0 -3 0 -5 1

5,331 7,278 10,548 10,324 9,960 13,007 15,714 16,311 17,528 4R

INDIAPRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT

HL&FS: Balance Sheet

(Rs. Million)

1991-92 1992-94 1994-95 1995-96 19967 .1.99-98 1998-99 1l999-00 2000-1:

ASSETSFixed Assets

Fixed Assets (Own) 311 465 603 939 1,203 1,499 1,632 1,724 1,799

LeasedAssets 1,663 2,641 3,217 4,585 5,977 7,525 9,262 11,271 13,424Leased WIP 216 321 624 456 1,084 1,636 579 670 717

Operating Assets 0 0 0 550 550 800 800 1,050 1,300

Project Assets 0 259 299 577 837 966 2,517 2,157 2,157

Less: Accumulated Depreciation -478 -989 -1,211 -1,561 -2,100 -2,746 -3,586 -4,644 -5,838

Total Fixed Assets 1,713 2,697 3,532 5,546 7,551 9,681 11,204 12,228 13,560

Long Term Investments

Premises Deposits 31 56 109 130 155 180 210 250 250

Deb/Bonds/Govt Securities 1,627 806 1,751 1,896 2,001 1,837 1,748 1,767 1,735

Unquoted Sbares 41 16 16 16 16 16 16 16 161

.. ..... .. . ..~~~~~~~~~~~~~~~~~~.

NewProjects-Debt 0 0 51 51 980 2,383 5,135 6,935 8,207p

NewProjects-Equity 3 11 224 224 351 724 1,104 1,378 1,656

Loans&LAdvances 1,013 2,962 4,730 6,237 6,144 9,112 11,315 13,649 15,660

Venture Capital 0 127 150 150 150 150 150 150 150Total Long Term Investments 2,715 3,978 7,031 8,704 9,798 14,402 19,679 24,144 27,674

Short Tern Investments

Bills of Exchange 786 425 354 281 250 218 191 0 0

Quoted Trade Investments 152 298 337 500 650 825 1,025 1,250 1,475

Units of Mutual Fund 303 344 509 179 209 239 269 299 329

Total Short Term Investments 1,241 1,067 1,199 961 1,109 1,282 1,486 1,549 1,804

Current Assets

Cash & Bank Balances 67 26 220 96 96 93 93 88 881,79

Trade Debtors 192 230 216 206 358 440 574 691 781342

Interest Accrued 86 24 63 254 279 398 580 761 880

AccruedRentalsnot due 316 557 536 503 390 301 198 85 26

Advance Tax 206 153 40 25 25 30 35 40 40

PrepaidExpenses 2 2 133 13 13 13 13 13 13

Total Current Assets 869 992 1,086 1,096 1,161 1,275 1,492 1,678 1,828

TOTAL ASSETS 6,538 8,733 12,849 16,307 19,619 26,640 33,860 39,599 44,866

IL&FS: Balance Sheet(Rs. Million)

1991-92 1992-94 1994-95 1995-96 1996-97 197-98 1998-9 19990 200041

LIABILITIES

Net Worth

Equity Shares 222 588 686 863 863 863 949 949 949

Preference Shares 52 31 31 31 31 0 0 0 0

P&L Surplus 109 119 106 380 921 1,613 2,663 4,140 5,898

DebentureRedemptionReserve 0 8 12 12 12 12 12 12 12

General Reserve 51 41 200 200 200 200 200 200 200

Investment Allowance Reserve 36 36 36 36 36 36 36 36 36

Share Premium 14 614 1,594 2,104 2,104 2,104 2,967 2,967 2,967

Contingency Reserve 0 67 117 117 117 117 117 117 117

Total Net Worth 484 1,503 2,781 3,742 4,283 4,944 6,944 8,420 10,178

Long Term Borrowings

Bank Term Loan 0 250 900 0 0 0 0 0 0

Fl Term Loan 1,942 2,098 2,432 1,633 1,282 1,868 2,253 2,405 2,547 I

Multilateral Agencies 272 272 1,056 2,042 2,740 3,519 4,047 4,876 5,804 4

IBRD Borrowing 0 0 0 0 929 2,332 4,208 6,008 7,000

OtherTermLoans 138 260 135 0 0 0 0 0 0

Deferred Credit 358 225 128 79 20 0 0 0 0

Fixed Deposits 10 4 3 253 625 1,125 1,375 1,750 1,875

Bank Overdraft 380 714 1,652 3,800 2,666 3,361 2,991 2,270 1,447

Floating Rate Bonds 0 0 0 500 900 900 1,000 1,000 1,250

Deposit from SPC 0 0 0 0 388 888 2,072 1,968 1,865

Total Long Term Borrowings 3,099 3,823 6,306 8,307 9,550 13,993 17,947 20,278 21,788

Current Liabilities

Short Term Loans 2,511 1,868 1,506 1,000 1,500 1,750 1,500 1,500 1,650

Debentures 0 1,105 1,656 2,156 2,556 3,556 4,556 5,556 6,306

Provision for Interest 111 129 88 395 477 607 772 902 1,012 IV

Sundry Creditors 277 45 63 103 385 435 253 328 403

Misc. Liabilities 18 107 193 304 568 1,059 1,576 2,302 3,216 HProposed Dividend 27 123 132 176 176 173 190 190 190

Customer Advance 10 24 56 56 56 56 56 56 56

Provision for Non Performing Assets 0 6 24 24 24 24 24 24 24

Provision for Investment Valuation 0 0 43 43 43 43 43 43 43

Total Current Liabilities 2,955 3,407 3,762 4,258 5,786 7,703 8,970 10,901 12,900

TOTAL LIABILITIES 6,538 8,733 12,849 16,307 19,619 26,640 33,860 39,599 44,866

IL&FS selected financial ratios

_- - -- --Debt:equity ratio

11.83 4.61 3.40 3.06 3.09 3.72 3.16 3.01 2.74Debt service coverage

ratio n.a. n.a. 2.21 1.47 2.14 2.00 2.10 2.24 2.45Return on net worth (%)

24.16 14.96 19.60 12.71 18.18 19.08 19.55 21.91 21.12Return on total assets

1.40 3.29 3.68 3.9 3.99 3.74 4.10 4.54 4.61

-43-

ANNEX 2.6Pikc of 2

INDIA


IL&FS's financial forecast: sensitivity analysis

A sensitivity analysis was carried out on IL&FS's financial forecast to assess theimpact of certain events on its future financial performance, as compared to the base casescenario discussed in Chapter II and Annex 2.5. The following scenarios are presentedbelow. Their respective outcomes are summarized in Attachment 1.

Scenario A: (a) commercial infrastructure assets grow at a slower pace to reach Rs.7,923 million (US$226 million) by March 31, 2001; US$150 million,instead of the projected US$200 million, is disbursed from the Bankloan;

(b) fee income increases by Rs. 150 million only over the 1995/96 figures;

(c) no income provision is made for capital gains on the proprietaryportfolio, the size of which remains the same over the entire period;

(d) leasing and investment banking assets are 20% lower than in the basecase through the entire period.

Scenario B: (a) same as above;

(b) fee income increases by Rs.65 million over 1995/96 (the establishmentof the AIG fund has already secured the receipt of such additionalincome);

(c) same as above;

(d) leasing and investment banking assets are one third lower than in thebase case.

Scenario C: (a) same as above;

(b) no increase in fee income as compared to 1995/96 results;

(c) same as above;

(d) leasing and investment banking assets are 50% lower than in the basecase.

-44-

ANNEX 2.6Attachment 1Page 2 of 2


Sensitivity Analysis Summary Results

1995/96 1996/97 1997/98 1998/99 1999/2000 2000/01Scenario A

Debt: equity ratio 3.06 2.86 3.33 2.80 2.77 2.66Debtservicecoverageratio 1.47 2.01 2.19 2.18 2.44 2.66Retumonnetworth(%/o) 12.71 15.94 15.87 15.52 17.00 16.10Retumontotalassets(%/6) 3.09 3.60 3.32 3.51 3.71 3.58

Scenario B

Debt: equity ratio 3.06 2.76 3.22 2.72 2.71 2.64Debt service coverage ratio 1.47 1.96 2.25 2.20 2.52 2.92Retum onnetworth(%/o) 12.71 14.40 13.12 13.25 15.49 14.78Retum on total assets (%/6) 3.09 3.29 2.80 3.05 3.41 3.28

Scenario C

Debt: equity ratio 3.06 2.64 3.00 2.45 2.40 2.33Debt service coverage ratio 1.47 1.89 2.26 2.27 2.70 3.01Retum on net worth (%/6) 12.71 12.02 11.40 12.57 15.07 14.17Retum on total assets (%/o) 3.09 2.78 2.52 3.06 3.53 3.38


INDIA


Subproject eligibility criteria

1. IL&FS, through a specialized group called Infrastructure Project Advisory Services, isconstantly developing a pipeline of projects, which constitutes the source of future business forits investment banking activities. The identification of potential investments is made throughpermanent contacts held by the company with major actors in the infrastructure field. Theiraction could be characterized as follows: (i) the continuous infrastructure needs searchconducted, on a regular basis, by relevant agencies in GOI and State governments; (ii) theidentification work being carried out by regional and local organizations, private as well aspublic, which also detect deficiencies and/or identify infrastructure requirements; and (iii)proposals raised by private groups interested in developing a certain undertaking which alreadyhas a tentative official approval. Upon receipt of the different ideas, IL&FS will screen theidentified projects, and start with the project appraisal cycle.

