Report and Recommendation of the President to the Board of Directors

Draft 25 June 2007Sri Lanka Project Number: 40655 November 2007

Proposed Multitranche Financing Facility India: India Infrastructure Project Financing Facility

CURRENCY EQUIVALENTS (as of 15 October 2007) Currency Unit Re1.00 $1.00 1.0 $1.0 1.0 $1.0 = = = = = = Indian rupee/s (Re/Rs) $0.254 Rs39.32 $2.4178 0.705 $0.0085 117.61

ABBREVIATIONS ADB CAGR COBP DEA DFI EA EC EIA EIRR EMP EMS ESS ESMU ESSF FFA FI FIRR FMA FRBM FY FYP GDP GOI IDFC IL&FS IIFCL IPPMS JBIC KfW LIBOR MCA MFF MoEF MOF NGO PFR PIM PMU PPP Asian Development Bank compound annual growth rate country operations and business plan Department of Economic Affairs development financial institution executing agency environment clearance environment impact assessment economic internal rate of return environmental management plan environmental management system environment and social standards environmental and social management unit environment and social safeguard framework Framework Financing Agreement financial intermediary financial internal rate of return financial management assessment fiscal responsibility and budget management fiscal year five-year plan gross domestic product Government of India Infrastructure Development Finance Company Infrastructure Leasing and Financial Services India Infrastructure Finance Company Limited investment program performance monitoring system Japan Bank for International Cooperation Kreditanstalt fr Wiederaufbau London interbank offered rate model concession agreement Multitranche Financing Facility Ministry of Environment and Forest Ministry of Finance nongovernment organization periodic financing request project information memorandum project management unit publicprivate partnership

PSP RBI SEBI SPV SSF TA

private sector participation Reserve Bank of India Securities and Exchange Board of India special purpose vehicle Social Safeguards Framework technical assistance WEIGHTS AND MEASURES

km MW

kilometer megawatt

NOTES (i) The fiscal years (FY) of the India Infrastructure Financing Company Limited (IIFCL) and the Government of India end on 31 March of the following year. FY before a calendar year denotes the year in which the fiscal year ends e.g., FY 2007 ends on 31 March 2008. In this report, "$" refers to US dollars.

(ii)

Vice President Director General Director Team leader Team members

L. Jin, Operations Group 1 K. Senga, South Asia Department (SARD) A. Sharma, Governance, Finance and Trade Division, SARD C. Kim, Senior Finance Specialist, SARD V. Rao, Finance Specialist (Public-Private Partnership), SARD R. Nagpal, Counsel, Office of the General Counsel J. Perera, Senior Safeguard Specialist, SARD J. Roop, Environmental Specialist, Regional and Sustainable Development Department J. Srinivasan, Senior Control Officer, SARD

CONTENTS Page INVESTMENT PROGRAM SUMMARY I. II. THE PROPOSAL RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES A. Sector Performance and Investment Requirements B. Analysis of Key Problems and Opportunities C. ADB Strategy, Sector Assistance, and Policy Dialogue THE PROPOSED FACILITY A. Impact and Outcome B. Outputs C. Special Features D. IIFCLs Investment Program and Financing Plan E. Implementation Arrangements TECHNICAL ASSISTANCE PROJECT BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS A. Benefits and Impacts B. Assumptions, Potential Risks, and Mitigations ASSURANCES RECOMMENDATION i 1 1 1 2 8 11 11 12 12 13 14 18 18 18 22 23 24 25 31 38 47 56 62 64 66 68 69 84

III.

IV. V.

VI. VII.

APPENDIXES 1. Design and Monitoring Framework 2. Infrastructure Sector Analysis 3. Scheme for Financing Viable Infrastructure Projects through the IIFCL 4. Market Analysis of the Role of the IIFCL 5. Corporate Governance Framework for the IIFCL 6. ADB Assistance to the Infrastructure Sector 7. External Assistance to the Infrastructure Sector 8. Illustrative List of Subprojects for Tranche 1 9. Implementation Schedule 10. Summary Environmental and Social Safeguards Framework 11. Summary of Poverty Reduction and Social Strategy SUPPLEMENTARY APPENDIXES (available on request) A. Matrix on Lessons Learned from Financial Intermediation Loans for Infrastructure Development B. Financial Due Diligence Report C. Technical Assistance: Capacity Development for IIFCL D. List of Subprojects Sanctioned by IIFCL E. Financial Management Assessment F. Memorandum and Articles of Association of IIFCL G. Environmental and Social Safeguards Framework of IIFCL

INVESTMENT PROGRAM SUMMARY Borrower Guarantor Classification India Infrastructure Finance Company Limited (IIFCL) India Targeting Classification: General intervention Sector: Multisector (energy, transport, and communications) Subsectors: Energy sector development, multimodal transport and sector development Themes: Sustainable economic growth, and private sector development, capacity development Subthemes: Public-private partnership, fostering physical infrastructure development, institutional development Category Financial Intermediary. IIFCL shall ensure that for each subproject, initial environmental examination, environmental impact assessment, and the environmental management plan, as applicable, are submitted to the Asian Development Bank (ADB) for review and approval before submission of a Periodic Financing Request (PFR). An environmental and social safeguards framework (ESSF) has been developed (Appendix 10) to guide the environmental and social safeguards assessment of subprojects during implementation of the Investment Program. The Investment Program supports the Scheme for Financing Viable Infrastructure Projects through the India Infrastructure Finance Company Limited (the Scheme) for promoting infrastructure development through public-private partnerships (PPPs). Pursuant to its Scheme (Appendix 3), IIFCL will provide long-term debt financing at commercial rates for stand-alone nonrecourse infrastructure subprojects. IIFCL will prioritize the financing of PPP subprojects selected through transparent and competitive bidding process and assessed for commercial viability. IIFCL will finance subprojects only as a member of lending consortium where its total lending to any subproject will not exceed 20% of the total capital cost for the subproject. IIFCL, through the Government of India (the Government) has requested ADB for financing the Investment Program through a multitranche financing facility (MFF). The MFF, amounting to $500 million over 4 years (FY2007-FY2011), will finance eligible subprojects that are in accordance with the Scheme, and the agreed criteria. The Facility will consist multiple tranches. Each tranche will be for not less than $100 million. Poor infrastructure is Indias Achilles heel which is estimated to cost India 34% of lost gross domestic product (GDP) a year. India needs to increase its spending on infrastructure from 45% to 9% of GDP to achieve the growth projection of 9% during the 11th (FY2007FY2012) Five-Year Plan (FYP). With higher growth

Environmental Assessment

Investment Program Description

Multitranche Financing Facility

Rationale

ii targets and a rising population, even maintaining current levels of infrastructure will require a staggering increase in investment. The total investment required is estimated at about $475 billion during the 11th FYP. Public sector has been the main provider of infrastructure in India. However, public financing alone will not be able to generate the needed level of investment ($475 billion). Accordingly, the Governments priorities for bridging the infrastructure deficit includes (i) revising policies and regulations for enhancing private sector participation (PSP) in infrastructure development including through PPPs, (ii) strengthening the capacity at all levels for promoting PPPs, and (iii) enabling arrangements for bridging the enormous deficit in infrastructure financing especially for long-term funds through all possible sources. Corresponding reform measures are underway. Infrastructure sector reforms are enhancing the enabling environment and encouraging participation of PSP from domestic and international sources. In addition, significant efforts are ongoing for mainstreaming PPPs in the states and in central line ministries. While a paradigm shift from public financing to PPP modality requires time, these measures have already facilitated the application of PPP modality in sectors such as road and power. India has also witnessed a visible shift in financial sector policies since the 1990s. The reform measures have led to increased allocative efficiency of the financial system brought about by a reduction in intermediation costs, enhanced competition, and increased diversity of products and services. Notwithstanding these, the infrastructure finance market in India is largely characterized with inadequate flow of long-term funds. In this context, the Government is pursuing reforms in contractual savings (pensions and insurance) and the corporate debt market. Considering several interlocking factors including policy and regulatory inadequacies in infrastructure and financial sectors, the impact of the ongoing reforms will only be felt over the medium- to long-term and as a result, the already significant gap in infrastructure financing will further increase. These concerns were extensively discussed within the Government as well as with financial market experts and international institutions for framing innovative responses consistent with the PSP and PPP agenda. Among the options, establishing IIFCL to provide the much needed long-term debt at commercial terms specifically for promoting PPPs was considered important in view of the limited availability of longterm debt for infrastructure financing. Central to the Governments PPP development strategy, IIFCLs operating paradigm is guided by the Scheme approved by the Governments Committee on Infrastructure chaired by the prime minister.

iii The Government has also designated IIFCL as the debt manager of a $3 billion debt fund of the $5 billion India Infrastructure Financing Initiative. IIFCL, in partnership with Blackstone Group, CitiGroup, and Infrastructure Development Finance Company are the initial investors in the $2 billion equity fund of the India Infrastructure Financing Initiative. Further, IIFCL and 3i Group plc. have entered into a strategic partnership for equity and long-term debt financing for projects in power, port, airport, and road sectors. IIFCL is also expected to be the lead agency for utilizing Indias foreign exchange reserves for infrastructure financing. For this purpose, IIFCL is likely to establish two offshore special purpose vehicles. The proposed India Infrastructure Project Financing Facility (the Facility) will directly support the Governments infrastructure development agenda by enhancing the availability of the much needed long-term funds for infrastructure financing. With ADBs assistance through the Facility, IIFCL will provide funds at commercial terms with over 20-years maturity for infrastructure subprojects which is currently not being provided by the market. The Facility is an integral part of the ADBs sector strategy and complements ADBs parallel initiatives in contractual savings, corporate bonds, PPPs, and infrastructure development, all of which contribute to creating an enabling environment for infrastructure development in India. Impact and Outcome It is estimated that the $500 million Facility will help catalyze an investment of $2.5 billion$3.5 billion from the private sector for financing PPP subprojects. The success of the Facility in establishing a framework for implementing the Scheme could trigger substantial investments considering the convergence that will emerge as a result of the (i) expected support from the World Bank, Japan Bank for International Cooperation, and Kreditanstalt fr Wiederaufbau; (ii) commitments from international private equity sources including 3i Group plc., Blackstone Group, and CitiGroup; and (iii) the synergies envisaged from the proposed offshore special purpose vehicles for utilizing Indias foreign exchange reserves for infrastructure financing. The Facility will result in infrastructure development through increased PSP, thereby promoting economic efficiency and growth and reducing poverty. This is expected to have a multiplier effect on the infrastructure sectors as well as on the broader economy. Enhanced PSP through PPPs will contribute to containing and eventually reducing fiscal deficit. The Facility is also expected to strengthen the institutional capacity of IIFCL in credit risk management and project risk appraisal. Investment Program The Investment Program of IIFCL is estimated to cost $6.0 billion. Of which, IIFCL is expected to raise $3.0 billion (or 50%) from the domestic market including insurance, pension funds, and the

iv National Savings Scheme, and the balance of $3 billion (or 50%) from international capital markets and bilateral and multilateral sources including the Facility. Financing Plan The proposed Facility of $500 million will capture 8.34% of the total financing plan. India Infrastructure Finance Company Limited Financing Plan to FY2007FY2011 ($ million)
Item Asian Development Bank Local Market Borrowing Foreign Borrowing Total Amount 500 3,000 2,500 6,000 % 8.34 50.00 41.66 100.00

FY = fiscal year Source: Asian Development Bank estimates.

Facility Amount and Terms

A $500 million lending facility will be provided to IIFCL under a MFF, with multiple tranches at an interest rate determined in accordance with ADBs London Interbank Offered Rate (LIBOR)based lending facility, and such other terms and conditions set forth in the loan and guarantee agreements. IIFCL has provided ADB with (i) the reasons for its decision to borrow under ADBs LIBORbased lending facility on the basis of these terms and conditions; and (ii) an undertaking that these choices were its own independent decision and not made in reliance on any communication or advice from ADB. India will provide a sovereign guarantee, in form and substance acceptable to ADB, for the term of each loan as a condition precedent to the effectiveness of each tranche requested by IIFCL and provided by ADB pursuant to the terms of each loan agreement.

Subloan Terms

IIFCL will onlend funds received through the Facility (via subloans) to eligible subprojects on commercial terms based on an independent assessment of subproject risk. The eligibility of the subprojects will be assessed in terms of compliance with ESSF, the conditions of the Scheme, and additional criteria agreed with the Borrower. The onlending to an eligible subproject will be preceded by an upfront evaluation of subprojects to ensure compliance with the ESSF to ensure that all subprojects financed through the Facility comply with ADB safeguard requirements. The Facility will be available for a 4-year disbursement period (FY2007FY2011). The last date on which any disbursement under any tranche will be 30 November 2011. The last PFR will have to be submitted no later than 1 November 2010.