2. For the proposed Bank loan, eligibility criteria (Attachment 1) have been developed tosort out priorities for Bank lending and ensure replicability of subprojects. The latter willsimplify the processing of onlending requests, through obvious economies of scales that wouldundoubtedly occur. The eligibility criteria will be applicable to all subprojects to be funded withthe assistance of the proposed line of credit to IL&FS, unless otherwise agreed by the Bank on acase-by-case basis. These subprojects would involve private investments for capacityaugmentation and/or new facilities. The criteria specify, as an illustration, the priority sectorsand give examples of the types of subprojects in each sector. They also include essentialfinancial eligibility criteria for onlending.

-46-ANNEX 3.1Attachment 1Page 2 of 3

ELIGIBILITY CRITERIA FOR BANK-FINANCED SUBPROJECTS

Priority Sectors integrated urban infrastructure: (i) provision of urbaninfrastructure facilities and services for municipalitiesand similar authorities in an integrated manner; (ii)provision of infrastructure services for industrial estatesand/or economic zones.

t transport sector: (i) toll bridges; (ii) toll urban bypases;(iii) other toll roads where there is an alternative non-

tolled road.* water supply and sanitation sector: (i) water source

augmentation and distribution; (ii) sewerage works anddomestic sewage and industrial waste treatment anddisposal; (iii) utility management with augmentation andrehabilitation; (iv) solid waste management.

* DSubprject Size Maximum of US$200 million and minimum of US$1 0million.

O Capital Struture No more than 75% debt (senior and subordinated).eof he SPV Promoter's contribution to represent at least 25% of the.

equity. Subproject debt service coverage ratio of no lessthan 1.25 on an annual cash-flow basis.

* Development Subprojects should have been developed within prudent

gidelines& project development guidelines, including experiencedparticipants (e.g., construction consortium, O&M operator),turnkey fixed price contract with specific performance andadequate liquidated damage provisions, prudent contracts forofftake sales or concession agreements, operatingagreements, linkage among the contracts to reduce risk,adequate insurance, and adequate protection for minorityequity owners (such as IL&FS).

* IBRD Financial Maximum 25% of individual subproject cost. Proceeds ofParticipation the Bank loan would be onlent only to those projects in

which the entire financing package has been finalized(committed or raised) or in which promoter guarantees ofhigh quality have been provided prior to the finalization of

C________________ ;the completion of the financial package.

-47- ~~~~ANNEX 3.1Attachment 1

Page 3 of 3

* Financial IRR Minimum real FRR of 14% required for each subproject.

* Econonic IRR Minimum ERR of 12% required for each subproject, andtest of optimum investment time through first yearbenefit/cost > 12%, or its equivalent maximum net presentvalue at i=12%.

* Environmental and Subprojects shall conforn to environmental and socialSocial Requirements (R&R) requirements of GOI and IBRD. Subproject

appraisal, approval, construction and operation consistentwith IL&FS environmental and social policy andoperational procedures.

* Institutional & The contractual agreements, in form and substanceContractual satisfactory to the Bank, should clearly lay down the mutualArrangements rights and obligations of the various participants to the

subproject, and reflect a fair and reasonable allocation ofrisks among them. In addition, there should be no explicitor implicit government guarantee in support of thesubproject.

* Implementation For subprojects < US$60 million, a maximumPeriod implementation period of three years; else, a maximum of

five years.

-48-ANNEX3.2Page 1 of 8

INDIA


Subproject pipeline and implementation schedule

1. IL&FS has identified a long list of projects in transport, mass transit systems, power,telecommunications, water supply, sewage and effluent treatment and integrated areadevelopment1 . Some of these projects are large, like the multi-purpose road bridge across theGulf of Cambay connecting the eastern and western regions of the State of Gujarat (totalestimated cost when all phases are completed: US$1.6 billion), or the Bangalore Mass RapidTransit System involving the construction of 90 km of light rail at a total estimated cost ofUS$1.4 billion. However, the more typical IL&FS project ranges from about US$60 million(Delhi-Noida bridge, Panvel bypass) to around US$200 million (Tirupur, Mangalore areadevelopment projects). The projects vary also with respect to project preparation, with somealready reaching the final stages prior to start of construction (Panvel bypass and, to a lesserextent, Delhi-Noida bridge), while others are still at a preliminary stage (Adityapur intra-citylink, Gujarat roads and Mangalore area development). Most of the projects are beingpromoted by state governmnents. Some, for example, are promoted by a group of industries toenhance the infrastructure facilities within and around their location; this is the case, forexample, of the Tirupur area development progran, which is promoted by the TirupurExporters' Association (combined annual turnover: US$1 billion), or the Dewas water supplyproject, promoted by a large pharmaceutical company.

2. The company is aware that some of these projects may either slip or not be executedat all, while new subprojects may be incorporated in the course of implementing the proposedProject. The atttached indicative pipeline of subprojects form the core group of investmentsidentified for possible financing under the Project. It is a scaled down version of the above-mentioned list, bearing in mind that (a) commercial infrastructure projects take a considerabletime to develop, and (b) IL&FS can only gradually build up its capacity to handle thecorrespondingly large volume of appraisal work. This pipeline should be considered asindicative as further changes may occur during the implementation of the Project.

3. The attached tables show the individual projects with a brief description, the estimatedcost, the current status and the planned construction period. Each table includes projects tobe started in three successive IL&FS fiscal years, the first one covering the period April 1,1996 to March 31, 1997. Subprojects in the 1996/97 group, for example, are quite advancedin general and have a high probability of being implemented soon: this is the case, forexample, of the Panvel bypass and the Delhi-NOIDA bridge where IL&FS is acting as projectsponsor and setting up joint ventures with other parties (contractors, toll operators) for the

Normally, it means the development of an area to facilitate industrial growth. Typically, an integrated areadevelopment program envisages the provision of several infrastructure services such as: surface transport,power, telecom, water supply, drainage and effluent treatment, and commercial and/or housingdevelopment.

-49-A1NNEX 3.2Page 2 of 8

implementation of the projects. Subprojects in the latter two groups vary in their degree ofcomplexity of preparation; hence the probability of their being started within theimplementation period of the Project varies significantly.

INDIA


INDIATIY PROJECT PIPELINE

1996-97

No Name Description Cost Status Implementation(Rs Mn)

Start CommissioningPanvel Bypass - National Highway project 2072 - Feasibility studies completed Q3 1996-97 Q4 1998-99Maharash - 10.135-km, four-lane bypass - Executed final MoU

to Panvel town on National - Detailed engineering studies completedHighway 4 (NH4); includes - Update traffic study to be completed byone flyover, three river February 1996bridges, one ROB and seven - Concession agreement to be executedunderpasses. between MoST, GoM and IL&FS by

March 1996 o

2 Delhi-Noida Bridge - State project 2309 - Feasibility studies completed Q4 1996-97 Q4 1998-1999UP/Delhi - 550-m eight-lane bridge - Detailed engineering completed

across river Yamuna; with - PQ for turnkey contract issuedapprox. 3.50 km. approach - Shortlisting completed in November 1995roads and grade-separated - Bid document finalisation and issue byinterchanges February 1996

- Concession agreement between GoD,GoUP and IL&FS to be executed byApril 1996

at

INDIA


INDICATIVE PROJECT PIPELINE

1996-97


Start Commissioning3 Tirupur Area - State project 7782 - Initial feasibility studies completed Q4 1996-97 QI 2000-2001

Develop. Programme - An integrated area develop- - SPV incorporated (NTADCL)Tamil Nadu ment scheme including water - GoTN order issued authorising NTADCL

supply, drainage, effluent to draw water to implement scheme on atreatment, roads and telecom commercial basis

- Detailed project studies, includingengineering, financial, economic, contrac-tual agreements, bidding documents, etc.,to be completed by July 1996

- Roads works to be awarded for cons-truction by December 1996

- Water supply and related infrastructureto be awarded by February 1997

4 Dewas Water Supply - State project 1579 - Feasibility studies completed Q4 1996-97 QI 2000-2001

Scheme - The project seeks to - Agreement on recommended com-

Madhya Pradesh substantially augment the mercial framework for implementationwater supply to Dewas reached in December 1995industrial estate - Contractual agreements to be drafted by

March 1996- PQ notice to be issued by April 1996

5 Borivali-Virar - Indian Railway project 2800 - Engineering studies completed Q4 1996-97 Q4 1999-2000

Quadrupling Project - Project being implemented - Commercial space development plan to

Maharashtra on a commercial format be completed by April 1996- 60 km of additional track - Agreement with IR by April 1996- 6 new stations - PPM to be completed by June 1996- Commercial development - Financial and technical close by

of space September 1996 xII

INDIA



1997-98


Start CommissioningAdityapur Bridge - State project 570 - Initial screening report completed Q3 1997-98 Q3 1999-2000Bihar - 500-m, 2-lane high level bridge - TORs finalised

- 5-km approach roads - Appointment of consultants to be completedby March 1996

- Project documentation to be completed bySeptember 1996

- Financial and technical close by June 1997

2 Elevated Highway - National Highway project 1000 - Initial engineering studies completed Q3 1997-98 Q3 1999-2000Panipat - 5-km elevated highway on - TORs for additional studies to be finalisedHaryana National Highway I (NH I) by March 1996