Period of Utilization

v Subproject and Subborrower Selection Criteria Each subproject and subborrower shall satisfy at all times the subproject and subborrower selection criteria as set out in the Scheme which includes, inter alia, appraisal for technical, economic, and commercial viability. In addition, each subborrower shall (i) be selected in accordance with ADBs Procurement Guidelines (2007, as amended from time to time); (ii) have adequate resources and financial capability to raise resources to complete and operate the relevant qualified subproject successfully; (iii) not be in default on any prior loan to any participating members of the consortium including IIFCL; (iv) be able to provide security as required by the consortium of lenders; (v) maintain appropriate financial record of income and expenditure to the satisfaction of ADB and IIFCL; and (vi) comply with ADBs and national and state policies, and laws and regulations relating to environment, resettlement, and indigenous peoples. IIFCL will be the Executing Agency of the proposed Facility, while the Ministry of Finance (MOF)-Department of Economic Affairs (DEA) will be the Executing Agency for the technical assistance (TA) grant. IIFCLs Board of Directors will provide policy direction and strategic oversight for the Facility. A project management unit (PMU) will be established by IIFCL to monitor, screen, and select subprojects in consultation with the consortium of lenders and oversee day-to-day implementation. The PMU will be supported by specialists with expertise in risk management and project advisory work. A senior officer, reporting directly to IIFCLs Chairman, will be appointed for ensuring compliance with the ESSF. The PMU will also have a dedicated finance and accounts officer to monitor project accounts and process claims. The PMU will report to ADB on implementation progress. Procurement and Disbursement All goods and services financed by the Facility will be carried out in accordance with ADBs Procurement Guidelines (2007, as amended from time to time). The individual loan proceeds will be disbursed in accordance with ADBs Loan Disbursement Handbook (2007, as amended from time to time). An imprest account will be established in a current account with a commercial bank acceptable to ADB. The initial amount to be deposited and to be maintained in the imprest account shall not exceed the lower of (i) the estimated expenditure for the first 6 months of implementation, or (ii) the equivalent of 10% of the tranche. IIFCL and the India have entered into a framework financing agreement (FFA) with ADB. The FFA satisfies the requirements established in Appendix 4 of the ADB document Innovation and Efficiency Initiative: Pilot Financing Instruments and Modalities. The FFA records the full set of assurances, warranties and representations on crosscutting themes, covering safeguards,

Implementation Arrangements

Framework Financing Agreement

vi governance, anticorruption, financial management, procurement, and disbursement and subproject selection. Before ADB accepts the PFR, India and IIFCL will ensure full compliance with the terms and conditions of the FFA. Periodic Financing Request The MFF transaction is accompanied by a PFR (PFR1), received from the borrower, for the first tranche amounting to $300 million. PFR 1 lists 24 potential subprojects, some of which will be earmarked for ADB financing. The subprojects are all in the road sector and are overwhelmingly under National Highway Authority of India. The total cost of the subprojects is about $3.32 billion, of which IIFCL's exposure will be about $500 million ($20 million$30 million exposure per subproject on average). Retroactive Financing Retroactive financing may be possible under individual loans for expenditures incurred up to 12 months before the signing of the corresponding loan agreement, with a ceiling of 20% of the loan amount. The Government and IIFCL have been informed that approval of advance procurement and retroactive financing does not commit ADB to financing any of the proposed subprojects. Each PFR will specify the nature of financing if retroactive financing is requested. A TA for an amount of $500,000 is attached to the Facility for (i) supporting capacity development within IIFCL for managing market and credit risks; and (ii) training IIFCL staff in subproject risk appraisal, management, and mitigation. An ongoing TA is building in-house capacity to ensure that subprojects financed by IIFCL adhere to the ESSF. This TA also supported the rating of IIFCL by an international rating agency for facilitating IIFCLs entry into the international markets. Project Benefits At the macro level, the Facility will help catalyze private sector investments for infrastructure development which will help contain and reduce the fiscal deficit at all levels. Financial closure of 64 subprojects sanctioned by IIFCL as of end September 2007 is expected to catalyze nearly $25 billion in investments, of which the Facility will help catalyze nearly $2.5$3.5 billion. The credit enhancing function of the Governments guarantee for IIFCL borrowings will also help channel latent sources of funds such as insurance and pension funds for infrastructure development. At the institutional level, IIFCL is designed to provide innovative financing options for supporting heterogeneous infrastructure delivery models by integrating a range of financing instruments (equity, debt, and guarantee) and financing sources (domestic markets, multilateral sources, international equity, domestic and international borrowings). In the process, IIFCL will also be able to leverage core competences of promoters and project development

Technical Assistance

vii agencies (including newly created PPP Cells in selected states and central line ministries) for building a shelf of PPP subprojects. The Facility will have a direct impact on poverty reduction by increasing farm and non-farm productivity. Empirical evidence suggests that that poverty incidence falls by 0.33% for every 1% growth in provincial GDP. Investment in infrastructure as a whole and on roads and transportation in particular has a direct contribution to this linkage by (i) reducing transactions costs; (ii) enabling economic agents like individuals, firms, and governments respond efficiently to demand; (iii) lowering costs of inputs used in production; (iv) opening up new opportunities for entrepreneurs; (v) creating employment especially in public works both as social protection and as a counter-cyclical policy in times of recession; and (vi) enhancing human capital by improving access to health and education. Risks and Assumptions The envisaged benefits depend on effective demand, IIFCLs institutional capacity, and the progress of the ongoing real and financial sector reforms. While PPP is emerging as the preferred mode for infrastructure development, capacity constraints will have to be addressed for transforming the potential for PPPs into a stream of bankable subprojects. This risk is being dealt by intensive support from ADB and other development partners for mainstreaming PPPs. In addition, upfront identification of potential subprojects for the first PFR of the Facility has been made. The ability of IIFCL to leverage government guarantee to generate low cost and longer tenor funds is critical for its catalytic role. This also depends on the market perception of the quality of IIFCLs pipeline, credit appraisal and disbursement procedures, risk management and appraisal systems, environment and social safeguard compliance procedures, and operational efficiency. Factors that mitigate these risks include (i) intensive appraisal of the subprojects by IIFCL; (ii) the emphasis of the Scheme on commitment to operational autonomy, good governance, and commercial orientation; and (iii) ongoing ADB and World Bank support to IIFCL for enhancing systems and procedures and human resource development. IIFCL will maintain a lean organization of core specialists for reducing cost overheads. Further, international credit rating required for accessing international capital markets will require IIFCL to adopt and maintain international best practices in corporate governance and financial management. Adverse impact of drop in the momentum of mainstreaming PPPs has been mitigated at the macro level through positive incentives by the Government for enhancing the bankability of infrastructure subprojects. In addition, state governments are proactively reducing constraints to infrastructure development for promoting economic growth.

I.

THE PROPOSAL

1. I submit for your approval the following report and recommendation on a proposed multitranche financing facility (MFF) to India Infrastructure Finance Company Limited (IIFCL), to be guaranteed by India, for the India Infrastructure Project Financing Facility (the Facility). The report also describes proposed technical assistance (TA) for capacity development of IIFCL and, if the Board approves the proposed loan, I, acting under the authority delegated to me by the Board, will approve the TA. The design and monitoring framework is provided in Appendix 1. II. A. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES Sector Performance and Investment Requirements

2. The Indian economy expanded significantly in fiscal year (FY)2006. According to advance estimates released by the Central Statistical Organization on 7 February 2007, the economy recorded a gross domestic product (GDP) growth rate (at factor cost) of 9.2% at constant (FY1999) prices, compared with 9% in the previous year. The increase in growth rates in recent years is reflected in the 11th (FY2007FY2012) Five-Year Plan (FYP) average annual growth target of 9% compared with the 10th FYP target of 8%. 3. High quality infrastructure is essential to harness the growth impulses in the economy. The Planning Commission has observed that poor infrastructure is Indias Achilles heel which is estimated to cost India 34% of lost GDP a year. The Planning Commission has estimated that India needs to increase its spending on infrastructure from 45% to 9% of GDP if it is to achieve its growth targets.1 Table 1 provides a comparison of Indias infrastructure availability. Table 1: Comparison of Infrastructure Availability in India
Population (million) 1,100 1,300 300 National Expressways (000 miles) 3.7 25.0 47.0 Major Airports 17 56 189 Electricity Production (billion of kWh) 652 2,500 4.000 Port Shipments (billion tons) 0.4 2.9 1.4

Item India PRC United States

kWh = kilowatt-hour, PRC = Peoples Republic of China. Sources: International Monetary Fund, United States Energy Information Administration, Morgan Stanley, China National Development and Reform Commission, and National Council of Applied Economic Research (India).

4. With higher growth targets and a rising population, maintaining current levels of infrastructure will require a staggering increase in investment. The total investment required is estimated at about Rs18,634 billion ($475 billion) during the 11th FYP by the Committee on Infrastructure headed by the prime minister. The estimated financing needs for major infrastructure subsectors during the 11th FYP include $50 billion$60 billion for roads, $15.5 billion for seaports, $200 billion for power (over the next 7 years), $10.9 billion for civil aviation, and $89.21 billion (over the next 7 years) for railways. A detailed sector analysis is in Appendix 2.

Chile, for example, is estimated to have spent about 7% of its GDP in 2006 on infrastructure while the estimated figure for the Peoples Republic of China is 9%.

2 B. Analysis of Key Problems and Opportunities

5. Public sector has been the main provider of basic infrastructure in India. However, public financingalready limited by the deficit reduction provisions of the Fiscal Responsibility and Budget Management (FRBM) Act 20032will not alone be able to generate the needed levels of investments ($475 billion) to improve infrastructure facilities. According to the 11th FYP, the targeted average GDP growth rate of 9% during FY2007FY2012 requires an increase in private investment for infrastructure from the historical average of 6.5% per year to nearly 12.0% per year. Accordingly, the strategy of the Government for bridging the infrastructure deficit includes (i) revising policies and regulations across sectors for enhancing private sector participation (PSP) in infrastructure development including through public-private partnerships (PPPs);3 (ii) enabling arrangements for bridging the enormous deficit in infrastructure financing especially for long-term funds through all possible sources; and (iii) strengthening the capacity at all levels for promoting PPPs for infrastructure development. The Government expects the shares of public and private investment through PSP including PPP in total infrastructure investment during the 11th FYP to be 70% and 30% respectively, compared to 83% and 17% respectively during the 10th FYP. Financing from multilateral and bilateral institutions during the 11th FYP are expected at around $40 billion to supplement resources raised in domestic and international markets. While the Government has pursued reforms for establishing a framework conducive for infrastructure development and broadening the range of financing modalities, significant scaling up of infrastructure investments still faces formidable challenges in the real and financial sectors. 1. Public-Private Partnership

6. Recognizing the significance of the role of private sector in infrastructure development, the Government has placed PSP and PPPs at the center of its infrastructure development strategy. The Governments framework and measures for promoting PPPs draw on international experience with appropriate adaptations to the Indian context4 include the following. (i) (ii) (iii) (iv) (v) Establishing a PPP cell in the Department of Economic Affairs (DEA) in the Ministry of Finance for coordinating the mainstreaming of PPPs nationwide. Institutionalizing PPP Cells in selected states and central line ministries for identifying and developing potential PPP opportunities, developing PPP projects, and bringing them to market for financial closure. Establishing India Infrastructure Project Development Fund for financing PPP project preparation activities such as conduct of feasibility studies. Establishing the IIFCL, the executing agency (EA) for the proposed Facility, for facilitating access to long-term funds for infrastructure development. Launching the Viability Gap Fund with a current annual allocation of about $340 million for encouraging PPPs.5

2 3

4 5

The FRBM Act, 2003 requires the Government to reduce the fiscal deficit by a minimum of 0.3% of GDP and the revenue deficit by 0.5% of GDP each year so that the fiscal deficit is reduced to 3% of GDP by March 2009. PPP projects are typically projects developed, implemented, and operated by bidders (stand-alone special purpose vehicles) where the private sector owns majority stake. Further, these projects have been selected on the basis of a competitive and transparent bidding arrangement and expected to build and operate infrastructure based on a concession with the Government. See www.infrastructure.gov.in and www.pppinindia.com. The Viability Gap Fund can provide catalytic assistance of up to 20% of the capital costs, through which it expects several projects to become bankable, attract private capital, and mobilize private sector efficiencies. This support is especially important for regions and sectors where PPPs are difficult.

3 7. Gaps in technical and management capabilities and in identifying market opportunities indicate that state governments and central line ministries have not yet fully grasped the potential of infrastructure development through PPPs. Accordingly, in catalyzing the PPP modality for infrastructure development, the DEA has emphasized awareness and capacity building for changing the values developed over decades of implementing public sector projects. While it will be some time before PPP modality is well anchored in the working of the state governments and central line ministries, it is encouraging to note that transport (road) and power (generation and transmission) sectors are already applying PPP modality and have generated a shelf of bankable PPP projects. PPP opportunities have been noted in the urban sector including urban mass transit. The Government is also emphasizing application of PPP modality in the health and education sectors. 2. Infrastructure Sector Reforms

8. The Government recognizes its important and expanded role in the changing economic and technological context for catalyzing PSP and PPPs in infrastructure development through (i) developing legal and regulatory frameworks and arrangements, (ii) planning and coordination, (iii) reforming institutions and developing partnerships among complementary institutions, and (iv) ensuring quality of infrastructure. In pursuit of these, policy actions have been taken across sectors to encourage PSP, both through direct PSP and PPPs. These reforms are designed to reduce risks by enhancing the enabling environment, provide stability to long-term cash flows and assist in project appraisal to facilitate financing. Table 2 below summarizes the major infrastructure sector reforms (Appendix 2). Table 2: Major Infrastructure Sector Reforms
Roads Model concession agreement for toll highways has been published. The National Highways Act, 1956, has been amended to attract private investment in road development, maintenance, and operation. A comprehensive national maritime policy is being formulated to establish the vision and strategy for the sector until FY2024. Private sector participation including foreign direct investment in ports is being encouraged. Establishment of tariff authority for major ports to regulate port tariffs. Major airports are being built or upgraded through PPPs. The process of building 35 smaller city airports using PPPs has been initiated. 100% equity ownership by non-resident Indians is permitted in airports. The Airports Authority of India Act has been amended to provide a legal framework for airport privatization. A new civil aviation policy has been tabled in the parliament proposing foreign direct investment of up to 74% in domestic carriers. A model municipal law has been developed to help states and urban local bodies enact reform legislation and to facilitate the development and disposal of excess land. The Urban Land (Ceiling and Regulation) Act, 1976 has been repealed. Innovative pricing structures are being adopted for attracting new customers. PPP-type initiatives are being considered for increasing capacity through the proposed dedicated freight corridors. The Electricity Act, 2003 and the National Electricity Policy, 2005 have been designed to facilitate competition, reduce technical and commercial losses, and provide remunerative returns on investments. The Central Electricity Regulatory Commission and 18 state electricity regulatory commissions have been established to regulate tariffs.

Seaports

Airports

Urban Infrastructure Railways

Power

FY = fiscal year, PPP = public-private partnership. Sources: Planning Commission, National Highways Authority of India, and Ministry of Power.

4 9. The DEAs lead role in mainstreaming PPPs (paras. 67) is facilitating coordination and sequencing of reforms for realizing intersectoral synergies. Further initiatives underway include (i) setting up state-level policy frameworks for enhancing PSP in roads and developing a mechanism for sharing traffic risk through annuity models and guarantees; (ii) developing a model concession agreement (MCA) setting out terms for PPPs for freight terminals, logistics parks, warehouses, and inland container depots, in railway operations; (iii) setting up an Airport Economic Regulatory Authority to determine capital expenditure needs, check monopolies, prescribe standards, and to set up a dispute resolution mechanism; (iv) increasing the concession period in ports; and (v) unbundling and financial restructuring of power utilities, implementation of availability-based tariff, setting up state electricity regulatory commissions, and issuing open access guidelines. 3. Infrastructure Financing

10. The infrastructure finance market in India is largely characterized with inadequate flow of long-term funds despite a large and diversified financial sector.6 The tenor of available funds from the domestic market is typically 10 years or less with a 23 year re-set clause, effectively making such funding short-term. This typically leads to front-loading of tariffs during the initial years of the project cycle which adversely affects affordability of the services for the low income end-users. Since user tariffs are required to provide for debt repayments, return on equity, and depreciation costs, tariff affordability depends on amortizing debt through smaller repayments over a longer period of time. In the absence of long-term fixed rate financing, stability of cashflows are difficult to achieve. Table 3 summarizes the available financing sources in infrastructure. Table 3: Financing Sources for Infrastructure Projects
Domestic Sources Equity Domestic developers (independently or in collaboration with international developers) Public utilities (taking minority holdings) Other institutional investors (likely to be limited) External Sources
International developers (independently or in

collaboration with domestic developers)

Equipment suppliers (in collaboration with

domestic or international developers)

Dedicated infrastructure funds Other international equity investors Multilateral agencies

Debt Domestic commercial banks (35 year tenor) Domestic term lending institutions (710 year tenor) Domestic bond markets (710 year tenor) Specialized infrastructure financing institutions
Source: Planning Commission, Government of India.