- Project documentation to be completed bySeptember 1996

- Financial and technical close by June 19973 Bubaneshwar-Cuttack - State project 1472 - Feasibility study completed in December 1995 Q4 1997-98 Q4 1999-2000

Bypass - Bypass to National Highway 5 - Additional project documentation to beOrissa (NH5) completed by June 1996

- Includes roads & bridges - Financial and technical close targeted forQ4 1997-98

4 Gujarat Roads Project - State project 1500 - Initial screening report completed Q4 1997-98 Q4 2000-2001Gujarat - Widening and strengthening of - Preliminary Report to be completed by

existing two-lane state high- February 1996ways - Detailed project documentation to be

completed by November 1996- Financial and technical close by Q3 1997-98

0I

INDIA



1997-98


Start Commissioning5 Moradabad Area - National Highway & Ministry - Projects promoted by local exporters' Q4 1997-98 Q4 2000-2001

Development Programme of Commerce project associationUttar Pradesh - The programe envisages two - Land has been acquired

distinct schemes: - TORs completed in Nov. '95(a) Implementation of a 2-lane 600 - Project documentation to be completed by

bypass of 20 km on Q3 1996-97National Highway 24 (NH24) - Financial & technical close by Q3 1997

(b) Provision of captive power 1000 wfacility for Moradabad exportunits

6 Mangalore Area - State project 7225 - Scheme has been approved by Govt. of Q4 1997-98 Q4 2000-2001Development Programme - Water supply scheme for KarnatakaKarnataka Mangalore industry and town - Cabinet approval for commercial

implementation of project expected byDecember 1995

- Project documentation to be completedbyQ3 1996

- Financial and technical close by Q41997-98 ___

Standby Project for FY 1997-98:No Name Description Cost Status Implementation

(Rs Mn)Start Commissioning

Worli-Bandra Link Bridge - State project 6331 - Feasibility studies completed Q4 1997-98 Q4 2000-2001Maharashtra - 1 2-km, 6-lane, partially cable- - Approval of MoEF for EIA awaited

stayed bridge - Financial and technical close targeted for Q4- 5.8-km approach roads 1997-98

INDIA



1998-99


Start Commissioning

I Vasai-Virar Area - State project 12000 -Initial concept has been proposed for Govt. Q4 1998-99 Q4 2003-04

Development Programme - Provision of water, transport of Maharashtra (GoM) approval

Maharashtra and related infrastructure to -GoM approval expected Q1 1996-97

rapidly developing region -Preparation of project documentation to

north of Bombay commence in Q2 1996-97

2 lndore-Bhopal Highway - State project 2000 -GoMP to tender for BOT operators Q1 1998-99 Q1 2003-04

Madhya Pradesh - 200-km state highway linking -Selection of BOT operators targeted for Q3

Indore, commercial capital of 1996-97 n

Madhya Pradesh to Bhopal -IL&FS review to appraisal targeted for Q4administrative capital of MP 1996-97

3 Tuticorin Port - National Port project 7000 -MOST tender selection to be completed Q1 1998-99 Q3 2001-02

Tamil Nadu - Upgrading, modernisation and by Q2 1996-97expansion of existing port ona commercial format

4 Vizag Area Development - State project 5000 -Vizag municipality and industry would Q2 1998-99 Q3 2001-02

Andhra Pradesh - 50 MGD water supply scheme be the sponsorsto industry to household -Preparation of project documentation to

- Effluent treatment scheme commence in Q2 1996-97

5 Outer Ring Road - State project 3000 -Proposal for implementation of outer Ql 1998-99 Q3 2001-02

Tamil Nadu - 60-km 2-lane highway ring road on a commercial format hasbeen accepted by GoTN-Initial screening report to be completedby December 1995-TORs to be finalised by February 1996-Preparation of project documentation tocommence from April 1996

-3Z

INDIA



Standby Project for FY 1998-99:


Start Commissioning

Gulf of Cambay - State project 50000 - Initial screening report completed Q4 1997-98 Q3 2002-03

Gujarat - Multi-facility bridge, includ- - MoU entered into between GIIC and IL&FSing road, rail, water, gas and - Project documentation to be completed byoil pipelines Q2 1997-98

- Approach roads- Area development

Qn

0Jac

-56- -56- ~~~~ANNEX 3.3Page 1 of 3

INDIA


IL&FS proposed training and technical assistance activities(summary)

Training

The development of infrastructure projects typically involves three distinct phases: (i)project identification and platning, (ii) detailed design and execution, and (iii) operation andmaintenance. Given the range of activities, IL&FS needs to deliver from within its ranks adiverse range of skills across infrastructure development and project management, including interalia, financial engineering, economic, legal and support functions. IL&FS has formulated acomprehensive staff development program, the details of which are contained in the project files.

In order to provide the appropriate skills to its personnel, the company proposes to have athree-tier staff development program aimed at providing specialized training based on thefunctional responsibilities of the staff. The method of achieving skill upgradation at variouslevels are as elaborated below:

* Junior level: IL&FS personnel would attend structured training courses, generally for aduration of 2-3 weeks, to familiarize themselves with techniques of project development andcommercialization of infrastructure projects, mainly as a public/private partnership. Courseswould consist of classroom training and case study presentations;

* Middle level: IL&FS personnel need to attend advanced courses on the formulation ofinfrastructure projects as well as develop expertise in designing innovative debt instrumentsand securitisation. The training program for such personnel would mainly be throughproviding avenues for interaction with experienced practitioners at workshops/seminars.Additionally, specially designed advanced courses would be delivered;

* Senior level: IL&FS personnel would be provided with an opportunity to visit projectsimplemented on a commercial format and interact with major bankers, suppliers, contractors,consultants, operators and concessionaires. Such interactions would expose them to the latestthinking on the nature and form of agreements reached, for implementation and operation ofsuch projects.

Additionally, it is proposed that international experts be invited to work along withIL&FS personnel on a focused basis in areas like risk assessment and allocation, bid evaluation,contracts and performance monitoring.

ANNEX3.Page 2 of 3

Technical assistance

IL&FS has identified a number of areas where detailed studies or focussed advisoryservices would be required to facilitate the evaluation and implementation of commercialinfrastructure projects. These are, for example, legal and regulatory framework applicable toBOT projects in sectors of IL&FS's interest, innovative financing for environmentalinfrastructure in medium-sized cities and townships, traffic forecasting, willingness to pay andfixation of user charges for water supply and road projects. A brief description of the proposedstudies is provided below. The results of these studies would be used by IL&FS and would beavailable to others on a selective basis.

Specific Studies:

* Contractual and legal documents: The main objective would be to examine the legal andregulatory framework applicable to sectors of IL&FS interest. Additionally the assignmentwould include preparation of an outline bid document to invite BOT operators. As a part ofthis document, evaluation criteria for selection of BOT operator in the sectors where IL&FSis actively involved would also be included.

* Financing environmental infrastructure in industrial townships: The main objective would beto examine innovative approaches to financing water supply, wastewater treatment andgarbage disposal as an integrated package. IL&FS has initiated some work as part of thepreparatory activities of the Tirupur integrated area development project, but this needs to besignificantly enhanced. The resulting model could be replicated in other industrialtownships. IL&FS will draw extensively from international experience, as there is nonecomparable locally. The scope of the assignment would include: (a) literature review andstudy of international experiences; (b) researching financial and regulatory instruments suchas municipal bonds, water tariffs, effluent charges, tradable pollution permits and self-enforcement; (c) applying these in two suprojects -- Tirupur and Mangalore; (d) negotiateingwith the Government to mainstream these instruments as an integral part of municipalfinancing; and (e) preparing the commercial documents for the two suprojects.

* Traffic forecasting: The principal objective of this study is to establish an appropriatemethod for forecasting traffic on the road network by relating it to population and socio-economic characteristics in its catchment area. It should be based either on a travel demandmodel, or other suitable method, that allows the analysis of the relationship between trafficvolume for each type of vehicles and specific economic variables. The study would includeanalysis of traffic and other information on two typical road stretches, where MOST hasalready undertaken traffic counts. The study should evolve a methodology using data basesas are generally available in the country, collection of specific primary information, andverify its consistency on the sample stretches.

-58- ANNEX 3.3

Page 3 of 3

* User charge estimation - Willingness to Pay: The main objective is to determine viable usercharges based on a willingness-to-pay assessment of users. The study would cover twosectors - water supply and roads. The consultant would be required to undertake user surveysand relate willingness to pay with service levels and income in the case of water supply andwith respect to perceived congestion and trip purpose in the case of road users. The studywould take into account the past literature and studies conducted abroad, and suggest anappropriate methodology for the conduct of such studies in India. It would be desirable if thestudy results in the construction of willingness-to-pay curves similar to indifference curves.

INDIA


IL&FS PROJECT CYCLE

MILESTONES J GOAL PROCESS STEPS RESPONSIBILITY DECISION/PRODUCTScreening - Assessment of initial feasibility a. Desk review IL&FS - Initial screening report

- Identification of critical issues b. Field investigations IL&FS/SPV/Sponsor Decision to proceed or otherwise- Examination of project eligibility with c. Interactions: IL&FS/SPV/Sponsor/ with the project

respect to IL&FS project selection criteria - Project sponsor/SPV Government- Delineation of IL&FS Role - Government- Initial risk assessment - Users

Scoping Consensus on: a. Interactions between IL&FS, IL&FS/SPV/ Sponsor/ - Memorandum of Understanding- Extent, scope and nature of project sponsors, SPV, government, Government (MOU)

preparation public, users, etc. Finalisation of Channels of- Allocation of responsibility Consultation- Methodology of study- Time frame '.