International

commercial banks (710 year tenor) Export credit agencies (710 year tenor) International bond markets (1030 year tenor) Multilateral agencies (over 20 year tenor)

Indias financial sector is large and diversified. The banking system comprises the Reserve Bank of India, the central bank, and a network of 93 commercial banks with over 61,000 branches, 196 regional rural banks, and 389 cooperative banks. In addition to commercial banks, the financial sector also includes non-bank financial companies, development finance institutions, insurance companies, and venture capital firms. Aggregate bank deposits were estimated at about Rs24,928.54 billion ($635.44 billion) in FY2006, a 25% increase over the previous year (which was itself 17% higher than the year before that). Non-food credit increased by about 19% during FY2006 to Rs18,014.13 billion ($459.19 billion). The Insurance Regulatory and Development Authority estimates that pension funds are worth Rs1,166 billion ($29.72 billion) and are expected to grow to Rs4,065 billion ($103.61 billion) by FY2024.

5 11. Infrastructure finance market is further characterized by the absence of an active longterm corporate debt market, asymmetric information on infrastructure projects, and inherent risks in financing infrastructure projects.7 Adding to the problem of inadequate long-term funds is the conversion of development finance institutions (DFIs), which had been the major source of long-term finance, into commercial banks. Further, the commercial banks in general have limited experience in infrastructure financing. 12. Development Finance Institutions. DFIs were originally established in the 1940s and 1950s to support industrial development through state intervention (directed lending). After financial liberalization in the early 1990s, subsidized funding to DFIs were discontinued. As intended, this led to the demise of most DFIs in view of their inability to compete in the market. DFIs that met prudential and regulatory requirements were allowed to convert into commercial banks by the Reserve Bank of India (RBI),8 the central bank. While the Industrial Credit and Investment Corporation of India merged with ICICI Bank Limited, the Industrial Development Bank of India became a commercial bank. Infrastructure Development Finance Corporation, promoted by the Government and government-owned financial institutions, undertook an initial public offering in January 2006 and became privately-owned and incorporated as Infrastructure Development Finance Company (IDFC). Infrastructure Leasing and Financial Services (IL&FS) incorporated in 1987, also broad-based its ownership. As compared to their equity, the loan books of IL&FS and IDFC are nearly full.9 Not being in a position to significantly expand their asset size, both IL&FS and IDFC have diversified into fee based activities such as project advisory, asset management (equity and debt investment funds), and project development. 13. Corporate Debt. The withering away of DFIs, should have prompted corporations to approach the market for resources, leading to a vibrant corporate debt market. However, domestic firms still rely more on banks and internal resources than on market borrowings, indicating weakness in debt markets especially secondary markets.10 A weak secondary market leads to an absence of benchmarks and an illiquid market for interest rate derivatives and hedging mechanisms does not provide investors the opportunity to exit investments. In response to these constraints, the commercial banks generally charge floating rates 11 which effectively makes a loan a short duration instrument and infrastructure providers pass on

Infrastructure projects are complex, capital intensive, and have long gestation periods that involve multiple and often unique risks to project financiers. Due to its non-recourse or limited recourse financing characteristic (i.e., lenders can only be repaid from the revenues generated by the project), and the scale and complexity, infrastructure financing requires a complex and varied mix of financial and contractual arrangements amongst multiple parties including the project sponsors, commercial banks, domestic and international financial institutions (FIs), and government agencies. The risk assessment for a project and its allocation will depend on the conditions including the type and location of the project, the sector, feedstock supply and off-take arrangement, and the proposed technology and so forth. Insufficient knowledge and appraisal skills related to infrastructure projects also add to the risk. 8 On 8 December 1997, RBI constituted a working group chaired by Mr. S.H. Khan to bring about greater clarity in the respective roles of banks and other financial institutions. The working group held the view that DFIs should be allowed to become commercial banks in order to facilitate efficient allocation of resources. 9 IDFCs equity book is currently around $192 million with a loan book of $3.6 billion. Currently, the Infrastructure Leasing and Financial Services has a total equity of $27 million ($436 million net worth) with an asset base of $2.2 billion. 10 World Bank. 2005. Indias Financial Sector: Recent Reforms, Future Challenges. Washington, DC. 11 At present, except for raising funds for infrastructure projects, commercial banks are not allowed to issue bonds with long maturities. Thus, there are not enough issuers of bonds. Restrictions have also been imposed on the investment activity of contractual savings institutions. As a result, lack of growth in bond investment persists.

6 hedging costs to the end-users. In addition, commercial banks largely depend on short-term deposits for funding and do not undertake long-term market borrowings.12 14. Reforms. Substantive and sustained institutional and market reforms in the financial sector are required to channel resources from domestic and internationally available debt and equity sources to infrastructure. Without reforms, it will be difficult to significantly enhance the market-based flow of resources from commercial banks, DFIs, as well as pension and mutual funds to meet the demand for infrastructure financing. (i) Government securities. RBI, has accorded priority to the consolidation of government securities and has re-issued existing securities to increase the floating stocks in the market, helping to increase liquidity in key benchmark maturities (310 years maturities). In the process, the maturity structure of government bonds has lengthened and a credible yield curve for government securities has developed, which now stretches to over 20-years maturity. This has created a benchmark for pricing long-term corporate debt including infrastructure bonds. Closely related to these developments are initiatives to strengthen the market for interest rate derivatives after RBI permitted the banks to engage in forward contract or interest rate swaps. The introduction of exchange-traded interest rate derivatives and the design of a sound risk management framework by the Securities and Exchange Board of India (SEBI), the capital market regulator, are important steps in this regard. These initiatives have positive implications on the corporate debt market. Over the medium-term these could lead to improved liquidity in infrastructure related financial instruments. Corporate debt market. Systemic measures for strengthening the corporate bond markets are ongoing pursuant to the recommendations of a high-level committee of the Government, the Patil Committee.13 The recommendations aim to (i) provide credit enhancements for instruments issued by financial institutions including special purpose vehicles (SPVs) for financing infrastructure projects. This measure would encourage long-term sources of debt especially from contractual savings institutions and foreign investors to invest in infrastructure; (ii) evolve a consensus on affordable levels of stamp duty on debt assignments; and (iii) implement a trading, clearing, and settlement system. 14 SEBI has been charged with the responsibility of providing a regulatory framework for the secondary bond market including establishing (i) a trade reporting system; (ii) clearing and settlement system; and (iii) an order matching system. In addition, RBI has drafted guidelines on the usage and offering of credit derivatives, specifically credit default swaps.15 Contractual savings. Going forward, the Government is expected to focus on reforming Indias contractual savings institutions namely, insurance, pension, and provident funds, which are the main sources of long-term funds. The Insurance Regulatory Development Bill, passed in December 1999, opened the insurance sector for PSP and allowed foreign equity up to 26% (increased to 49% in FY2005). A recent study estimated Indias unfunded pension liabilities at

(ii)

(iii)

12 13

Long-term government securities are usually absorbed by pension and insurance funds and held until maturity. High Level Committee on Corporate Bonds and Securitization (2005). 14 This measure is to give investors who have illiquid corporate bonds an opportunity to re-cycle them. 15 Source: RBI, DBOD. NO.BP.1409.157/2006-07, 16 May 2007.

7 Rs17,355 billion ($441.38 billion) or 55.9% of GDP. 16 Given the high ratio of national public debt to GDP at 84.9%, the contingent liability related to the unfunded-defined benefit pension schemes compounds Indias public debt problem. To address these issues, the Government embarked wide-ranging reforms of its pension systems including (i) discontinuing unfunded defined benefit pension schemes, (ii) introduction of a new pension scheme with defined contributions and requiring the funds in this new pension scheme to be privately managed, and (iii) the establishment of an interim Pension Fund Regulation and Development Authority. Privately managed pension scheme will allow the fund managers to explore the possibility of channeling pension funds to long-term infrastructure bonds. 4. India Infrastructure Finance Company Limited

15. Infrastructure is a critical determinant of productivity, inclusive development, national integration, and poverty reduction. Insufficient capacity across infrastructure sectors leads to a widening infrastructure gap, resulting in lower productivity, higher transport and logistics costs, reduced competitiveness, and slower growth. While these aspects are well recognized by the policy makers and corresponding reform initiatives are underway, several interlocking factors including policy and regulatory inadequacies in infrastructure sector persist. Despite initiatives by the Government for improving the availability of long-term funds, policy, institutional, and market gaps remain. The impact of the ongoing reforms in the real and financial sectors will only be felt over the medium- to long-term and as a result, the already significant gap in infrastructure financing will further increase. Innovative responses consistent with the PSP and PPP agenda are required for addressing the prevailing market inadequacies and at the same time keeping the infrastructure development agenda moving forward. 16. IIFCL was established on 5 January 2006 under the Companies Act, 1956 as a Government-owned SPV specifically in the context of (i) the magnitude of infrastructure investments required and very limited supply of long-term resources and (ii) the need to catalyze financing for PPP projects. Central to Governments PPP development strategy, IIFCLs establishment has been extensively deliberated within the Government and with experts such as the Patil Committee and international and domestic financial institutions. Asian Development Bank (ADB) and the World Bank have extended support to ensure IIFCLs autonomy and commercial orientation. 17. IIFCL has a lean capital and operating structure with paid-in capital of $76.3 million and authorized capital of $225.3 million. IIFCL is expected to raise (i) rupee debt of 10-year maturity and beyond, (ii) debt from bilateral or multilateral institutions, and (iii) foreign currency market borrowings. 17 IIFCLs market borrowings are government-guaranteed 18 to encourage funds resident in long-term financiers such as insurance and pension funds to invest in infrastructure. IIFCLs operating paradigm, the Scheme for Financing Viable Infrastructure Projects through IIFCL (or the Scheme) was approved by the Committee on Infrastructure chaired by the prime
16

This does not include liabilities related to defense employees, central and state civil pensioners, and the funding gap in the Employees Provident Funds. 17 Currently, IIFCL is holding discussions with Kreditanstalt fr Wiederaufbau (KfW) for 280 million ($395 million) loan. Japan Bank for International Cooperation (JBIC) is also considering a 70.5 billion ($600 million) loan under a JBIC-guaranteed United Loan Program. IIFCL has also approached the World Bank for a line of credit of $500 million. IIFCL plans to raise up to $1 billion through external commercial borrowing and has approached the Government and RBI for approval. 18 Currently, a guarantee limit of Rs100 billion ($2.54 billion) has been specified by the Government.

8 minister (Appendix 3). Pursuant to its Scheme, IIFCL will provide long-term debt financing at commercial rates for stand-alone non-recourse infrastructure projects or projects that are units of larger corporate entities. While IIFCL can fund both public and private sector projects, it prioritizes PPP projects selected through transparent and competitive bidding and assessed for commercial viability. The mechanism by which IIFCL performs its market enhancing role is analyzed in Appendix 4. The corporate governance framework of IIFCL is in Appendix 5. 18. IIFCL is expected to catalyze and promote PPPs by leveraging market-based project development skills and providing much needed long-term debt for financing infrastructure projects. This includes (i) extending support to infrastructure projects in partnership with institutions like IL&FS, IDFC, and National Highway Authority of India; (ii) considering PPP projects at the state and municipal levels e.g., roads, urban development, ports, tourism related infrastructure; (iii) providing financial instruments for enhancing investments in infrastructure, e.g., such as guarantees, debt, and equity; and (iv) establishing market benchmarks. Accordingly, the Government has also designated IIFCL as the debt manager of a $3 billion debt fund of the $5 billion India Infrastructure Financing Initiative. IIFCL, in partnership with Blackstone Group, CitiGroup, and Infrastructure Development Finance Company are investors in the $2 billion equity fund of the India Infrastructure Financing Initiative. Further, IIFCL and 3i Group plc. have entered into a strategic partnership for equity and long-term debt financing for projects in power, port, airport, and road sectors. 19. IIFCL is also expected to be the lead agency in using Indias foreign exchange reserves to finance infrastructure projects. Under this arrangement, IIFCL has been given in principle approval for setting up two offshore SPVs which will borrow funds from RBI and lend to Indian companies implementing infrastructure projects, or to co-finance their external commercial borrowings for such projects solely for incurring expenditure outside India. C. ADB Strategy, Sector Assistance, and Policy Dialogue

20. ADBs Sector Strategy. ADBs Country Operations and Business Plan 2007200919 recognizes that (i) the rapid growth envisaged in the 11th FYP cannot be achieved or even sustained at the current rate without the support of high quality infrastructure and (ii) the challenges in raising the estimated $475 billion investment in infrastructure over the 11th FYP period remain a major constraint in realizing the projected economic growth. The Governments development strategy for the 11th FYP emphasizes (i) continued focus on infrastructure development, i.e., road, rail, air, and water transport, power, telecommunication, water supply, irrigation, and storage; and (ii) measures to encourage PPPs for the financing, designing, implementing, and operating existing and new infrastructure subprojects. 21. ADBs Sector Assistance. Since India began to borrow from ADB in 1986, ADB has assisted public sector infrastructure projects especially in transport and power sectors. As of 31 March 2007, ADBs infrastructure portfolio in India includes 50 projects (energy, power, transport, roads, railways, and communications) totaling over $9.86 billion (Appendix 6). ADB also provided 114 TA projects totaling over $56.3 million as of 31 March 2007.

19

ADB. 2006. India Country Operations and Business Plan 2007-2009. Manila.

9 22. ADBs ongoing TAs20 are providing crucial support for mainstreaming PPPs (paras. 67) through the establishment of PPP cells in selected states and central line ministries and capacity building support for (i) PPP project preparation, appraisal, and evaluation skills; and (ii) operationalizing identified PPP opportunities. In addition, these TAs also support (i) refining the PPP policy and regulatory framework, (ii) improving bidding documents and procedures, (iii) compliance with public safety norms, (iv) building a PPP database, and (v) conducting valueadded research. ADB has also provided sector specific TAs for promoting PPPs.21 Through its private sector operations, ADB invested in two infrastructure equity funds and in the equity capital of IDFC. More recently, ADB provided assistance to a private sector power transmission project and a private sector liquefied natural gas terminal. 23. ADB has also provided extensive support for developing Indias domestic capital market. ADB-funded Financial Sector Program Loan 22 supported the development of a diversified, competitive, and market-based financial sector. Building on this, the Capital Market Development Program Loan23 helped establish an integrated national capital market system. ADB has also been actively engaged in insurance and pension reforms.24 These programs have increased operational and market efficiency and reduced costs and risks, improved market accessibility, strengthened investor protection, and enhanced the availability of long-term funds for infrastructure and industry. For promoting greater PSP, ADB also provided two financial intermediation loans for infrastructure development.25

ADB. 2006. Technical Assistance to India for Mainstreaming Public-Private Partnerships at State Level. Manila (TA 4890-IND, approved on 11 December, for $3.0 million). ADB. 2007. Technical Assistance to India for Mainstreaming Public-Private Partnerships at Central Line Ministries of the Government of India. Manila (TA 4993-IND, approved on 16 November, for $2 million). 21 ADB. 1998. Technical Assistance to India for Western Transport Corridor-Facilitating Private Participation. Manila (TA 2986-IND, for $1 million, approved on 9 February). ADB. 1999. Technical Assistance to India for Private Sector Participation in Electricity Transmission. Manila (TA 3380-IND, approved on 28 December, for $600,000). ADB. 2001. Technical Assistance to India for Preparing the National Highway Corridor Public-Private Partnership Project. Manila (TA 3752-IND, approved on 29 October, for $700,000). ADB. 2003. Technical Assistance to India for Development of High-Density Corridors Under the Public-Private Partnership. Manila (TA 4271-IND, approved on 18 December, for $700,000). 22 ADB. 1992. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to India for the Financial Sector Program. Manila (Loan 1208-IND, approved on 15 December). 23 ADB. 1995. Report and Recommendation of the President to the Board of Directors on a Proposed Loan for Capital Market Development Program in India. Manila (Loan 1408-IND, approved on 28 November). 24 ADB. 1999. Technical Assistance to India for Reform of the Private Pension and Provident Funds System and the Employees Provident Fund Organization. Manila (TA 3367-IND, approved on 26 December, for $1.0 million). ADB. 2000. Technical Assistance to India for Policy and Operational Support and Capacity Building for the Insurance Regulatory and Development Authority. Manila (TA 3460-IND, approved on 22 June, for $800,000). ADB. 2003. Technical Assistance to India for Pension Reforms for the Unorganized Sector. Manila (TA 4226-IND, approved on 25 November, for $1 million). ADB. 2003. Technical Assistance to India for State-Level Pension Reforms. Manila (TA 4548-IND, approved on 23 December, for $750,000). ADB. 2007. Technical Assistance to India for Implementing Pension Reforms. Manila (TA 4938-IND, approved on 8 June, for $1.0 million). 25 ADB. 1996. Report and Recommendation of the President to the Board of Directors on Three Proposed Loans for the Private Sector Infrastructure Facility. Manila (Loans 1480/1481-IND, approved in November). ADB. 2001. Report and Recommendation of the President to the Board of Directors on Proposed Loans to Infrastructure Leasing and Financial Services Limited and Industrial Development Bank of India and Proposed Technical Assistance Grant to India for the Private Sector Infrastructure Facility at State Level Project. Manila (Loan 1871-IND, approved in November).

20

10 24. Lessons Learned. While the overall assessment of the first financial intermediation loan was successful,26 the low utilization experienced in the second loan27 suggest the need to (i) incorporate flexibility in financing arrangements, (ii) address environmental and social safeguards issues at the project design stage instead of at the implementation stage, (iii) support PPPs, and (iv) improve ADBs capacity in subsovereign and non-sovereign public sector financing to respond to the changing environment and client needs. A matrix summarizing the lessons learned is presented in Supplementary Appendix A. In addition, the Country Assistance Program Evaluation for India28 also emphasizes effective demand as prerequisite for financial intermediary loans. It also underlines the need for addressing structural issues that affect mobilization of domestic resources as well as effective demand. 25. External Assistance. As of June 2006, the World Bank (including International Development Assistance) had an infrastructure investment portfolio of 56 projects, amounting to $11.3 billion. 29 Official Development Assistance loans by the Government of Japan have steadily increased since FY1990. As of March 2006, a total of 185 projects had been committed by Japan Bank for International cooperation (JBIC) for a total of 2,252.5 billion ($19.15 billion).30 The Government of Germany has made financial commitments to India amounting to 6.3 billion ($8.93 billion). In addition, Kreditanstalt fr Wiederaufbau (KfW) has extended 774 million ($1.1 billion).31 External assistance for infrastructure in India is summarized in Appendix 7. 26. Policy Dialogue. ADBs extensive support for the financial sector and infrastructure (paras. 2123) is in the context of sustained policy dialogue at various levels of the government. Substantive assessment32 underpinned the mainstreaming of PPPs through ongoing TAs (para. 22), among others, for developing a pipeline of bankable projects to establish effective demand for infrastructure financing. The ongoing dialogue has also led to amendments to the Scheme for incorporating best practices such as risk-based pricing and in-house risk assessment capacity in IIFCL. ADB extended support to develop IIFCLs business strategy in consultation with development partners and also enabled IIFCL to undertake international rating (para. 33). ADB also led the effort to establish a common environmental and social safeguards framework (ESSF) 33 of IIFCL which has since been endorsed by JBIC, KfW, and the World Bank (paras. 66-67). Policy dialogue also facilitated the adoption of international best practices in IIFCL with
ADB. 2003. Project Completion Report on the Private Sector Infrastructure Facility (Loans 1480/1481-IND) in India. Manila. 27 ADB. 2006. Project Performance Evaluation Report on Private Sector Infrastructure Facility. Manila. 28 ADB. 2007. Country Assistance Program Evaluation. Manila. 29 Available: http://www.worldbank.org.in/WBSITE/EXTERNAL/COUNTRIES/SOUTHASIAEXT/INDIAEXTN/0,content MDK:20195738. 30 Available: http://www.jbic.go.jp/english/oec/project/yen_loan_list.php. 31 Available: http://www.kfw.de/EN_Home/index.jsp. 32 ADB. 2000. Technical Assistance to India for the Development of Secondary Debt Market. Manila (TA 3474-IND, approved on 28 July, for $600,000). ADB. 2001. Technical Assistance to India for Enhancing Private Sector Participation in Infrastructure Development at the State Level. Manila (TA 3791-IND, approved on 11 December). The recommendation of these TAs emphasized the establishment of PPP units at central and state government levels to assist in project development and achieving financial closure considering that corporate long-term debt market remained undeveloped and suffered from a number of impediments, including limited participation by long-term market participants such as provident and pension funds and insurance companies, a weak secondary market, absence of a benchmark yield curve, and inadequate support infrastructure. 33 ADBs safeguards policies, namely, Involuntary Resettlement Policy (1995), Environment Policy (2002), and Policy on Indigenous Peoples (1998) require that the financial intermediary should have an adequate policy framework backed by institutional capacity to ensure that any subproject financed by the financial intermediary, using ADB funds, comply with ADBs safeguards policy requirements.
26

11 regard to financial management and review mechanisms (paras. 6869). As part of the ongoing policy dialogue, ADB plans to assess the progress in infrastructure financing and suggest evolution to the Scheme in view of the ongoing real and financial sector reforms. III. THE PROPOSED FACILITY

27. The Facility involving a loan of $500 million to IIFCL (the Borrower) will directly support the Governments infrastructure development agenda through enhancing the availability of the much needed long-term funds for infrastructure financing. With ADBs assistance through the Facility, IIFCL will be able to provide funds at commercial terms with over 20-years maturity for infrastructure subprojects, which is currently not being provided by the market. 28. The Facility is an integral part of ADBs sector strategy and complements ADBs parallel initiatives in contractual savings, corporate bonds, PPPs, and infrastructure development, all of which contribute to creating an enabling environment for long-term financing for infrastructure development. 29. Multitranche Financing Facility. The MFF is particularly well-suited for the Facility because (i) the MFF structure allows the flexibility to IIFCL in its investment decisions based on the readiness of subprojects which will dictate disbursement projections as well as fund raising plan of IIFCL; and (ii) the performance of the subprojects financed can guide the financing of further subprojects, among others, through incentives such as introduction of free limit for facilitating implementation. Further, the Facility supports IIFCLs institutional transformation in line with the evolving real and financial sector reforms, thus building a long-term partnership between ADB and IIFCL. A. Impact and Outcome

30. A significant share of the estimated investment requirement of $475 billion during the 11th FYP needs to originate from the private sector. In this context, the Facility, while small compared to the total needs, is the first international assistance to IIFCL. It is estimated that the $500 million Facility will help catalyze an investment of $2.5 billion$3.5 billion from the private sector for financing of 3040 PPP subprojects.34 The success of the Facility in establishing a framework for implementing the Scheme could trigger substantial investments considering the convergence that will emerge as a result of the (i) expected support from the World Bank, JBIC, and KfW; (ii) firm commitments from the international private equity sources (Blackstone Group, CitiGroup and 3i Group plc); and (iii) the synergies envisaged from the proposed overseas subsidiaries of IIFCL (paras. 1719). 31. The Facility will result in infrastructure development through increased PSP thereby promoting economic efficiency and growth and reducing poverty. This is expected to have a multiplier effect on infrastructure sectors as well as on the broader economy. Enhanced PSP through PPPs will contribute to containing and eventually reducing the fiscal deficit. 32. The Facility is also expected to strengthen the institutional capacity of IIFCL in credit risk management and project risk appraisal. International credit rating will enable IIFCL to source stable long-term funding from the international markets. This in turn will encourage IIFCL to adopt international best practices in corporate governance and financial management.
34

IIFCL will finance subprojects only as a member of consortium where its total lending to any subproject will not exceed 20% of the total capital cost for the subproject (Appendix 3).

12 B. 33. Outputs The ADB supported outputs through the Facility are grouped into two areas: (i) Creating high quality and viable infrastructure assets. 35 The Investment Program (para. 39) of IIFCL will create high quality and viable infrastructure assets across sectors including roads (37 subprojects), power (22 subprojects), seaports (2 subprojects), airports (2 subproject), and urban infrastructure (1 subproject) covering the states of Andhra Pradesh, Gujarat, Himachal Pradesh, Karnataka, Madhya Pradesh, Maharashtra, Orissa, Rajasthan, Sikkim, Tamil Nadu, and Uttar Pradesh. Creating institutional capacity: The Facility seeks (a) IIFCL to be rated by international credit rating agencies 36 for facilitating access to international markets, (b) to develop capacity of IIFCL for the implementation of the ESSF to screen and monitor subprojects and develop reporting formats (paras. 66-67), and (c) to provide capacity building and institutional development support to strengthen IIFCLs resource management, project risk appraisal capability, and investment policies.

(ii)

C.

Special Features

34. Promoting PPP and PSP is a major paradigm shift in infrastructure financing in India. Governments request for ADB support in this process is in recognition of ADBs extensive involvement in infrastructure sector and financial sector reforms. Consultations with the Government and other stakeholders including development partners enabled the design of the Facility as a second generation financial intermediation loan that is in the context of effective demand. Further, the Facility through the Scheme is well-anchored to the ongoing reforms in the infrastructure and financial sectors. 35. Transaction Costs. The Facility, the first MFF through a financial intermediary, is designed to enable ADB to leverage its resources to finance a wide range of subprojects in a programmatic manner across subsectors rather than discretely finance individual subprojects. This is expected to reduce transaction costs for the Government as well as for ADB. 36. Public-Private Synergy. The Facility is part of the integrated PPP development strategy in India and draws on the extensive ADB support for infrastructure development through PPPs. IIFCL is well-positioned to finance PPP subprojects emerging from the ongoing ADB support (para. 22) for mainstreaming PPPs. The development of PPP subprojects by professional project developers (such as IDFC and IL&FS) and consideration of such subprojects for financing by a consortium of investors and lenders including IIFCL, ensures deepening of project preparation and financing skills in the country. Among the development partners, ADB is uniquely placed to finance PPP subprojects by offering customized financing options through its public and private sector windows. 37. Lead Role. IIFCL has been designed to catalyze the flow of foreign institutional and private equity funds in the emerging PPP space in India. This ushers in international best
35

Figures refer only to 64 approved subprojects. This list will be extended further as 70 more subprojects are expected to come into IIFCLs pipeline over the next fiscal year (FY2008). 36 On 7 August 2007, Standard & Poors Ratings Services assigned its BBB-/Stable ratings to IIFCL at par with the sovereign rating of India.

13 practices in infrastructure financing including financial products and technology. The diligence of the policy makers in ensuring that IIFCL remains anchored to the market and evolves with real and financial sector reforms reinforces the catalytic role for IIFCL in infrastructure development. 38. Long-Term Benchmark Rate. By providing long-term lending on commercial terms, IIFCL will facilitate pricing of risk for infrastructure. This will also help establish benchmark rates for infrastructure bonds. The presence of IIFCL as a long-term financier will also provide comfort to equity investors who have exposures to subprojects for the length of the concession period. D. IIFCLs Investment Program and Financing Plan

39. As of end September 2007, IIFCL had a pipeline of 64 sanctioned subprojects37 with a total cost of Rs1,115.85 billion ($28.38 billion), of which IIFCLs financing is estimated at $3.81 billion (about 15% of total subproject costs). Additional 70 subprojects are expected to come into its pipeline over the next fiscal year (FY2008). As a result of these asset additions, IIFCLs balance sheet will grow to around $6 billion$8 billion during FY2007-FY2011. Table 4 summarizes the indicative financing plan for FY2007FY2011 under the assumption that IIFCLs balance sheet will grow to $6 billion. Table 4: Financing Plan FY2007FY2011 ($ million)
Source Asian Development Bank Local Market Borrowingsa Foreign Borrowingsb Total Total 500 3,000 2,500 6,000 % 8.34 50.00 41.66 100.00

Funds that the India Infrastructure Finance Company Limited will raise from the domestic market including insurance and pension funds, and the National Savings Scheme. b Foreign borrowings include bilateral and multilateral sources and funds that the India Infrastructure Finance Company Limited will raise from the international capital markets. Source: Asian Development Bank estimates.

40. IIFCL, through the Government, has requested financing of $500,000,000 from ADBs ordinary capital resources (OCR) to help finance part of its Investment Program. Accordingly, the Facility was included in the India Country Operations Business Plan FY2007 (footnote 19). The Facility will have multiple tranches and will be in accordance with ADB policy.38 The Facility will have an interest rate determined in accordance with ADBs London interbank offered rate (LIBOR)-based lending facility, a commitment charge and such other terms and conditions set forth in the draft loan and guarantee agreements.39 IIFCL has provided ADB with (i) the reasons for its decision to borrow under ADBs LIBOR-based lending facility, and (ii) an undertaking that these were its own independent decision and not made as a result of any communication or advice from ADB. 41. India will provide a sovereign guarantee in form and substance, acceptable to ADB, for the term of each loan as a condition precedent to the effectiveness of each tranche requested by IIFCL and provided by ADB pursuant to the terms of each loan agreement.
37 38

The list of sanctioned subprojects is in Supplementary Appendix D. ADB. 2005. Innovation and Efficiency Initiative: Pilot Financing Instruments and Modalities. Manila. 39 ADB rules on commitment charges, which are in effect when a tranche is provided, will apply with respect to such tranche.