- Sharing of costs- Channels of Consultation

Finalisation of terms of reference - TOR to be finalised with respect to all a. Preparation of TOR SPV/Sponsor/Consultant - Terms of reference (TOR) for(TOR) for project preparation tasks to be undertaken during project - findings from screening and appointment of consultantsstudies preparation phase scoping

- technical components- execution arrangements

b. Verification of TOR and IL&FSconsistency check with IL&FSbusiness practices

Appointment of consultants - Selection of suitable consultants a. Selection of suitable consultants SPV/Sponsor - Consultants appointedb. Consistency checks with IL&FS

business practices IL&FS

iir

MILESTONES GOAL PROCESS STEPS RESPONSIBILITY DECISION/PRODUCTProject preparation - Establish technical, economic, financial, a. Field SPV/Sponsor/Consultant - Detailed feasibility and

environment and social viability - investigation investment banking report- Evolve a suitable procedure for the - surveys (DFIBR)

commercial implementation of the project - interactions - Environmental and social- Establish the contractual framework for - sector studies assessment report (ESAR)

the project including preparation of draft b. Technical and engineering SPV/Sponsor/Consultant - Contractual frameworkcontractual agreements studies documentation (CFD)

- Identify, assess and allocate risks c. Environmental and social studies SPV/Sponsor/Consultant - Detailed process ofassociated with the project during d. Market demand studies implementation, includingconstruction, operation and maintenance e. Economic analysis SPV/Sponsor/Consultant request for proposal/biddingphases f. Financial analysis SPV/Sponsor/Consultant documents and evaluation

g. Resource mobilisation plan Sl'V/Sponsor/Consultant criteria for selection of operatorh. Institutional and legal SPV/Sponsor/Consultant (DPI)

framework SPV/Sponsor/Consultant - Risk identification. assessmenti. Development of contractual and management plan (RMP)

framework Sl'V/Sponsor/Consultantj. Documentation for BOT operator

selection SPV/Sponsor/Consultant T- Performance standards- Execution arrangements- Evaluation framework

k. Risk analysis and allocation SPV/Sponsor/ConsultantInitial project evaluation - Review of draft project documentation by a. IL&FS verification IL&FS/Consultants - Initial project evaluation report

IL&FS b. Clearance/concurrence - Agreement on:- Clearances/approvals by government - State govemment clearance SPV/Sponsor - DFIBR

- GO[ clearance SPV/Sponsor - EAR/SAMP- MA concurrence IL&FS - CFD

-DPI

- RMPSelection of Operator Selection of a suitable Operator a. Issue of PQ Notice SPV/Consultant - Award recommendation

b. Shortlisting of Operators SPV/Consultantc. Bid document release SPV/Consultantd. Evaluation and selection of SPV/Consultant

operatore. Consistency check with IL&FS IL&FS

business practices

MILESTONES | GOAL | PROCESS STEPS RESPONSIBILITY DECISIONIPRODUCT

Project financial close -Translation of agreement into legally a. Negotiation of contractual IL&FS, SPV/Sponsor, - Final Project Evaluation Reportbinding instruments documentation between SPV, Govemment. Operator, - Signed:

- Finalisation of financial consortia for the government and Operator SPV/Merchant Banker a. Concession agreementproject b. Preparation of private b. Shareholders agreement

placement memorandum. and c. Construction agreementnegotiation with lenders and d. O&M contract agreementother shareholders Finalisation of project I

consortium- I.enders' agreement

Project Monitoring and Audit - Ensuring conformity to standards and a. Periodic progress report SPV/IL&FS - Compliance reportagreements during construction. b. Field visits IL&FS/Lenders - Annual auditoperation, and maintenance c. Interactions with IL&FS/SPV

- Ensuring compliance with respect to Govemment, SPV. Operator,disbursement procedures lender. MA. local

user groups, etc.

H

-62-ANNEX 3.5Page 1 of 3

INDIA


Subproject evaluation report

1. The development and financing of commercial infrastructure projects are highly complexoperations. IL&FS is expanding not only onto new grounds, but also into a demanding line ofactivities, where no experience is available in India. Because of its early involvement in thedesign of some projects, its extensive role in bringing them to financial close and their inherentcomplexity, IL&FS is compelled to set for itself high standards of project appraisal.

2. A project report will be the document that includes all necessary supporting data, analysisand recommendations for a proposed onlending operation to become a subproject of theproposed Bank loan. It will be the basic document that IL&FS submits to the Bank for reviewand. if applicable. for issuance of the Bank's no objection for the operation to become asubproject. To avoid duplications and possible misunderstandings, the project reports willresemble to a large extent what IL&FS will submit to its Board for project approval.

3. Attachment I shows, schematically, the agreed content of a typical project report. Withrespect to the section on "Sectoral Framework", IL&FS may have a problem in covering thisarea, in a comprehensive manner, in those cases where there is no official sectoral plan orstrategy, as its staff is not mandated, nor has the capacity to undertake this type of backgroundstudy. In such cases, IL&FS would strive to collect as much sectoral information as possiblethrough meetings with government officials and lending agencies, and review of relevantdocuments, and would take the results as a framework to check the overall economic viability ofthe sub-projects.

4. IL&FS is adequately getting organized to prepare project reports for each case. Most ofthe contents of such reports are already being covered by the company, although not in asystematic way. As indicated elsewhere in this SAR, IL&FS currently has an advanced input inindividual projects by providing advisory services to public agencies extending the concessions.These public agencies do not yet have the capabilities, nor the financial means to developprojects on their own in India. Thus, IL&FS is temporarily filling a vacuum, but at the sametime is getting valuable experience in project appraisal. The project report, in most cases, will bethe culmination of a lot of works that IL&FS will have been involved in through those advisoryservices.

-63-ANNEX 3.5

Attachment 1Page 2 of 3

CONTENT OF A PROJECT EVALUATION REPORT

* ... IL&FS'9s Role inTProject Brief history of IL&FS's involvement in projectPreparation preparation, other groups involved, coordination, details

on who prepared the report.* Sectoral Framework Available plans in relevant and related sectors,

consistency of proposed subproject with future sectoralplans, risk evaluation, proposal by promoter to improvesome sectoral issues.

* S*uproWect Technical Location, size, capacity, general configuration and layout,Description . . alternative designs, basis for selecting the design,

technical data, construction procedure, timetable,

proposed management.* Subproject Cost| Break-down of cost estimate, base data, physical and price

Estimate contingencies, interest during construction, fees.. Resource Availability Availability and estimated cost of construction materials,

water, power, human resources, social infrastructure, asneeded.

* Procurement Detailed description of procurement process, compliancewith Bank guidelines, expected subcontracts, samplebidding documents.

* Sponsor Members of consortium, previous experience,organization, management, staffing, legal constitution,technical/financial capabilities, assets/liabilities.

' Institutional & Details of all contractual agreements required for theContractual Framework commnercial implementation of subprojects.

* Implementation Timeframe.Framework

* Market Assessment Willingness to pay surveys for relevant income groups,representative samples, rejection criteria for inconsistency,forecasted users' behavior; existing, diverted andgenerated demand, its mix, forecasted demand, scenarioson variations of relevant economic variables, includingdifferent toll rates and structure; optimum tariff/price tomaximize revenues, recommended value, comparison withusers' perceived benefits and willingness to pay.

-64-ANNEX3.

Attachment 1 (cont'd)Page 3 of 3

* Economic Analysis Underlying rationale for the choice of each subproject,expected beneficiary groups, economic benefits and costs,each increment of investment to be feasible (marginalanalysis), staged construction, shadow prices, optimumtiming, economic indexes (ERR, NPV, B/C) if relevant.

+ Environment & In accordance with IL&FS policy.Social Assessment

f Financing Plan Identification of sources of funding, the nature of thefinancing instruments, their terms and conditions, the statusof financing commitments already received or to be received,the proposed security package and associated interereditorarrangements. Details of IL&FS financial involvement:amount and description of securities to be acquired(senior/subordinated/deep discount), including couponondebt, any equity kickers, repayment schedule, securitypackage, major lending terms or conditions for funding.

* Financial Analysis Detailed cash flow analysis, calculation of FRR. Base caseproformas of revenues and costs by major categories; majorassumptions, including taxes, interest and operating costs(fuel and O&M, escalation rates, currency rates). Indicationof the next actions involved for reaching financial closure,clearances/approvals to be received from DEAIRBI, etc.Audit arrangements for the project presentation of thefinancing plan for the project, with distinction between"during construction" and "after commissioning", if required.

* Risk Analysis; Risk due to uncertainties on cost, financing shortage,Sensitivity demand, Government policies, tariff/price levels, users'

behavior, actions to be taken by other parties, competingprojects, and currency fluctuations. Sensitivities.

* Required Clearances detailed list of official authorizations/clearances obtained andto be obtained, estimated required timing.