14 42. Framework Financing Agreement. The Borrower and India have entered into a framework financing agreement (FFA) with ADB. The FFA satisfies the requirements established in Appendix 4 of the ADB Innovation and Efficiency Initiative: Pilot Financing Instruments and Modalities. 40 The FFA records the full set of assurances, warranties and representations on crosscutting themes covering safeguards, governance, anticorruption, financial management, procurement, and disbursement and subproject selection. Before ADB accepts the periodic financing request (PFR), India and IIFCL will ensure full compliance with the terms and conditions of the FFA. 43. Periodic Financing Request. Multipurpose subloans will be extended under the Facility to a range of subprojects subject to submission of the related PFR by IIFCL and execution of related loan and guarantee agreements. Each PFR will be accompanied by a list of subprojects identified for financing under the Facility including those subprojects which can be substituted for subprojects that are not in compliance with ADB requirements. Each individual tranche will be for not less than $100 million. The first tranche PFR (PFR1) for $300 million to finance infrastructure subprojects has been received. Appendix 8 lists 24 illustrative subprojects which have been submitted to ADB for consideration under PFR 1. E. Implementation Arrangements

44. Project Management. IIFCL will be the EA of the proposed Facility. Policy direction and strategic oversight will be provided by IIFCLs Board of Directors. A project management unit (PMU) will be established by IIFCL to monitor the screening and selection of subprojects in consultation with the consortium of lenders. The PMU will also monitor day-to-day implementation of the Facility. The PMU will be staffed with existing IIFCL staff to the extent possible and consultants will fill residual capacity gaps. PMU staff will consist of specialists with expertise in risk and project management. A senior officer, reporting directly to the Chairperson of the IIFCL, will be appointed to ensure and certify project compliance with the ESSF. The PMU will have a dedicated finance and accounts officer to monitor accounts and processing claims. The PMU will be responsible for the identification, screening, selection, and monitoring of all subprojects ensuring compliance with state and national policies and the ESSF. In addition, the PMU will be responsible for developing and implementing an investment program performance monitoring system (IPPMS). The Implementation Schedule is provided in Appendix 9. 45. Subproject and Subborrower Selection Criteria. The Scheme defines the subborrower and subproject selection criteria, appraisal and monitoring mechanisms and lending terms for projects (Appendix 3), which includes, inter alia, appraisal by the lead bank for technical, economic, and commercial viability. In addition, each subborrower funded under the Facility will (i) (ii) (iii) (iv) be selected in accordance with ADBs Procurement Guidelines (2007, as amended from time to time); have adequate resources and financial capability to raise resources to complete and operate the relevant subproject successfully; not be in default on any prior loan from the Borrower or from any of the participating members of the consortium of lenders; be able to provide security as required by the consortium of lenders;

40

ADB. 2005. Innovation and Efficiency Initiative: Pilot Financing Instruments and Modalities. Manila.

15 (v) (vi) maintain appropriate financial records of income and expenditure to the satisfaction of the Borrower and ADB; and comply, and cause each subproject to comply, with ADB's and national and state policies, laws, and regulations relating to environment, resettlement and indigenous peoples.

46.

Approval Procedure. Subprojects under the Facility will be processed as follows. (i) (ii) IIFCL will review the preliminary designs and cost estimates for all subprojects proposed under the respective tranches as approved by the lending consortium. Prior to the preparation of each PFR, the applicability and relevance of common ESSF for environmental assessment, involuntary resettlement, and indigenous peoples will be reviewed and updated to ensure their relevance and consistency with applicable country frameworks. In formulating each new PFR, IIFCL will review potential ongoing subprojects to ascertain their compliance with ESSF. These review reports will be submitted to ADB together with other relevant safeguard documents for information and review. If any major non-compliance is found during such a review, ADB will request a corrective action plan which will be prepared by IIFCL and submitted to ADB for review and approval. In addition, any subproject which will be financed under the Facility will follow the approved common ESSF. IIFCL will submit the compliance certificate along with the PFR to ADB for approval.

(iii)

(iv)

47. A PFR will (i) state the required loan amount; (ii) list the subprojects to be financed under the tranche; (iii) be accompanied by appraisal reports for the listed subprojects including the environmental assessment report41 and appropriate resettlement plan and indigenous peoples plan, if any; (iv) give cost estimates and detail the financing plan; (v) spell out the implementation arrangements; (vi) confirm the continuing validity and adherence to the provisions of the FFA; (vii) confirm compliance with the provisions under previous loan agreements; and (viii) provide other information required under the facility administration memorandum to be prepared and agreed upon by ADB, the Government, and IIFCL to facilitate the implementation and processing of the Facility. 48. Maximum Subloan Size and Free Limit. As IIFCL is limited by its Scheme to financing up to 20% of subproject cost, ADB will not stipulate any additional limitation on the size of the subloans. However, all subloans under the first tranche will be subject to prior review and approval of ADB. For subsequent tranches, a suitable free limit pursuant to the provisions of ADBs Operations Manual 42 may be determined for IIFCL based on ADB's assessment of IIFCLs performance, appraisal standards, portfolio quality, management, average loan size, and the subproject pipeline. ADB will, however, reserve the right to review subprojects even below the free limit to ensure safeguard compliance. 49. Period of Utilization. The Facility will be available for 4 years (FY2007FY2011). To ensure timely implementation in line with the Governments emphasis on the disbursement readiness of approved loans, the Borrower will prepare a detailed disbursement plan for the

41

For subprojects categorized as environment category Bsensitive or category A, ADBs 120-day rule for the submission of the periodic financing request will apply. 42 ADB. 2003. Operations Manual. Section D6/OP: Financial Intermediation Loans. Manila (15 December), para. 7.

16 PFR of the tranches. The last date on which any disbursement under any tranche may be made will be 30 November 2011. The final PFR should be submitted no later than 1 November 2010. 50. Procurement. In accordance with ADBs Procurement Guidelines (2007, as amended from time to time), 43 ADB will encourage the Borrower to require its subborrowers to adopt internationally competitive bidding procedures to the extent possible when the amount of the investment is unusually large and economy and efficiency can be gained by following such procedures. For procurement of goods and services to be financed by subloans out of ADB loan proceeds, the Borrower will ensure that the price paid is reasonable, and that account is taken of factors such as time of delivery, efficiency, and the reliability of goods. For build-operatetransfer projects and their variants, if the subproject sponsor or engineering, procurement, and construction contractor is selected through competitive bidding among international entities in accordance with procedures acceptable to ADB, such subproject sponsor or contractor may apply its own procedures for procurement, provided that such procurement is for goods, services, and works supplied from, or produced in ADB member countries. 51. Disbursement Arrangements. The EA shall ensure that the individual loan proceeds under the Facility will be disbursed in accordance with ADBs Loan Disbursement Handbook (2007, as amended from time to time). While making disbursements, IIFCL will review the utilization report for each subproject verified by a chartered accountant and lead bank. The utilization report shall also be accompanied by an engineers certificate. The borrower will establish an imprest account in a current account, with a commercial bank acceptable with ADB. The imprest amount at any time will not exceed (i) 10% of each loan tranche, or (ii) estimated expenditures for the first 6 months of project implementation, whichever is lower. 52. Governance and Anticorruption Policy. ADBs Anticorruption Policy (1998, as amended to date) was explained to and discussed with IIFCL. Consistent with its commitment to good governance, accountability, and transparency, ADB reserves the right to review and examine, any alleged corrupt, fraudulent, collusive, or coercive practices relating to the subprojects under the Facility. To support these efforts, relevant provisions of ADBs Anticorruption Policy are included in the loan regulations and the bidding documents for the projects under the Facility. In particular, all subprojects financed by ADB in connection with the Facility shall include provisions specifying the right of ADB to review and examine the records and accounts of the Borrower, subborrowers, suppliers, contractors, and other service providers as they relate to the subprojects. 53. IIFCL will, under its comprehensive business plan, disclose to its Board of Directors all financial relationships and transactions of the non-executive directors in its Annual Report. Compensation levels of all Board of Directors will also be disclosed. IIFCL management will be required to disclose to the Board of Directors all the material, financial, and commercial transactions where members of management have a personal interest and transactions that have a potential conflict of interest with the interests of the IIFCL. The management of IIFCL will also provide clear description of contingent liabilities and associated risks. 54. IIFCL will constitute an audit committee with non-executive directors as members and 50% representation by independent directors. In addition, IIFCL will have a whistle blower policy which will help to maintain the ethical standards of IIFCL and enhance its image with stakeholders. Under this policy, staff members who notice unethical or improper practices will be able to approach the audit committee without informing their supervisors. Employment and
43

ADB. 2007. Procurement Guidelines. Manila (para. 3.12).

17 other personnel polices will contain provisions protecting whistle blowers from unfair termination and other unfair employment practices. IIFCL will present its corporate governance framework in a separate section in its Annual Report along with a compliance report. 55. Accounting, Auditing, and Reporting. IIFCL, through the PMU, will establish and maintain separate records for works, goods, and services financed out of loan proceeds. IIFCL will maintain separate project accounts according to generally-accepted accounting principles for all expenditures incurred under the Facility and the subprojects, whether out of loan proceeds or from other sources, and record, in a transparent manner, all funds received from the Government, ADB, and other sources. 56. Detailed consolidated annual project accounts will be maintained by IIFCL through the PMU and will be audited by independent auditors whose qualifications, experience, and terms of reference are acceptable to ADB. The accounts will be submitted to ADB within 6 months of the end of the fiscal year. The annual audit report will include a separate audit opinion on the use of loan proceeds, free limit (para. 48), and compliance with financial loan covenants. IIFCL has been made aware of ADBs policy regarding delayed submission of audits and its requirements for a satisfactory and acceptable audit of accounts. 57. Advance Contracting and Retroactive Financing. In cases where IIFCLs management has approved advance contracting for consultant recruitment and procurement of goods and civil works, retroactive financing may be requested for the first PFR under the MFF. For subsequent loans as well, ADB may agree to a request for advance contracting and retroactive financing of civil works, equipment and materials, and recruitment of consulting services, subject to these being requested under following PFRs and subject to the request being in accordance with the agreed procedures and guidelines. All such requests will be assessed on a subproject-by-subproject basis. These arrangements will facilitate the readiness of subprojects under the Facility and will be considered for subsequent subprojects during the processing of individual PFRs. The total eligible expenditure under retroactive financing will not exceed an amount equivalent to 20% of the individual loan and must have been incurred not more than 12 months before the signing of the related legal agreements. However, approval of advance action and retroactive financing does not commit ADB to finance the subprojects being developed under the facility. Before being accepted for retroactive financing, such subprojects will be reviewed and certified by IIFCL for their compliance with ESSF. 58. Subproject Performance Monitoring and Evaluation. IIFCL will be responsible for establishing an IPPMS acceptable to ADB within 3 months from the signing of the FFA and the first PFR. For the IPPMS, IIFCL will first select a set of clearly measurable performance monitoring indicators relating to implementation, improvements, institutional development, and capacity building milestones including those in the design and monitoring framework. IIFCL will establish a baseline data for each of the selected indicators within 6 months of the date that the first loan under the Facility takes effect. Subsequently, IIFCL will conduct annual surveys and will update ADB on progress against each indicator. IIFCL will submit quarterly progress reports attached to the facility administration memorandum. IIFCL will also submit to ADB a completion report within 3 months of the completion of all ADB-supported activities and subprojects. 59. Subproject Review. ADB will, at its discretion, conduct reviews of the management, financial, and operational performance of the Borrower and subprojects financed under the Facility after the closing of withdrawals. Such reviews will include safeguard implementation and procurement procedures used by the subprojects.

18 60. The performance of the Facility will be reviewed periodically at three levels: (i) by IIFCL through the PMU (quarterly), (ii) by IIFCLs Board of Directors (semi-annually), and (iii) by ADB (annually). The quarterly review by the PMU will be completed by the 10th day following the quarterly review. IIFCLs Board of Directors will review the performance semiannually and will forward the semi-annual progress reports to ADB by the 10th day of the month following the semi-annual review. ADB will review the quarterly progress reports and semi-annual reports during the annual review missions and during the tripartite reviews chaired by the Government. In addition, a midterm review of the investment program will be conducted in FY2008. The review will cover disbursements, implementation progress, including progress of capacity building initiatives, ESSF implementation, and status of the IPPMS. The review will identify weaknesses and suggest changes in scope, outputs, and due diligence, and agree on suggested changes. IV. TECHNICAL ASSISTANCE

61. The TA for an amount of $500,000 is attached to the Facility. The TA is expected to be implemented over a 12-month period from July 2008 to June 2009, and aims to (i) support capacity development within IIFCL to manage market and credit risks; and (ii) to train IIFCL staff in risk assessment, management, and mitigation. The TA consists of the following components. (i) Enhancement of resource management function. The TA will assist IIFCL to strengthen the capacity of its resource management function to manage risks arising from its funding and financing activities. Risk assessment. The TA will assist the development of (i) risk appraisal procedures, (ii) pricing tools, and (iii) credit risk management processes to enable IIFCL to acquire in-house project risk assessment capability. Enhancement of resource management systems. The TA will identify software and hardware for upgrading IIFCLs resource management systems and processes. Training of staff. The TA will provide training on resource management and risk assessment.

(ii)

(iii)

(iv)

62. IIFCL will be the EA for the TA. The TA outcomes will be monitored by DEA, ADB, and IIFCL through consultant reports, periodic consultations, and review missions. ADB will engage TA consultants through a firm, in accordance with ADBs Guidelines on the Use of Consultants (2007, as amended from time to time). The quality- and cost-based selection and biodata technical proposal methods will be used. The terms of reference, cost estimates, and implementation arrangements are described in Supplementary Appendix C. V. A. PROJECT BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS

Benefits and Impacts

63. Glaring infrastructure deficits in all sectors can be felt in all locations in India. The huge cost on the society of this deficit from lower productivity to reduced competitiveness has prompted concerted efforts for infrastructure development. In this context, the Facility is designed as part of the policy, regulation, and institutional mechanisms being established for

19 mainstreaming PSP and PPPs for enhancing the role of private sector funds, technology, and management in infrastructure development. 1. Integrated Framework

64. As a financial institution, IIFCL can respond to infrastructure financing opportunities only when it operates in a conducive policy environment, is commercially oriented, and appropriately funded. The Scheme provides this framework. (i) IIFCLs Scheme is designed for enabling innovative financing options for supporting heterogeneous infrastructure delivery models by integrating a range of financing instruments (equity, debt, and guarantee) and financing sources (domestic markets, multilateral sources, international equity, domestic and international borrowings). IIFCL will be able to leverage the core competences of promoters and project developers for building a shelf of PPP subprojects. As a result, IIFCL will be able to intermediate and provide innovative solutions for designing, packaging, and financing PPP subprojects for sectors and locations in need for such support. By limiting IIFCLs financing to 20% of subproject costs and long-tenor funds (20 years and above), the Scheme seeks to catalyze investments. Financial closure of subprojects sanctioned by IIFCL as of end September 2007 is expected to catalyze nearly $25 billion in investments,44 of which the Facility will help catalyze nearly $2.5 billion$3.5 billion. Catalyzing private sector investments for infrastructure development will help contain and reduce the fiscal deficit at all levels. IIFCL will keep itself aligned to best practices for ensuring international ratings at investment grade and above. The commercial orientation of IIFCL is further reinforced by the requirement of the Scheme to finance only viable subprojects. The credit enhancing function of the Government guarantee for IIFCL borrowings will help channel latent sources of funds, such as insurance and pension funds, for infrastructure development. The pricing of long-term loans by IIFCL in line with the risk characteristics of subprojects will also facilitate the creation of pricing benchmarks for infrastructure related financial instruments. Financial Analysis

(ii)

(iii)

(iv) (v)

(vi)

2.