-65- ANNEX 3.6

INDIA


Performance monitoring indicators

INPUT INDICATORS 4 Overall loan disbursement (cumulative, computedannually)

4 Technical assistance to IL&FS (consultants' inputsin staff-weeks/ training of IL&FS staff in staff-days)

4 Technical assistance to public. authorities(consultants' inputs in staff-weeks)

PROCESS INDICATORS 4 Financial closure of subprojects (# of projectsclosed per year)

* Magnitude of private sector funds leveraged4 Start of construction of subprojects (# of projects

started per year)* Subproject commissioning of projects

commissioned per year)

OUTPUT INDICATORS 4* Kilometers of roads constructed/improved4 Liters/day of water delivered* Cubic meters of waste water/effluentrteated* Kilometers of sewers built*: Number of houses built

OUTCOME INDICATORS 4: Vehicle usage (traffic eounts on roads/bridgeaillink built)D Daily water consumption (domestic, Industial)

4 Ratio of final cost vs. closure estimate by :subproject

4 Ratio of actual vs. projected construction period

IMPACT INDICATORS 4 Growth in industrial output in subproject area4 Reduced transportation costs* Improved water quality4* User satisfaction (% of surveyed)


Supervision Plan

Total Estimated number of subprojects in the pipeline 18

of which: transport 10

integrated area development (IAD) 6

others 2

P = Preparation C = Construction 0 = Operations

Y Subproject Development Lifeline Supervision Requirements (in staff weeks)

Task Manager/ Environmental Social BOT Expert Economist Technical Annual_ Transport I TAD Others Financial Analyst Specialist Specialist Experts Total

95/96 P 5 3 7 7 6 6 4 4 10

C -- -- -- -- -- -- -- -- -- 3

96/97 P 7 4 2 12 6 6 8 8 10C 3 2 -- 2 2 2 - 6O - -- -- -- -- -- -- -- -- 62

97/98 p 3 2 2 8 4 4 6 4C 7 4 -- 2 2 2 -- 10

mid term review5 5 5 3 6 66

98/99 P I -- -. 3 1 1 4 2

C 7 6 2 4 3 3 -10

O 2 -- -- 3 1 1 2 38

9/2000 P 1 -- -- -- I I -- --

C 4 6 2 3 3 3 - 8

O 5 -- -- 5 2 2 4 4 36

000/01 P I -- -- -- 1 --

C 4 2 2 3 2 2 4

O 6 4 0 5 2 2 4 4 30_ II] X "§ 7 4 1 . 12 I 33 80 269


Notes:

The plan is prepared on a rolling basis with subprojects moving from one phase toanother -- preparation, construction and operation -- over the successive years. Afurther 9 projects are expected to enter the preparation phase in FY96/97.

Tasks in subproject preparation will include the review of initial screening report,terms of reference for studies, study outputs (e.g., detailed feasibility reports, EA/SA,EMP, RAP, IPDP), project agreements and other legal instruments. Duringsubproject construction and operation, execution of construction contracts,implementation of EMP, RAP and IPDP will be monitored.

The Bank review function will progressively reduce as IL&FS develops in-houseexpertise. As regards environmental and social considerations, an in-depth review ofthe ESR and IL&FS organizational arrangements will be reexamined during the mid-term review of the Project. Following the review, the supervision plan may need tobe modified.

-68-ANNEX 3.8Page I of 3

INDIA


Selection of BOT operators

1. In several cases, it is proposed that the BOT operator for the subprojects to be financedunder the loan will be selected competitively, following which the selected entrepreneur will befree to procure the goods. works and services required for the facility, from eligible sources,using its own procedures. It is essential then that, to enable IL&FS to use the proceeds of theBank loan to onlend to the subprojects, transparent and explicit procedures be followed in theselection of the BOT operator. Below is an outline of the general guidelines applicable to whatshould be an open and competitive process for selecting BOT operators. Naturally, the specificsof individual subproject specifics would bear heavily on the actual application of theseguidelines.

2. Selection of operators would normally be on the basis of price'. As such selectioninvolves operational and financial issues not usually faced in the procurement of goods andtherefore requires considerable effort from the operators as well as the entity in charge ofmanaging the competitive bidding process, it is recommended that a two-stage process befollowed that involves prequalification and selection from the prequalified bidders.

3. Stage I -- Prequalification. This involves the solicitation of interested private operators toconstruct, own and operate the subproject. Solicitation should be made through anannouncement published in the international and Indian press and also distributed to theembassies of member countries of the Bank. Interested firms would submit prequalificationstatements based on a prequalification document (Request for qualification -- RFQ) which setsout the information required from the developers and the evaluation criteria which are based onthe operators': (a) ability to raise equity and implement the subproject; (b) the operator'sfinancial condition, capacity to borrow and experience in raising equity; (c) technicalqualifications, including key personnel and experience with similar technology; and (d) projectdevelopment experience, which includes development of projects of a similar nature andexperience with private sector projects in developing countries. In their response, firms wouldoutline their experience and qualifications as they relate to implementing the proposedsubproject. The prequalification statements would then be evaluated using a "pass-fail criteria"approach based on the criteria set out, enabling the establishment of a short list of prequalifiedbidders.

This would typically be the case for water distribution systems, waste disposal, effluent treatment plants, power plants. etc.Variations thereon could also he used for tolls charged on road or bridge projects.


4. Stage II -- Selection. The prequalified operators would be required to respond to aRequest for Proposals (RFP) (bidding documents). The list of prequalified applicants could alsobe published in the international press to ensure that qualified manufacturers are aware of thesubproject. The RFP would be broadly structured under the following headings:

* Invitation to prequalified applicants

* Information for applicants

* Instructions to applicants

* Security package and financing structure

* Proposal evaluation and criteria for evaluation

* Applicants' proposal and supporting data

* Mandatory performance requirements and drawings

5. The RFP should also contain drafts of the contractual framework (e.g., concessionagreement and other relevant documents), feasibility and investment banking report, riskidentification, environmental and social assessment reports, and management plans. The RFPshould clearly define operating requirements, evaluation methodology, technical requirements,capital structure conditions for obtaining resources from IL&FS under the proposed World Bankloan, etc. The operators would submit their bid to develop the subproject based on the RFP. Apre-bid meeting of the prequalified applicants could be held to elicit their comments on the RFP.Clarifications based on the issues raised during the pre-bid meeting would then be issued to allprequalified applicants. Bids for the subproject would be evaluated and ranked based on theprice quoted for the service to be rendered. The responsive proposal with the lowest evaluatedtariff would be selected and given an exclusive right -- for a limited time -- to develop theproject. The selected operator would be required to finalize the subproject agreements withconcerned parties (Government. lenders, etc). The second and third ranked candidates would,however, be requested to keep their bids valid in the event the selected candidate does not fulfillan agreement satisfactorily. The RFP would stipulate a project implementation schedule whichthe selected operator would be required to adhere to and would be enforced through liquidateddamages contained in the subproject agreements. A minimum level of equity financing from theoperators could be required.

6. Evaluation Methodology. The evaluation methodology would of course vary with thetype of subproject and service to be provided. In general, the price of the service required (e.g.,price of water delivered) is a function of the operating efficiency and cost of the infrastructurefacility, as well as financing terms and operating regime. The concession agreement andaccompanying documents define the operating regime. The operators, in response to the RFP,are required to quote for each year of the concession, the price for the service to be rendered,based on prices for equipment, goods and services, as of 30 days prior to bid opening forexample. and other prices that might have already been furnished in the RFP. Based on the


quantity of service that will have been specified in the bidding documents (e.g., quantity of waterto be supplied to the distribution system, traffic volume, plant capacity and annual energy to begenerated) and the bidder's quoted prices, the revenue stream is computed for each year over thelife of the concession. The revenue streams are then discounted using a discounting ratespecified in the bidding documents to arrive at the "averaged discounted price or levelized tariff'which forms the basis of selection. The investors are also required, in their proposal, to furnish:(a) details of the cost of the investment; (b); construction schedule; (c) financing plan; (d) termsof financing; and (e) details of the calculation of the price of the service to be rendered. The loanproceeds will be disbursed against construction costs. The developer is therefore required toprovide details of the construction cost, i.e., cost of supply, civil works and installation, and thecalculation for arriving at the quoted price. Moreover, as a condition for obtaining finance fromIL&FS, the operator should be required to submit a construction contract satisfactory to IL&FS.


INDIA

PROPOSED PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT

IL&FS pari passu security structure

1. Security offered to the initial lenders to IL&FS was in the nature of a negative lien on thecompany's assets. With effect from November 30, 1993, security in the nature of a negative lienwas substituted by way of a pari passu security structure. The structure envisages that all thepresent and future assets (except those specifically exempted) of the company standhypothecated/mortgaged to Central Bank of India (CBI) acting as trustee to the present andfuture senior lenders. It is illustrated in the figure below.

Security structure

IL&FS Hypothecation/Mortgage Central Bank of India3(8rrower) & Power Attorney (trustee)

Responsibility to

ABC(Lenders)


2. The responsibilities of the trustee are as follows:

* Effective and valid creation of the security on the movable assets by IL&FSby way of registration of the charge with the Registrar of Companies (ROC) (other than theassets specifically excluded).

+ To ensure that the security coverage of 1.33 times the outstanding mortgage debtthereby secured is maintained throughout the currency of trust security.

* Effective and valid insurance cover for normal risk and for assignment ofassurance policies or registration of bank clause thereon in favour of the trustee/ existing andfuture lenders.

* Safe custody of all original documents of title, lease agreements, invoices,registration books and other documents of title, to ensure the due recognition of the interest ofthe Agent and Trustee and the existing and future senior lenders in respect of the leased assets bythe lessees and hirers and the due noting of the creation and registration of security created infavour of the trustee and various other matters as may be provided.

* Issue of periodical statements and certificates by the Agent and Trustee afterdue verification and various other matters as may be provided therein.

3. Under the security structure the company is required to maintain an asset cover of 1.33times the borrowings. IL&FS has to submit to the trustee each quarter an auditors' certificateconfirming that the asset cover is being maintained.


Documents that covers the pari passu security structure

Document Features

Memorandum of hypothecation of movable This document provides for creation of firstassets by IL&FS in favour of CBI (Trustees) charge on all the movable assets of IL&FS

in favour of Central Bank of India (CBI).

Power of attorney in favour of CBI as Agent This document authorizes CBI to receive alland Trustee for collection of lease rentals the amounts due to I1&FS by way of leaseand/or hire charges in respect of movable rentals and initiate legal proceedings, ifleased assets necessary, in respect of lease agreements

between IL&FS and its lessees.

Power of attorney in favour of CBI as Agent This document authorizes to executeand Trustee for senior lenders for creation of mortgages in a form acceptable to seniorfirst mortgage and charge on immovable lenders over all the immovable propertiesassets and assets of IL&FS.

Power of attorney regarding assignment and This power of attorney authorizes CBI tocharge of book debts and lease receivables recover all book debts of IL&FS, including

lease receivables.

Deed of covenant and undertaking from This is an undertaking from IL&FS to CBIIL&FS in favour of CBI as Agent and to furnish periodic statements containingTrustee for senior lenders to furnish description of the new leased assets alongperiodical statement of new assets/excluded with relevant documents.assetsTrusteeship letter by senior lenders to CBI to Authorization by senior lenders to CBI toact as agent & Trustee for and on behalf of act as Agent & Trustee on behalf of thethe senior lenders senior lenders and to accept and hold the

mortgages, charges and securities created byIL&FS in trust and for the benefit of thesenior lenders.

Acceptance letter by CBI consenting to act as Acceptance by CBI to act as Agent &Agent and Trustee for and on behalf of the Trustee on behalf of the senior lenders andsenior lenders to accept and hold the mortgages, charges

and securities created by IL&FS in trust andfor the benefit of the senior lenders.

New common loan agreement with new The new loan agreement between IL&FSsenior lenders and the proposed/new senior lenders

provides for creation of security on a paripassu basis with the existing senior lenders.

-74-ANNEX 3.10

Page 1 of 2

INDIA


IL&FS: foreign exchange risk management and treasury operations

Until now, IL&FS has hedged against foreign exchange (F/X) risk incurred inborrowing long term in foreign exchange (from IFC and ADB) by arranging with localcounterparties back-to-back loan swaps. In these transactions, the company exchanges aF/X liability for a rupee-denominated liability with repayment structures identical to theoriginal foreign exchange loan. In this fashion, the swap counterparty agrees, in acommercial sense, to take over the F/X obligations of IL&FS and directly services thelender. However, IL&FS remains the borrower on record and is liable for the loan and allother obligations and covenants.

So far, IL&FS has successfully executed three such swaps: one with IFCI and twowith the Export-Import Bank of India for F/X loans bearing maturities of 10 or 15 years.It is currently finalizing a fourth one with Bank of India for a USAID-guaranteed 30-yearUS$-denominated borrowing. Because there is no market in India for such hedgingmechanisms, loan swaps are strictly negotiated transactions subject to exchange rules andregulations imposed by both the Ministry of Finance (MOF) and the Reserve Bank ofIndia (RBI). Arranging a swap is a relatively time-consuming process as a creditworthyswap counterparty needs to be identified, the terns of the swap negotiated on atransaction-by-transaction basis, and approval of the proposed swap obtained from MOFand RBI,. Therefore, two basic conditions need to be met for these swaps to be cost-effective: (i) there must be a minimum size to the transaction, in the order of US$20-25million; and (ii) there must be predictability in the timing of the F/X liability so thatIL&FS can manage the transaction as efficiently as possible and avoid finding itself in asupplier's market.

IL&FS will use the same mechanism for managing its foreign exchange risk underthe Project. To facilitate the execution of swap transactions, a Special Account, with anauthorized allocation of US$25 million, will be established by IL&FS in a commercialbank, on terms and conditions satisfactory to the Bank. Amounts deposited into theSpecial Account will be withdrawn exclusively for the purpose of executing swaptransactions; the rupees obtained thereby will be deposited in a Swap Account, paymentsout of which will be used exclusively for eligible expenditures under the Project.

For the first deposit into the Special Account, IL&FS will submit to the Bankcopy of the draft negotiated swap agreement as documentation for the withdrawal of theauthorized allocation from the loan account. Within seven working days of disbursement

-75- ANNEX31DPage 2 of 2

by the Bank, the swap transaction will have to be executed and the rupees thus obtainedby IL&FS deposited in the Swap Account. If the swap is not executed within sevenworking days, IL&FS will have to refund the deposit.

For replenishment of the Special Account, IL&FS will submit, not only copy ofthe associated negotiated swap agreement, but also evidence of payments for eligibleexpenditures made out of the proceeds of the previous deposit in the Swap Account.

Any unutilized portion of a deposit in the Swap Account, or such portion requiredto be refunded under certain circumstances, will have to be refunded to the SpecialAccount for immediate refunding to the Bank in US dollars, using the exchange rate inforce at the time of the executed swap transaction.

It can be noted that ADB recently negotiated a loan with the HousingDevelopment Finance Corporation (HDFC) whereby arrangements similar to the onesdescribed above have been agreed and the use of the Special Account for swaps has beenpermitted.

ANNEX 3.11-76- Page 1 of15

INDIA


Environmental and social report (ESR)

The objective of the environmental and social report (ESR) is to put in place anenvironmental and social assessment process in IL&FS which adequately responds to GOIrequirements and, for subprojects involving Bank financing, the Bank's operational directives(ODs), namely OD 4.01 on Environmental Assessment, OD 4.30 on InvoluntaryResettlement, and OD 4.20 on Indigenous People, as well as Bank Procedures (BP) 17.50 onPublic Disclosure.

The process followed by IL&FS for preparing the ESR is summarized below:

(a) drafting of the ESR began in July 1995, as a recommendation of the Bankpreparation mission. The effort was led by IL&FS with the assistance of theNGO/Consultant -- Development Alternatives -- and guided by terms ofreference agreed with the Bank;

(b) preparation followed a consultative process involving independent experts,senior managers and Projects staff of IL&FS;

(c) IL&FS shared interim outputs with the Bank for its comments. The Bank'senvironment, social and legal divisions (ASTEN, ASTHR, LEGSA) and theDepartmental staff (SA2EI, SA2RS) reviewed these outputs. Additionally,IL&FS managers visited Washington in September and October 1995 forconsultation on the ESR;

(d) the final draft version of the ESR was discussed with the Secretary andofficials of the Ministry of Environment and Forests (MOEF) to obtain GOIconcurrence. IL&FS also consulted with NGOs;

(e) the ESR was formally approved by IL&FS's Board of Directors on November27, 1995; and

(f) responding to the advice given by Bank management to field-test theapplication of the ESR approach, IL&FS also prepared the detailedenvironment and social assessment report for the proposed Delhi-NOIDALink Bridge subproject. The report built on the previous initial environmentalexamination of the project and was prepared by National EnvironmentalEngineering Research Institute (NEERI) and AIMS Research.

ANNEX 3.11-77- Page2 of 15

The ESR, as a document, is in 3 volumes: Volume I -- Executive Summary, VolumeII -- ESR, and Volume III -- Attachments. It: (a) states the company's environment andsocial goals; (b) provides the contextual setting for the environmental and social assessmentprocess. (c) identifies the major issues in the priority sectors; (d) details the environmentalassessment and social assessment (EA/SA) process (operational procedures) that IL&FS willfollow when appraising subprojects; (e) outlines methods to moderate risks and liabilities dueto environmental and social factors; (f) specifies the organizational arrangements in IL&FS tomanage the environmental and social assessment process; and (g) spells out the staffdevelopment plan. Relevant regulations, guidelines, checklists and protocols are provided asan attachment to the report.

The EA/SA process framework is intrinsically linked to the company's project cycleand involves the following iterative stages: (a) screening; (b) scoping, including publicconsultation; (c) drafting terms of reference for the preparation of the EA/SA report; (d)preparation of EA/SA study by subproject proponents; (e) EA/SA review, institutionalinterface and public consultation; (f) translation into legal instruments of agreements on theEnvironrnental Management Plan (EMP), the Resettlement Action Plan (RAP) and theIndigenous Peoples Development Plan (IPDP); (g) implementation monitoring; and (h)annual environmental and social audit. The latter is a novel feature, and for the first time, itis being employed by a financial institution in India.

The executive summary of the ESR is provided below.