65. While the subprojects sanctioned by IIFCL are spread across all subsectors, the majority of subprojects tentatively identified for first PFR of the Facility are for roads. The economic efficiency of road projects is typically high with Economic Internal Rate of Return (EIRR) in the 2530% range and Financial Internal Rate of Return (FIRR) in the 1015% range. The estimates are also robust from a sensitivity point of view with the EIRRs and FIRRs not
44

The total cost of the subprojects sanctioned by IIFCL at the end of September 2007 (Supplementary Appendix D) is ($28.38 billion), of which IIFCLs financing is estimated at $3.81 billion. As a result, financial closure of these subprojects would imply catalyzing nearly $25 billion worth of investments. With the projected growth in balance sheet of IIFCL during the next 5 years, the catalytic role could be significant. Additional resources would also be catalyzed through equity from various sources as a result of IIFCLs long-term debt financing.

20 declining significantly even in worst case scenarios. Further, the EIRRs and FIRRs are significantly above the opportunity cost of capital. The Facility is also expected to finance power transmission projects. The EIRR estimates in this case also meet the benchmark requirements. 3. Environmental and Social Safeguards

66. ADB took the lead45 in developing a common ESSF46 (Supplementary Appendix G) in consultation with World Bank, KfW, and JBIC for harmonizing the safeguards policy framework for involuntary resettlement, the environment, and indigenous peoples (paras. 26, 33, 6667). Showing remarkable awareness of the need for environmental and social safeguards in all aspects of infrastructure development, IIFCL participated in the development of ESSF and adopted the same. As part of the subproject selection process, IIFCL will screen subprojects to determine whether they trigger the compliance requirements of ADBs involuntary resettlement, environment, and indigenous peoples policies. If they do, IIFCL will ensure that each subproject has appropriate instruments to adequately address these requirements and will submit the required documents either to ADB or a third party acceptable to ADB for review. IIFCL will not finance subprojects, using the funds from the Facility which do not adequately address safeguard requirements. 67. In-house capacity to implement the ESSF is being established with ADB support and IIFCL is setting up a unit for ensuring that all subproject proposals to be financed under the Facility comply with the requirements of the ESSF. The capacity building initiatives at IIFCL include appointing qualified specialists in environment and social safeguards issues to staff the unit47 who will train IIFCL staff in reviewing and approving subprojects. Appendix 10 provides the Summary ESSF. 4. Financial Management

68. A financial management assessment (FMA) to examine IIFCL's financial and fiduciary management capacity for implementing the Facility was undertaken (Supplementary Appendix E). 48 IIFCL has adopted an accrual system of accounting reflecting double entry accounting principles and supported by standardized software. IIFCL undertakes three levels of audit: (i) a concurrent internal audit by a firm of chartered accountants, (ii) a statutory audit by an independent firm of chartered accountants appointed by the Comptroller and Auditor General of India, and (iii) a supplementary audit by the Comptroller and Auditor General of India. As part of the Facility, IIFCL will closely monitor the physical and financial progress of subprojects based
45

The process of preparing the environmental and social safeguards framework was guided by ADBs Environment and Social Safeguards Division. The first meeting of development partners took place on 9 February 2007 and the second meeting on 13 August 2007. The draft social safeguards framework was uploaded to the ADB website on 17 August 2007. Available: http://www.adb.org/Documents/Resettlement_Plans/IND/40655/default.asp. 46 The common safeguards frameworks include (i) the anticipated impacts of the components or subprojects likely to be financed under the multitranche financing facility on the environment, involuntary resettlement, and indigenous peoples; (ii) safeguards criteria to be used in selecting subprojects; (iii) requirements and procedures to be followed to screen and categorize them, conduct impact assessments, develop management plans, hold public consultations, and disclose public information (including the 120-day disclosure rule, if required), and monitor and report the progress of such subprojects or project components; (iv) the institutional arrangements (including budget and capacity requirements); and (v) IIFCLs and ADBs responsibilities and authorities for the preparation, review, and clearance of safeguards documents. 47 As an interim measure, two national consultants (one environmental and one social safeguards specialist) were hired in July 2007 and have commenced the work. 48 The FMA was based on discussions with various officials of IIFCL, Indian Credit Rating Agency Limited, and the World Bank. The World Bank conducted its own FMA and the ADB and World Bank teams shared the findings of their respective FMA reports.

21 on the utilization certificates provided by the firm of chartered accountants and lead banks prior to disbursements in line with Government norms. ADB will reserve the right to verify the financial accounts of IIFCL and related parties. 5. Enhanced Governance Framework

69. IIFCL is governed by the Companies Act, 1956, (Appendix 5) which prescribes disclosure norms. IIFCL intends to self-regulate and has incorporated best practices of nonbanking finance companies in its comprehensive business plan.49 The regulatory regime will be based on (i) nonperforming asset norms, (ii) asset classification, (iii) provisioning norms, (iv) income recognition, (v) credit concentration, (vi) special reserve maintenance (capital requirements) liquidity requirements, and (vii) resource-raising norms. Adherence to this regime will be reviewed annually and reported to the Board of Directors of IIFCL. Further, in addition to Standard & Poors, IIFCL also plans to be rated by Fitch and Moodys for strengthening its compliance with best international practices.50 As part of the Facility, the best practices adopted by IIFCL are summarized below. Table 5: Internal Governance Impact on India Infrastructure Finance Company Limited
Area Financial Management and Audit Resource Management Key Internal Reform Elements Review and audit by ADB of IIFCL and eligible subborrowers, Regular review of s accounts by ADB, and Adoption of measurable financial management indicators. Improving resource management operations through enhanced Financial Policies, Investment Policies, Asset-Liability Management Procedures and Systems, and Functional Support for Efficient Resource Management. Improved staff capability. Review and examination of the subborrowers by ADB and Reporting of observed malpractices to the authorities.

Anticorruption

ADB = Asian Development Bank, IIFCL = India Infrastructure Finance Company Limited. Sources: India Infrastructure Company Limiteds Comprehensive Business Plan and ADB analysis.

6.

Poverty Impact

70. Infrastructure investments lead to higher farm and nonfarm productivity, employment and income opportunities, and increased availability of wage goods, thereby reducing poverty by raising mean income and consumption. If higher agricultural and nonagricultural productivity and increased employment directly benefit the poor more than the non-poor, these investments can both reduce poverty and improve income distribution. Investment in infrastructure as a whole and on roads and transportation in particular contributes to poverty reduction by (i) reducing transactions costs; (ii) enabling economic agents like individuals, firms, and governments to respond efficiently to demand; (iii) lowering costs of inputs used in production of
49

ICRA Management Consulting Services Limited was mandated by IIFCL to formulate a comprehensive business plan in November 2006 under World Bank TA grant. The final report was submitted on 17 May 2007 to IIFCL. ADB was given an opportunity to comment on the draft final report. 50 International credit rating agencies closely monitor all aspects of operational performance and failure to comply with best practice is likely to lead to a rating downgrade and an increase in financing costs.

22 almost all goods and services; (iv) opening up new opportunities for entrepreneurs; (v) creating employment especially in public works both as social protection and as a counter-cyclical policy in times of recession; (vi) enhancing human capital by improving access to health and education; and (vii) improving environmental conditions which have an impact on improved livelihoods, better health, and vulnerability of the poor The Summary Poverty Reduction and Social Strategy is in Appendix 11. B. Assumptions, Potential Risks, and Mitigations

71. While the growing recognition of the significance of infrastructure development and the ongoing reforms in the infrastructure and financial sectors provide the context for the Facility, the envisaged benefits and impact depends on several assumptions that are subject to varying degrees of risk. Mitigating measures have been put in place where feasible and appropriate. 72. Effective Demand. The identification and development of bankable PPP subprojects provides the effective demand for the Facility. While PPP is emerging as the preferred mode for infrastructure development, capacity constraints will have to be addressed for transforming the potential for PPPs into a stream of bankable subprojects. This risk is being dealt by intensive support from ADB and other development partners for mainstreaming PPPs. Upfront identification of subprojects for the first PFR of the Facility has been made. 73. Institutional Capacity. The ability of IIFCL to leverage government guarantee to generate low-cost and longer tenor funds is critical for its catalytic role. This also depends on the market perception of the quality of IIFCLs pipeline, credit appraisal, and disbursement procedures, risk management and appraisal systems, environmental and social safeguards compliance procedures, and operational efficiency. Factors that mitigate these risks include (i) intensive appraisal of the subprojects by IIFCL; (ii) the emphasis of IIFCLs mandate and Scheme on commitment to operational autonomy, good governance, and commercial orientation; and (iii) ongoing ADB and World Bank support to IIFCL for developing systems and procedures and human resource development. IIFCL will maintain a lean organization of core specialists for reducing cost overheads. 74. Regional Distribution. Variations in the preparedness for PPPs across states pose the risk of regional concentration of subprojects supported by the Facility. While relative merits of the viable subprojects should guide IIFCLs financing decisions, a reasonable geographical spread is also desirable. In consultation with the IIFCL, the identified subprojects to be financed by the Facility are spread over a number of states (para. 33). The ongoing efforts for mainstreaming PPPs will also help generate viable subprojects in all parts of the country. 75. Reform Commitment. Despite the recent success in reducing constraints to infrastructure development, the shift from public financing of infrastructure to PPPs could take more time than expected. In addition, the reforms involve a range and hierarchy of stakeholders that could also slow the momentum of reforms. This risk is being mitigated through positive incentives by the Government for enhancing the bankability of infrastructure projects (para. 6(v)). In addition, for promoting economic growth, state governments are proactively reducing constraints to infrastructure development.

23 VI. ASSURANCES

76. In addition to the standard assurances, the Government and IIFCL have given the following assurances. These will be incorporated into the individual loan agreement(s) as applicable and mutually agreed by the Government and ADB for each tranche under the MFF. 77. The Government and IIFCL will ensure the following: (i) The Government remains committed to the implementation of the Scheme for Financing Viable Infrastructure Projects through IIFCL. In the event of any change in the Scheme, the Government, IIFCL, and ADB will assess the potential impact on the Facility and evaluate any change in scope, amendment, or continuation, as appropriate, of the Facility; IIFCL complies, at all times, with the prudential norms, as made applicable to it by the Government, including capital adequacy, income recognition, classification, and provisioning of nonperforming assets; IIFCL maintains a debt service coverage ratio of at least 1.0 and ensure that it has no arrears in repayment of its current debt obligations; The subprojects and subborrowers meet the eligibility criteria agreed with ADB, including financial and economic viability and positive developmental impact; All subprojects are submitted to ADB for prior review, unless otherwise agreed between ADB and IIFCL; The on-lending rates to subborrowers are market-based and adequate to cover all costs and risks associated with on-lending including any foreign exchange risk; The subborrowers adopt and implement appropriate procurement procedures that are based on competitive bidding and foster economy, efficiency, and transparency; A subloan to a subborrower is made for only such subproject that involves procurement of goods, works, and consulting services from member countries of ADB, and the amount of which is at least equal to the size of the subloan for such subproject; The ESSF formulated with other development partners and satisfactory to ADB is implemented and that all subprojects financed with ADB funds comply with the ESSF; The environmental management system framework as set out in the ESSF is implemented in accordance with its terms and acceptable to ADB to ensure that each subproject is undertaken in compliance with applicable environmental laws of India, relevant State of India, and ADBs Environment Policy (2002). Further, that for each subproject, initial environmental examination (IEE), environmental impact assessment (EIA), and the environment management plan, as applicable, are submitted to ADB for review and approval before IIFCL submits the PFR, and that for any category A or environmentally sensitive B subproject, the IEE or the summary EIA is made available to the public 120 days before a PFR is submitted to ADB; The social safeguards framework (SSF) as set out in the ESSF is implemented in accordance with its terms and satisfactory to ADB, and that each subproject, which involves land acquisition and has resettlement impacts, is undertaken in compliance with all the applicable laws of India, the relevant State of India, and ADBs Involuntary Resettlement Policy (1995). Further, that the resettlement plans are submitted to ADB for approval, before IIFCL approves the subproject.

(ii) (iii) (iv) (v) (vi) (vii) (viii)

(ix) (x)

(xi)

24 Furthermore, each subborrower is required by IIFCL to ensure that (a) all land and rights-of-way required for subprojects are obtained in a timely manner; (b) the provisions of the resettlement plans are implemented in accordance with its terms; (c) all compensation and resettlement assistance is given to the affected persons prior to their dispossession and displacement and commencement of civil works; (d) resettlement plans are updated upon completion of the detailed design and submitted to ADB for approval prior to commencement of civil works; (e) adequate staff and resources are committed to supervising and monitoring implementation of the resettlement plans; and (f) an independent agency acceptable to ADB and IIFCL is engaged by the subborrower to monitor and evaluate results of implementation of resettlement plans and forward reports to ADB and IIFCL as required; Subprojects do not adversely affect vulnerable groups, such as indigenous peoples, and in the event of any impact or their involvement, IIFCL will implement the SSF as set out in the ESSF in accordance with its terms to ensure compliance with ADBs Policy on Indigenous Peoples (1998); Adequate number of staff are trained and deployed to fully implement and comply with the ESSF; Accountability and transparency in IIFCL are maintained in its operations through the stakeholder meetings and publication of progress reports through the duration of the Facility. Internal procedures and controls are instituted, maintained, and complied with to prevent any corrupt, fraudulent, collusive, or coercive practices. All contracts financed by ADB in connection with the subprojects specify the right of ADB to review and examine the records and accounts of the subborrowers, suppliers, and contractors, as they relate to the subprojects. An appropriate corporate governance framework is formulated reflecting international best practices and reported annually to IIFCLs Board of Directors and ADB; and All IIFCL subloan agreements appropriately reflect the obligations assumed by IIFCL and the respective subborrowers under the Facility including those in respect of any existing subprojects that IIFCL has already approved but which receive ADB financing under the Facility. VII. RECOMMENDATION

(xii)

(xiii) (xiv)

(xv)

78. I am satisfied that the proposed multitranche financing facility would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the provision of loans under the mutitranche financing facility in an aggregate principal amount not exceeding $500,000,000 to India Infrastructure Finance Company Limited, to be guaranteed by India, for the India Infrastructure Project Financing Facility from ADBs ordinary capital resources, with interest to be determined in accordance with ADBs London interbank offered rate (LIBOR)-based lending facility, and such other terms and conditions as are substantially in accordance with those set forth in the Framework Financing Agreement presented to the Board.