ANNEX 3.11-78- Page 3 of 15

INFRASTRUCTURE LEASING & FINANCIAL SERVICES LIMITED

ENVIRONMENTAL AND SOCIAL REPORT

VOLUME I: EXECUTIVE SUMMARY

November 1995


LIST OF ACRONYMS

ADR - Alternative Dispute ResolutionBOO - Build Own OperateBOOT - Build Own Operate TransferBOT - Build Operate TransferCBO - Community Based OrganisationCC - Corporate ConsultantCFD - Contractual Framework DocumentationCOD - Committee of DirectorsCPCB - Central Pollution Control BoardCRZ - Coastal Regulation ZoneDFIBR - Detailed Feasibility and Investment Banking ReportDPI - Detailed Process of ImplementationEA - Environmental AssessmentEAP - Environmental Assessment ProcessEAR - Environmental Assessment ReportED - Executive DirectorEIA - Environmental Impact AssessmentEMP - Environmental Mitigation PlanESMG - Environmental and Social Management GroupESR - Environmental and Social ReportFRI - Forest Research InstituteGOI - Government of IndiaIL&FS - Infrastructure Leasing and Financial Services LimitedIPDP - Indigenous People Development PlanISR - Initial Screening ReportITRC - Indian Toxicology Research CentreLA - Local AuthorityLAA - Land Acquisition AssessmentMA - Multilateral AgenciesMoEF - Ministry of Environment and ForestsMOU - Memorandum of UnderstandingNEERI - National Environment Engineering Research InstituteNGO - Non Governmental OrganisationO&M - Operation & MaintenanceOD - Operational DirectivePAP - Project Affected PersonPRA - Participatory Rural AppraisalR&R - Resettlement and RehabilitationRAP - Rehabilitation Action PlanREP - Risk Evaluation Process


RMG - Risk Management GroupRMP - Risk Mitigation PlanSA - Social AssessmentSAMP - Social Assessment and Management PlanSAP - Social Assessment ProcessSAR - Social Assessment ReportSDP - Staff Development PlanSIA - Social Impact AssessmentSPCB - State Pollution Control BoardSPV - Special Purpose VehicleTOR - Terms of ReferenceUMTS - Urban Mass Transit SystemWB - World BankWll - Wildlife Institute of India


EXECUTIVE SUMMARY

PURPOSE

(1) Infrastructure Leasing and Financial Services Limited (IL&FS) is pioneering andpromoting innovative approaches to infrastructure development in India. It is developinga pipeline of commercially viable projects which includes urban by-passes, mass transitsystems, water and sanitation infrastructure and integrated area development. Theprojects are to be developed as Build-Own-Operate-Transfer (BOOT) or Build-Operate-Transfer (BOT) schemes

(2) The environmental and social framework for IL&FS has been designed to be consistent,inter alia, with the BOOT/BOT framework. The ESR outlines the various policies,procedures and assessments that will enable IL&FS as a financial intermediary to ensurethat a project is developed in consonance with the ESR and is adequately protected fromattendant risks

(3) Thus, the purpose and aim of the ESR is to provide the Institution an overall frameworkto guide it in the identification, assessment and management of environmental and socialconcerns at the organisational and at the project level

(4) The ESR has been prepared by IL&FS with the assistance of Consultants - DevelopmentAlternatives - specialised in the field of environment and social issues. The process ofpreparing this report has included desk research on the legal and institutional framework,analysis of priority issues in the infrastructure sector, consistency checks withoperational directives of the World Bank and other multilateral agencies. There havealso been a series of discussions within and outside IL&FS for the preparation of theReport

(5) The ESR has been formally approved by the Board of Directors of IL&FS

ENVIRONMENTAL AND SOCIAL STATEMENT OF IL&FS

(6) The Environmental and Social Statement of the Institution commits each project to threecardinal principles:

(a) Enhance the quality of life and environment in and around the project location

(b) Prevent adverse environmental and social situations

(c) Mitigate possible adverse environmental and social impacts

While enhancement is the first priority, incorporation of prevention and mitigationmeasures will ensure minimal adverse impacts


(7) IL&FS is internalising this Environmental and Social statement into its businessoperations through detailed operational procedures including systems for continuousperformance evaluation and self regulation. The highlights of an Annual Environmentaland Social Audit will be made public alongwith the Annual Balance Sheet

LEGAL AND INSTITUTIONAL SETTING

(8) The legal and constitutional setting provides the context in which the environment andsocial statement and operational procedures of IL&FS is framed. Fundamental nationalcommitments are enshrined in the Constitution of India, while the Acts, Notifications,policies, rules and other documents issued by Central and State Governments provideoperational details. India also has obligations on environmental and social issuesthrough its participation in international conventions and treaties

(9) A number of specific regulatory instruments for environmental protection have beendeveloped by both Central and State Governments. Many of these have a bearing onIL&FS infrastructure projects. (India's contributions to and learnings from negotiationsfor international treaties have also helped immensely in sharpening the focus of theregulatory instruments currently in place). Most States and Central Government haveeither Ministries or departments of environment and forests as agencies dealing withenvironmental issues

(10) With its basic commitment to address environmental concerns in infrastructure projects,IL&FS has attempted to capture the essence of the regulatory framework in India and theexperience of the World Bank as embodied in its Operational Directives. It hasincorporated the strengths of both the World Bank operational directives and the Indianlegislation and policies in the ESR

(I1) Compared to the more specific legal instruments on environmental issues, thelegislations, notifications, rules and policies on social issues are relatively less definitive.While Constitutional provisions provide several guarantees to project-affected persons,international agreements on social and cultural issues have only limited application

(12) Given its concern for social issues associated with infrastructure projects, IL&FS hasdeveloped its policy and operational procedures based on the legal and policy frameworkin India and the operational directives of the World Bank

(13) In order to provide a benchmark for the discussion of possible entitlements in the R&Rprocess, the ESR provides a menu of typical impacts that project affected households andindividuals may experience. Against these impacts, the corresponding beneficiarydesignation and the possible entitlement options have been developed based on theoperational directives of the World Bank


(14) The actual combination of types of impact, beneficiaries and entitlement options willdepend on the specificities of a sub-project itself. It would, thus, be up to the SpecialPurpose Vehicle (SPV) and its sub-project consultants team to develop a coherentrehabilitation action plan. IL&FS will remain responsible for appraising it within theproposed operational framework

MAJOR ISSUES IN PRIORITY SECTORS

(15) While infrastructure projects deliver major benefits, the construction and operation ofeach type of project involves certain activities that could have adverse environmental andsocial impacts

(16) Presently, IL&FS focus in the infrastructure sector includes the following:

(a) Integrated Area Development(b) Water Supply and Sanitation(c) Transportation(d) Power

(17) Specific environmental impacts during the construction and operation phase of theproject will be identified, assessed and a suitable mitigation plan evolved. The exercisebegins with the identification of issues in the alternative project sites. The degree andmagnitude of these issues are captured in the subsequent investigations (EA and SAprocess). Resolution of these issues are incorporated in the project design

(18) Infrastructure projects are also often confronted with a range of socio-economic issues.The socio-economic impacts will vary considerably depending on the specifics of theproject location and the resettlement area. IL&FS is committed to:

(a) Fulfilling the legitimate needs of the project affected groups, and(b) Adopting a transparent process acceptable to the concerned stakeholders.

(19) The salient social issues related to infrastructure projects include:

(a) Involuntary Resettlement(b) Protection of Marginalised and Vulnerable Groups(c) Public Consultation and Consensus Building

(20) While IL&FS will aim to avoid involuntary resettlement, it may become inevitable insome of the projects. In such cases, the attempt will be to atleast restore, if not improve,the standard of living of the affected persons. IL&FS will ensure proper valuation ofland and assets, on entitlement policy for each category of impact, minimisation ofcumbersome procedures and a well developed compensation package


(21) In some of the infrastructure projects, there may be specific issues relating tomarginalised and vulnerable groups like the economically and socially disadvantaged;the elderly; women and children; the physically handicapped; and indigenous people. Asa general principle Il,&FS will aim at enhancing their opportunities

(22) In each project, IL&FS will attempt to establish an effective local mechanism sensitiveto socio-economic issues and capable of co-ordinating implementation of. various projectcomponents including RAP and IPDP. Non-Government Organisations (NGOs) andCommunity Based Organisations (CBOs) will play a critical role in this process whichwill also redress the grievances of the affected groups

OPERATIONAL PROCEDURES

(23) The environmental and social assessment process will dovetail with the IL&FS projectcycle. It is envisaged that at each stage of the project cycle, environmental and socialassessment issues would be addressed concurrently. Based on the foregoing principles, asummary of the IL&FS project cycle is provided in the table below

IL&FS PROJECT CYCLE SUMMARY

MILESTONE I RESPONSIBILITY ::PRODUCT

Screening IL&FS/SPV/Sponsor/ Initial Screening ReportGovernment

Scoping IL&FS/SPV/Sponsor/ Memorandum of UnderstandingGovernment (MoU)

Finalisation of Channels ofConsultation

Finalisation of Terms of L&FS,SPVSponsor/ Terms of Reference (ToR) for Reference for project Consultant appointment of consultantspreparation studiesAppointIent of consultants IL&FS SPV/Sponsor Cons-utants Ap oi nedProject Preparation SPV/Sponsor/Consultant Draft final documentation prepared

.acording to agreed formats.................................................................................................. ........................................................................Initial Project Evaluation IL&FS/ Consultants, - Initial Project Evaluation

' SPV/Sponsor ReportAgreements on projectdocumentation

Selection of Operator IL&FS;SPV/Consultant Award of RecommendationProject Financial Close IL&FS;SPV/Sponsor, Final Project Evaiuation

Government, Operator, ReportMerchant Banker Signing of Agreements

Finalisation of project financeconsortium

Project Monitoring and Audit IL&FS/SPV/Lenders Compliance ReportAnnual Audit

ANNEX 3.11-85- Page 10 of 15

(24) Based on the IL&FS project cycle, IL&FS has developed an Environmental & SocialAssessment process. IL&FS is committed to ensure that each project will rigorouslyfollow a detailed Environment and Social Assessment Process as summarised in the tablebelow:

EA/SA PROCESS SUMMARY

MILESTONE RESPONSIBILITY PRODUCT

Environmental/Social Screening IIL&FS, SPV/Sponsor. IL&FS - Environmental screening andwith SPV/Sponsor social screening as part of

Project Initial ScreeningReportDecision to proceed orotherwise

i ..................................... ............. ................................................................... ..........................................................................Environmental/Social Scoping I SPV/Sponsor/LA ' Scope and coverage of EAR/SARli .............................................................. .................................... I.............................. ............................. I...........................................Finalisation of Terms of IL&FS,SPV/LA/Consultant Terms of Reference (ToR) forReference for EA and SA appointment of consultantstudiesA ppointment of consultants IL&FS /SPV/Sponsor Consultants Appointedl EA/.SAStudy SPV/Sponsor through Draft EAR/SAR including:

Consultant - EMP- RAP

IPDP- Implementing Monitoring Plan- Institutional Responsibility

FrameworkRisk Allocation Framework

Review of EAR/SAR . IL&FS/SPV/Sponsor Clearance by GovernmentagenciesConcurrence by MAAgreement on EAR/SARactions

..................... .......... .............................................................. ........................................................................ Translation of Agreements into IL&FS/SPV/Operator/ Concession AgreementLegal Instruments Contractor, SPV & Government Shareholders Agreement

Construction AgreementO&M AgreementLenders Agreement

..... ....................................................................................................................... ;... .........................................................................

Project Monitoring IL&FS/SPV/Lenders I Periodic Monitoring ReportsAnnual Environmental and I Corporate Consultant Environment and social audit reportSocial Audit

ANNEX 3.11-86- Page 11 of 15

(25) The Environmental Assessment Process (EAP) will identify likely environmentalimpacts and evolve relevant mitigation measures. While the project will attempt toenhance environmental quality, it will at a minimum prevent or set in place appropriatemitigation measures. The EAP will be undertaken by a multi-disciplinary team ofconsultants with support from NGOs, CBOs, Government Agencies and due processes ofconsultation

(26) IL&FS is committed to ensure that the legitimate needs of the project affected groups arefulfilled through a transparent process acceptable to the concerned stakeholders. TheSocial Assessment Process (SAP) adopted will restore the quality of life, if not improveit, when compared to the situation before the infrastructure project. The SAP will beundertaken by a composite team drawn from among specialists like anthropologists,sociologists, community development experts; and others from non-governmentalorganizations (NGOs), community based organizations (CBOs), project affected personsand appropriate public institutions

ENVIRONMENTAL AND SOCIAL RISK MANAGEMENT

(27) IL&FS shall establish structures that will serve to minimise many of the normalinfrastructure project risks. Nevertheless, IL&FS will remain exposed to several otherrisks, especially relating to environmental and social concerns

(28) Major environment and social problems could adversely affect project operations,earnings and hence loan servicing obligations. Consequently IL&FS will placesignificant emphasis on a rigorous Environment and Social Risk Assessment, Analysisand Management at the project level

(29) In order to effectively manage the environmental and social risks attendant toinfrastructure projects, IL&FS will incorporate a risk evaluation process at each stage ofthe EA/SA process

(30) In essence, the risk evaluation process shall enable the Institution to develop appropriatemechanisms to manage and monitor risks on an on-going basis. Within IL&FS the riskevaluation process shall be implemented by the project team and the Risk ManagementGroup

(31) The risk evaluation process shall thus comprise of the following sequence of steps

* Risk Identification* Risk Assessment* Allocation of Risks* Risk Management including mitigation measures

(32) After the appropriate risk management systems are set in place, IL&FS will ensure theappropriate allocation of risk and the associated liabilities, through a contractualframework and, if feasible, insurance coverage

ANNEX 3.11

-87- Page 12 of 15

(33) Each project will have a responsibility framework outlining the extent of risk andassociated liability to be shared between each of the project stakeholders. Theinstruments through which this will be implemented, include:

(a) Risks/responsibilities of Government Concession Agreement

(b) Risks/responsibilities of SPV Concession Agreement,Lenders' Agreement, O&MAgreement, ConstructionAgreement

(c) Risks/responsibilities to be borne by Shareholders' agreementShareholders

(d) Risks/responsibilities to be borne O&M Contractby Operator

(e) Risks/responsibilities to be borne Construction Agreementby Contractor

ORGANISATIONAL SUPPORT

(34) IL&FS shall establish an organisational structure with the requisite expertise to facilitatecompliance with the ESR. It will inculcate and develop the requisite skills within theInstitution, and access complementary and specialised skills through the appointment ofExternal Consultants on an assignment basis

(35) The table below summarises the responsibility for each task within IL&FS. Thisallocation framework assigns departmental responsibilities with a view to integrating theenvironment and social assessment process with the overall project cycle. The processflow in terms of preparation, review and authorisation is geared towards ensuring thatsufficient independent cross-checks exist within the system to ensure effective processand management control

ANNEX 3.11-88- Page 13 of 15

SUMMARY OF IL&FS DEPARTMENTAL RESPONSIBILITY ALLOCATION

MILESTONE | PREPARATION |_REVIEW APPROVAL

Screening Project team Executive Director Committec Of

ESMG * (Infrastructure) Directors

Corporate Consultant **

Finalisation of TOR Consultants ESMG Executive

consistency check Director

(Infrastructure)

Appointment of consultant Project team ESMG

Review of EAISA Project team Credit Committee of

ESMG Legal Directors

Corporate Consultant RMG

ED (Infrastructure)

Translation ol agreements Legal ESMG ED

into Legal Instruments Project Team (Infrastructure)

RMG

Credit

Monitoring Project team ESMG Committee of

Corporate Consultants Directors

Environmental and Social Independent Consultants Committee of Board ofAudit Directors Directors

* ESMG Environmental and Social Management Group** Corporate Consultant IL&FS Corporate Consultant for

Environmental and Social Issues

(36) At the Corporate level, IL&FS will

(a) Create an Environmental and Social Management Group (ESMG) as a part of theProjects Department

(b) Appoint a Corporate Consultant for Environmental and Social issues

(c) Clearly delineate functions/across concerned Departments and provide thenecessary training required to ensure that the requisite levels of skills andawareness are developed within each of the concerned Departments

ANNEX 3.11-89- Page 14 of 15

\ (37) At the project level, IL&FS will ensure that the SPV/Project Sponsor appoints ProjectConsultants to undertake assignments on environmental and social issues in conformitywith its business practices. Project Consultants for social issues will be selected fromamong non-governmental organisations (NGOs), community based organisations (CBOs)or public agencies

STAFF DEVELOPMENT PLAN

(38) In order to position the organisation to achieve the objectives as set in the ESR, IL&FSwill implement a staff development plan. The Staff Development Plan (SDP) is orientedto facilitate the implementation of the environmental and social assessment process as anintrinsic part of the project cycle

(39) A number of Departments in IL&FS would be routinely involved in the preparation,review and approval of the various outputs emanating from the environmental and socialassessment process. At the present juncture, IL&FS staff have not been formally trainedwith respect to environmental and social issues. Thus, all concerned staff will initiallyundergo an orientation programme on the ESR and its application to project specificenvironmental and social issues. Subsequently, each Department will undergo trainingspecific to their responsibilities in the EA/SA process

(40) Training modules will include a combination of workshops, seminars, site visits andinteractions with project authorities. The responsibility for implementing the SDP inIL&FS will vest withi the Personnel Department

IL&FS - MULTILATERAL AGENCY INTERFACE

(41) As a financial intermediary, IL&FS will access funding from a variety of lendersincluding multilateral agencies such as the World Bank

(42) In order to ensure that the projects are in conformity with World Bank's ODrequirements and business practices, IL&FS shall submit the following documents forthe review of the Bank. The table below provides the institutional interface matrix

INTERFACE MATRIX

EA/SA MILESTONE OUTPUT TO BE SUBMITTED TO THEWORLD BANK

Screening Initial screening reportFinalisation of terms ofl reference tor EA and SA Terms of referencestudies

.4 ....... .... .... .... ... ........ ..... . ............. .......... .... ............ ....... .... ........................................................... ................................................Reviexw of EA and SA studies and mitigation Draft EAR and SAR according to agreed formatsplansTranslation of agreements into instruments e nders Agreement alongwith other Agreements

onitoring Compliance reportEnvironmental and Social Audit . Audit compliance report

ANNEX 3.11-90- Page 15 of 15

43) It is envisaged that World Bank concurrence to the output generated at each milestonewill be obtained prior to progressing to the next stage. However, when the capacity ofIL&FS is in place, it is expected that World Bank and other multilateral agencyconcurrence will be required only for the EAR and SAP Summary Reports and theagreements, prior to approving finances for sub-projects. This capacity building isexpected to take two years

IMAGING

Report No: 15364 INType: SAR

World Bank Document APPRAISAL REPORT I -ECONOMIC AND SECTORAL BACKGROUND ... 1.01 In mid-1991...

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Transcript of World Bank Document APPRAISAL REPORT I -ECONOMIC AND SECTORAL BACKGROUND ... 1.01 In mid-1991...