23 November 2007

Haruhiko Kuroda President

Appendix 1

25

25 June 2007Sri LankaDESIGN AND MONITORING FRAMEWORK

Design Summary Impact 1. Improved per capita infrastructure availability in India 2. Mainstreaming PPP modality for infrastructure development Performance Targets/Indicators Reduction in peak and average energy deficit during 11th FYP Achieving target seaport capacity of 1,300 MTPA during 11th FYP Widening of national highways in line with National Highways Development Project during 11th FYP Achievement of national urban transport policy goals during 11th FYP Private investment in infrastructure to reach 30% of overall infrastructure investment during 11th FYP Outcome 1. Increased private sector participation in infrastructure development through PPPs Contribution in achieving the targeted 9% GDP growth during 11th FYP Planning Commission reports Economic Survey of India Relevant government publications Data Sources/Reporting Mechanisms International and domestic business climate surveys Annual reports on infrastructure availability including Planning Commission studies ADB review and evaluation missions Economic Survey of India, industry reports, and relevant government publications Assumptions and Risks Assumptions Continued priority accorded to infrastructure sector Continued priority accorded to financial sector development Increased efficiency of infrastructure investment Strong government commitment to IIFCL Risks Government commitment to infrastructure and financial sector reforms diluted Subprojects are not commissioned in time

Assumption Government policy of encouraging PPPs continues Risk Lack of Government commitment and capability to carry forward reform agenda Assumption Continued commitment of the Government for fiscal discipline Risks Unforeseen fiscal stress

2. Containing and reducing fiscal deficit through private sector participation in infrastructure

Contribution in achieving fiscal deficit target of 3% GDP in line with FRBM Act, 2003, by 31 March 2009

Annual budget announcements of the Government RBI reports ADBIndia Economic Quarterly Bulletin IMF India reports

26

Appendix 1

Design Summary

Performance Targets/Indicators

Data Sources/Reporting Mechanisms

Assumptions and Risks Decline in Government commitment to FRBM Act, 2003 Assumptions Governments financial sector and infrastructure sector reforms continue
Government guarantee

3. Improved lending terms of IIFCL for infrastructure subprojects

Reduction in average borrowing costs for IIFCL and improvement in availability of finance for infrastructure during FY2007 FY2011 Increased duration of financing provided by IIFCL for subprojects over time during FY2007FY2011

Progress reports of PMU Rating agencies reports Lead banks reports IIFCL annual reports IPPMS data and reports

for IIFCLs borrowings continues

IIFCL maintains and/or

improves its current credit ratings Risks Financial sector and infrastructure sector reforms curtailed
Government guarantee

to IIFCL diluted and/or curtailed

Sovereign and IIFCLs

credit ratings deteriorate 4. Improved capacity in IIFCL to ensure that ADB funds are used for subprojects that conform to ESSF through relevant TA support IIFCL staff are able to (i) understand the ESSF, and (ii) use ESSF to assess proposed subprojects during FY2007 FY2008 Year-on-year improvement in number of subprojects assessed for compliance under ESSF during FY2007FY2011 ADB review missions Quarterly, semiannual, and annual reports of IIFCL World Bank review missions IPPMS data and PMU progress reports Assumptions Deployment of adequate and suitable staff resources Trained staff will continue to work for IIFCL IIFCL absorbs capacity with regard to ESSF compliance through TA IIFCL ensures availability of suitable staff Risks Trained staff may leave

Appendix 1

27

Design Summary

Performance Targets/Indicators

Data Sources/Reporting Mechanisms

Assumptions and Risks Delays in procuring relevant subproject documents from subborrowers, lead banks, and lead syndicators Assumptions Deployment of suitable staff Trained staff will be retained by IIFCL IIFCL absorbs resource and risk management capacity through TA Risks Inability of IIFCL to deploy suitable staff in a timely manner Trained staff may leave IIFCL Staff capability may decline in the absence of continuous training

5. Improved resource management and project risk assessment capabilities in IIFCL

Reduction in duration gap between asset and liability portfolio of IIFCL during FY2007FY2011 Enhanced processes, systems, and staff capacity for subproject risk assessment during FY2007FY2011 Improvements in (i) asset profile, (ii) liquidity indicators, and (iii) value at risk indicators during FY2007FY2011

Quarterly, semiannual, and annual reports of IIFCL Investment bank reports of IIFCL bond issuances Rating agencies reports IPPMS data and PMU progress reports

Outputs 1. High quality infrastructure assets created in various subsectors across the country

Assumptions Average subloan size of $20 million$30 million 30-40 subprojects financed during FY2007FY2011 Full utilization of the first tranche of $300 million by November 2009 Full utilization of the second or subsequent tranches by November 2011 Quarterly, semiannual, and annual reports of IIFCL ADB review mission reports
IIFCLs long-term

lending mandate continues

IIFCL undertakes

structured borrowing program based on riskreturn considerations and subproject financing requirements Risks The Government deemphasizes IIFCLs long-term lending mandate

28

Appendix 1

Design Summary

Performance Targets/Indicators

Data Sources/Reporting Mechanisms

Assumptions and Risks IIFCLs portfolio quality deteriorates which results in shortening of its lending terms
Regulatory and policy

risks leading to above 2. Availability of longterm funding to IIFCL and improved ability of IIFCL to provide long-term financing to subprojects 3. International credit rating attained by IIFCL and periodically updated Reduction in duration gap between asset and liability portfolio of IIFCL during FY2007FY2011 Rating agencies reports IIFCL annual reports, IPPMS data, and PMU progress reports

Internationally acceptable credit rating accorded to IIFCL for accessing international markets in August 2007 Annual credit rating by internationally accredited rating agencies by end September each year

Rating agencies updates. Investment bank reports of IIFCL bond issuances

Assumption Rating assessments and reviews are rigorous and conducted on time Risk Counterpart staff from IIFCL and line ministries not made available on time to rating agencies

Assumptions 4. Improved (i) financial policies, (ii) staff capacity, and (iii) risk management systems of IIFCL Improved financial policies, ALM policy and tools, investment policies, deal documentation formats, pricing tools, and risk appraisal templates developed for IIFCL by end December 2008 IIFCL ALM data ADB and World Bank review missions Rating agencies updates IPPMS data and PMU progress reports
High quality consultant

reports prepared on time

IIFCL staff are able to

adapt to the new risk management and pricing systems Risks Trained staff may leave IIFCL Staff capability may decline in the absence of continuous training

5. Development and implementation of

Adoption and implementation of

ADB reviews

Assumptions Rigorous and timely reviews conducted

Appendix 1

29

Design Summary ESSF

Performance Targets/Indicators ESSF in August 2007 ESSF implementation commence in October 2007 High quality due diligence ESSF reports during October 2007 November 2011.

Data Sources/Reporting Mechanisms Consultant reports World Bank review reports IIFCL compliance certificates for subprojects PMU progress reports

Assumptions and Risks Timely availability of required documents from subborrowers Risks Counterpart staff from IIFCL and subborrowers are not made available on time for ESSF Delay in obtaining the required documents from subborrowers Non-availability of qualified staff and resources

Inputs ADB Part A: Preparatory capacity building (up to second quarter 2008) $500 million 1.1 Identifying subproject pipeline to be financed through ADB funds. First tranche of $300 1.2 Developing common ESSF (August 2007). million 1.3 Ensuring international credit rating for IIFCL (August 2007). Second and/or 1.4 Determining adequate monitoring arrangements for ADB (September subsequent tranches 2007). of $200 million 1.5 Developing capacity in PMU in IIFCL (by December 2007). TA funds of $500,000 1.6 Commencing due diligence of potential subprojects (October 2007). for enhancing resource management function Part B: Additional capacity development (continues to second quarter and risk management 2009) function 2.1 Determining capacity building requirements for resource management National consultants and project risk management functions (by July 2008). (24 person-months) 2.1.1 Developing guidelines, manuals, and specifications for IIFCL Review missions resource management and project risk assessment (by Participation in December 2008) including tripartite meetings Financial policies, ALM policy, Government/IIFCL Pricing tools and risk appraisal templates, Counterpart staff Deal documentation formats, Office accommodation Back-office requirements, and and transport Resources management system requirements. Administrative services 2.2 Providing capacity development support and training (January 2009 Facilitation for June 2009) for resource management to meetings enhance the risk management capacity, Obtaining necessary use risk assessment models and develop options for appropriate information from risk-sharing schemes such as guarantees, subborrowers/lead effectively use tools for assessing value for money, syndicators usage of resource management systems and documentation, Participation in understand the structure and regulatory implications of concession tripartite meetings contracts, and Activities with Milestones

30

Appendix 1

Activities with Milestones address issues relating to competition and regulation in infrastructure. 2.3 Assessing the impact of training to feed into redesign of training program during the midterm review. Part C: Tranche release progress and reporting (continues to third quarter 2011) 3.1 Periodic Financing Request (PFR1) for the first tranche of $300 million has been signed and submitted on 16 November 2007. 3.2 First tranche disbursement requirements indicated (first quarter 2008). 3.3 Full utilization of the first tranche of $300 million by 30 November 2009. 3.4 Periodic Financing Request for the second tranche and/or subsequent tranches submitted for tranche release no later than 1 November 2010. 3.5 Full utilization of the second and/or subsequent tranches of $200 million no later than 30 November 2011. 3.6 Supporting documentation submitted regarding compliance with ADB requirements (quarterly, semiannual, and annual reports).
ADB = Asian Development Bank, ALM = asset-liability management, ESS = environmental and social safeguards, ESSF = Environmental and Social Safeguards Framework, FRBM = Fiscal Responsibility and Budget Management, FYP = five-year plan, IIFCL = India Infrastructure Finance Company Limited, IMF = International Monetary Fund, IPPMS = investment program performance management system, MIS = management information system, MTPA = million tons per annum, PFR = Periodic Financing Request, PMU = project management unit, RBI = Reserve Bank of India, TA = technical assistance.

Appendix 2

31

INFRASTRUCTURE SECTOR ANALYSIS A. Introduction

1. In recent years, India has been one of the fastest growing economies in the world with growth rates averaging around 79% per annum during the 10th Five-Year Plan (FYP) period (fiscal year [FY]2001FY2006). This is partly due to the 15 years of economic reform. The Government of India (the Government) would like to push growth rates even higher to match the performance of countries like the Peoples Republic of China (PRC), but to do so will require high quality infrastructure. There is a significant infrastructure deficit in the economy requiring large scale investment in almost all infrastructure subsectors including transportation (roads, ports, rail, and airports), energy (generation and transmission), and communications. Table A2.1 provides a comparison of infrastructure indicators for India and the PRC. Table A2.1: Comparative Infrastructure Availability
Item Per capita income ($) Electricity consumption (kWh per capita) Urbanization (%) Railways (goods hauled per capita in MT per km) Roads (length in km per million people) Ports (container traffic in TEU per million people) Air (passengers per million people) India 571 380 28 313 3,116 10,305 18,286 PRC 1,416 987 39 1,171 1,371 62,434 66,802 Year 2003 2002 2003 2003 2002 2003 2003

km = kilometer, kWh = kilowatt-hour, MT = metric tons, PRC = Peoples Republic of China, TEU = twenty-foot equivalent units. Source: World Bank.

2. The PRC spends seven times as much as India on infrastructure in absolute terms, spending $150 billion in FY2003 on electricity, roads, airports, ports, and telecommunications, compared with $21 billion spent by India. While PRCs capital spending on infrastructure is about 10.6% of gross domestic product, expenditure in India is around 4%. According to the Committee on Infrastructure, as India aims to expand its economy at the rate of 89% in the coming years, infrastructure spending will have to reach around 9% of GDP. It is further estimated that infrastructure investments of around $475 billion will be required to sustain a growth rate of 9%. These figures translate into a required compound average growth rate (CAGR) of investments of around 15% over the 11th FYP period (FY2007FY2012). The critical gaps in each subsector are outlined in this appendix. 3. Traditionally, the Government was the sole investor in infrastructure and has financed and implemented the bulk of its infrastructure outlays and also managed risks. The ability of the Government to commit funds for infrastructure has come under pressure. The overall fiscal deficit continues to remain high with wide variations across states. As can be seen from Table A2.2, while the deficit position has improved since FY2004, the levels continue to remain high constraining the state from being able to fulfill infrastructure funding requirements. Table A2.2: Fiscal Performance Indicators ($ billion)
Period (FY) 2000 2001 2002 Gross Fiscal Deficit GDP% 30.29 5.69 35.93 6.18 36.98 5.90 Revenue Deficit GDP% 25.53 4.08 27.50 4.39 25.46 4.40 Primary Deficit GDP% 4.97 0.93 8.54 1.47 6.95 1.10

32

Appendix 2

Period (FY) 2003 2004 2005 (RE) 2006 (BE)

Gross Fiscal Deficit GDP% 33.67 4.80 35.03 4.40 37.26 4.10 37.90 3.80

Revenue Deficit GDP% 19.42 3.60 23.53 2.50 22.62 2.60 23.53 2.17

Primary Deficit GDP% 1.92 0.30 2.02 0.30 4.11 0.40 2.26 0.10

BE = budget estimates, FY = fiscal year, GDP = gross domestic product, RE = revised estimates. Source: Reserve Bank of India.

4. The Fiscal Responsibility and Budget Management Act of FY2002 targeted the elimination of the revenue deficit by FY2008 and a reduction in the fiscal deficit to 3% in the same period. In response, a series of improvements in the area of transparency and mediumterm fiscal planning at both the national and statelevel has been instituted. By the end of the first quarter of FY2005, 22 of the 28 states had enacted their own Fiscal Responsibility and Budget Management Act. Most states have also established state finance commissions for equitable revenue distributions across districts, parallel to the central finance commission. 5. In order to meet the infrastructure deficit and harness the financing and project management capabilities of the private sector, the Government has taken several initiatives to provide the necessary environment in which the private sector can operate both via direct private sector participation as well as through public-private partnership (PPP) arrangements. These include (i) introducing model concession agreements in various subsectors such as roads, ports, and airports; (ii) establishing independent regulatory mechanisms to enforce service standards and improve cash flow stability; (iii) encouraging participation of long-term financiers in the market through credit enhancement measures and provision of implicit risk capital; and (iv) reforming the capital markets to support long-term financing instruments and implicit risk capital, etc. Nodal agencies such as National Highways Authority of India and Airports Authority of India have taken the lead in partnering with financial institutions to promote PPP. Government policy initiatives indicate that it is being driven by a desire to make infrastructure inclusive. The overall reform agenda is being pursued to ensure that policy and regulatory frameworks under which infrastructure is developed promotes contestable markets which ensure competitive pricing of services that are natural monopolies. 6. Further, PPP enabling initiatives include (i) relaxing regulations; (ii) reducing foreign investment restrictions; (iii) introducing tax, customs, and other incentives to enable PPP; and (iv) developing the capital market. Table A2.3 below (page 36) provides an overview of the policy initiatives that have already been undertaken to promote PPP and private sector participation and the forward reform agenda. B. Current State of Indian Infrastructure

7. The infrastructure deficit in India requires large scale investments in all subsectors including roads, ports, airports, power, and urban infrastructure. In the power sector alone, in order to sustain a GDP growth of 89%, India needs around 10,000 MW of capacity addition every year over the next decade. Estimates suggest an investment requirement of over $600 billion over the next few decades in the power sector. These investments do not include investments needed to augment capacities in fuel supply infrastructure, mining and supply, and ports and terminals in order to sustain expansion in generation capacity. Thus, meeting infrastructure requirements in one subsector may not be sufficient as one subsector is linked to another through the supply chain that ultimately delivers electricity, water, transportation, and other services to end beneficiaries. These linkages suggest an overall investment program for power plants, electricity transmission and distribution systems, ports, roads and expressways,

Appendix 2

33

bridges, railway engines and tracks, product handling, and storage facilities etc. The discussion below provides a snap shot of the current state of Indias infrastructure and investment requirements in key infrastructure subsectors. 1. Roads

8. India has an extensive road network of 3.3 million kilometers (km), 2nd largest in the world, carrying 61% of the countrys total freight and 85% of total passenger traffic. Projected annual growth over the 11th FYP is 1215% for passenger and 1518% for cargo traffic. World Bank estimates indicate that over the next 10 years, there will be a need to widen 15,000 km of national highways from two to four lanes, and a further 16,500 km requires upgrading from intermediate to two lanes. Estimates suggest that about 25,000 km of state highways need widening. An estimated $50 billion$60 billion investment is required over the next 5 years to improve road infrastructure. The cumulative funding shortfall from defined road user charges over the next 10 years is estimated at $25.66 billion, or 39% of total requirement. 2. Railways

9. Indian Railways, with a network of 63,221 route km, 1.6 million employees, 440 billion ton kms of freight, and 615 billion kms of passenger traffic, is one of the largest in the world. Over the last few years, Indian Railways has managed to achieve a dramatic improvement in business performance and is witnessing one of the largest expansions in history. The railways have targeted moving 1,100 billion ton kms of freight and 8.4 billion passengers by the last year of the 11th FYP. Planned initiatives during 11th FYP include (i) (ii) (iii) (iv) (v) Construction of the eastern and western dedicated freight corridors at a cost of $15.29 billion. Construction of high-speed passenger corridors to run trains at more than 300 km per hour. Expansion of suburban services through completion of the Mumbai Urban Transport Project phase I and initiation of phase II. Double production of rolling stock compared with 10th FYP. Increased production of high horsepower and energy efficient locomotives.

10. These initiatives are expected to require investments of around $89.21 billion between FY2006 and FY2014. Investment on this scale would have a multiplier effect resulting in an estimated increase in Indias GDP by $356.86 billion during the investment period. 3. Seaports

11. Indian ports handled cargo of 573 million tons per annum (MTPA) in FY2005, an increase of over 10.4% compared with FY2004. These ports transported about 95% by volume and 70% by value of Indias international trade in FY2005. Further, 70% of the traffic at major ports by volume is dry and liquid bulk, the remaining 30% is general cargo including containers (a figure which has grown by 9.5% per annum over the last 3 years). The current capacity of 660 MTPA across existing ports needs to be increased to 1,300 MTPA by FY2011, requiring an estimated total investment of $15.33 billion during the 11th FYP.

34

Appendix 2

4.

Airports

12. India has 450 airports, some of which are nonfunctional. The Airports Authority of India (AAI) owns and operates 125 airports, of which only 62 are operational for commercial purposes and 11 are designated international airports. In FY2005, Indian airports handled 73 million passengers and 1.4 million tons of cargo. Passenger traffic grew by over 23% during FY2005 compared with the pervious year, while cargo traffic increased by 9.5%. 13. Passenger traffic is expected to increase at a CAGR of 25% in the next 5 years. Over 40% of passenger traffic is concentrated in the two main airports of Delhi and Mumbai. The total number of aircraft parking bays available in the country is around 200 and the actual fleet size is 213. With plans for airline expansion and new entrants into the Indian domestic airspace, fleet size is expected to double by FY2009. While work is underway to construct 60 new parking bays, there is a shortfall of over 250 parking bays in the domestic airline industry.These factors, along with limited terminal capacity, increased congestion, poor infrastructure, and inadequate ground handling systems aggravates the situation at the airports. An estimated investment of around $10.91 billion for airport upgrade is required over the 11th FYP. 5. Urban Infrastructure

14. Adequate and equitable distribution of urban infrastructural services such as water and sewage disposal, and per capita provision of these basic services, are not in accordance with prescribed norms. According to data from the Ministry of Urban Development, of the 393 class I cities, only around 77 have water supply coverage. The per capita water supply is as low as 9 liters per capita per day in some areas. Also, 203 of the 401 class II towns have supply of less than 100 liters per capita per day. 15. The Jawaharlal Nehru National Urban Renewal Mission envisages assistance of around $12.74 billion over the next 7 years to improve infrastructure in 63 cities across the country, with total investments of around $26.28 billion. Major urban infrastructure projects include (i) Bangalore metro, (ii) Mumbai metro, and (iii) Mumbai trans-harbor link. 6. Power

16. The total power generation capacity in India is more than 127,000 megawatt (MW). The total generation in FY2005 was 590 billion units registering a CAGR of 4.6% over the last 4 years. While India has the 5th largest electricity generation capacity in the world, per capita consumption is low at 606 units (half that of PRC). Indias transmission and distribution network consists of 5.7 million circuit km, making it the third largest in the world. 17. Despite the above, during the first half of FY2006, the total energy demand was 393 billion units, of which 361 billion units was met (deficit of 8%). The peak demand during this period was 98,520 MW, of which 86,468 MW (deficit of 12.2%). With the demand-supply gap and growth driving incremental demand, over 90,000 MW of fresh generation capacity is required over the next two FYPs. C. Conclusion

The infrastructure sector in India faces multiple constraints, and the policy and institutional response has been appropriately designed. With regard to financing, initiatives are underway to strengthen the capital market to channel long-term funds to the sector. Simultaneously,

Appendix 2

35

institutional mechanisms have been established to provide the market with the necessary risk capital to attract long-term debt and equity. Initiatives are also underway to establish appropriate regulatory mechanisms in various subsectors. While these initiatives are ongoing, they have not yet been fully completed. Various subsectors still require regulatory commissions, regulatory rulings, and redressal mechanisms. These mechanisms need to be strengthened to provide stability to long-term cash flows and reduce the need for risk capital and/or allow the marketbased provision of the same. The scale of financing required is beyond the financial capabilities of the public sector alone. Widespread reforms are thus underway to ensure sustained and profitable private sector operations in infrastructure development.

36 Table A2.3: Overview of Private Sector Participation/Public-Private Partnership Policy Initatives in Infrastructure Sector
Sector Roads and Highways Key Reform Initiatives MCA for PPPs in national highways has been approved by the Planning Commission. To attract private investment in road development, maintenance, and operation, the NH Act 1956 was amended in June 1995. Amendments include Allowing private investment in national highways projects. Allowing private investor to levy, collect, and retain user fees. Regulate traffic on NH according to the provisions of the Motor Vehicle Act, 1988. NHAI has also formed an SPV for funding road projects involving minimal support from National Highway Authority of India for equity or debt. Industry status has been accorded to the road sector as infrastructure as defined in Section 18 (1) (12) of the Infrastructure Act includes roads. Railways, which was declared to be heading towards bankruptcy in FY2000, is today one of the countrys largest profit-making public sector undertakings. Net revenue improvements were a result of (i) increased axle loads, (ii) reduced wagon turnaround time, (iii) market-oriented tariffs and schemes, and (iv) innovative pricing structures. PPP initiatives have been taken for leasing catering and parcel services. In March 2006, railways privatized container-freight operation while retaining the core activity of train operations. Tariff Authority for major ports has been established to regulate the tariff ceiling. Comprehensive National Maritime Policy is being formulated to lay down the vision and development strategy until FY2024. Pipavav and Mundra ports operate under the private sector ownership. For improving the quality of investments in PPP projects, Planning Commission has prepared an MCA for port terminals. Forward Reform Agenda Reducing resource constraints in terms of finances, technical manpower, project management, and institutional strength in sector institutions. Establishing a policy framework in states as most roads are in the state sector. Process to reduce risk perception among project developers and investors. Improving land acquisition. Increasing availability of traffic data to facilitate financial viability projections. Appendix 2 Engaging the labor union to reduce opposition to private sector participation which is averse to changes that disadvantage existing employees. Rationalizing railway operations which include fulfilling social obligations, entailing investments in unviable projects. These unviable projects account for 2030% of borrowed capital, thereby diverting resources from clogged routes. Improving inland connectivity to major ports. Improving storage infrastructure at ports and container freight stations and the inland road and rail networks. Considering private operator request to lengthen concession period to increase financial viability of PPP projects and on the setting of tariffs and royalty charges. Improving support infrastructure like road connectivity and terminals for cargo transit.

Railways

Ports

Sector Airports

Key Reform Initiatives Government has started the process of revamping the Mumbai and Delhi airports through PPP. 100% foreign direct investment is now permissible for existing airports. Foreign Investment Promotion Board approval required for foreign direct investment beyond 74%. The AAI Act amended to provide legal framework for airport privatization. Government has initiated construction of state-of-the-art Bangalore and Hyderabad airports under PPP. Government has initiated the process of building 35 smaller-city airports under the PPP.

Forward Reform Agenda A comprehensive civil aviation policy is on the anvil. Airports Economic Regulatory Authority Bill for economic regulation is being considered. MCA is also being developed for standardizing PPP transactions for airports. Proposals for revamping AAI are being considered to upgrade air traffic controller services. Customs, immigration, and security issues are being resolved to enhance efficiency of airport usage. Hiring qualified personnel and improving management of ULBs. Establishing state or regional level regulatory mechanism to regulate tariffs and monitor service for water supply. Strengthening municipal or local body finances through (i) the sharing of revenues between the state and ULBs, (ii) rationalizing user charges, and (iii) enabling ULBs to access capital markets. Improving financial conditions in state utilities: Improving tariff structures and realizations. Reducing commercial and technical losses. Simplifying procedures to reduce delays in finalization of contracts such as power purchase agreements, fuel supply agreements, and fuel transport agreements. Completion of unbundling and financial restructuring of utilities. Implementation of availability-based tariffs. Issuing state electricity regulatory commissions guidelines pertaining to open access. Appendix 2

Urban Infrastructure

Model municipal law developed to support states and ULBs to enact reform legislation. Government has provided tax-free status to municipal bonds. Guidelines have been issued by the MoUD in FY2004 to sensitize ULBs with policy and procedural issues to reform urban water and sewerage services and facilitate PPP. In March 1999, parliament repealed the Urban Land Ceiling and Regulation Act 1976 to facilitate development and disposal of excess land.

Power

The Electricity Act 2003 and National Electricity Policy 2005 have been passed, advocating Promotion of competition to maximize consumer benefits. Reduction of technical and commercial losses. Remunerative returns on investments. Central Electricity Regulatory Commission has been set up for determining tariffs for central power projects and 18 state electricity regulatory commissions for determining tariffs of state utilities. Central Electricity Regulatory Commission has issued interstate trading licenses to more than 10 traders.

AAI = Airports Authority of India, FDI = foreign direct investment, MCA = model concession agreement, MoUD = Ministry of Urban Development, NH = National Highways, NHAI = National Highway Authority of India, PPP = public-private partnership, PSP = private sector participation, SPV = special purpose vehicle, ULB = urban local bodies. Source: Planning Commission.

37

38

Appendix 3

SCHEME FOR FINANCING VIABLE INFRASTRUCTURE PROJECTS THROUGH THE INDIA INFRASTRUCTURE FINANCE COMPANY LIMITED A. Background

1. This initiative addresses the need for providing long-term debt for financing infrastructure projects that typically have long gestation periods. Debt finance for such projects should be of a sufficient tenure that enables cost recovery across the project life. However, Indian capital markets lack the maturity to provide long-term debt instruments. Setting up of the India Infrastructure Finance Company Limited (IIFCL) is a policy initiative aimed at filling this gap. 2. Underdeveloped pension and long-term debt markets have restricted the tenure of project finance in India. Most of the available debt is of 712 years maturity, whereas infrastructure projects require a longer repayment period. This constraint leads to front loading of tariffs during the initial years of the project cycle with a view to ensuring repayment of debt. Apart from affecting the users, this handicap also affects the competitiveness of infrastructure projects. 3. The Scheme for Financing Viable Infrastructure Projects through the India Infrastructure Finance Company Limited (the Scheme) was devised by the Ministry of Finance (MOF) after extensive deliberations with the Planning Commission, financial institutions, experts, and other stakeholders. Thus, the Scheme formulated was considered and approved by the Committee on Infrastructure chaired by the prime minister, and was subsequently endorsed by the union cabinet. 4. IIFCL has since been corporatized and will provide financial assistance through longterm debt, either by way of refinance to banks and financial institutions, or by direct lending to project companies. It will lend up to 20% of the capital costs of a project. For project appraisal and lending operations, IIFCL will rely on the lead banks associated with the respective projects. Built into this Scheme is a preference for public-private partnership (PPP) projects that are awarded to private companies selected through a competitive bidding process. Such projects will be eligible for direct lending by IIFCL and will also receive an overriding priority. 5. IIFCL will raise funds from both domestic and external markets on the strength of government guarantees which will be extended as necessary. In the first year of its operation, a guarantee limit of $2.55 billion has been specified by the Government. 6. IIFCL is expected to provide the much needed long-term debt for financing infrastructure projects. In doing so, it will play a catalytic role in building world class infrastructure in India. 7. The Scheme was notified by the Ministry of Finance and the Department of Economic Affairs vide O.M. No. 10/12/2005-INF1 dated 13 April 2006. The Scheme has been amended on 23 April 2007 and on 30 April 2007. The office memorandums notifying the amendments are attached as Annex 1 and Annex 2 hereto.

Secretariat for the Committee on Infrastructure. 2006. Scheme for Financing Viable Infrastructure Projects through the India Infrastructure Finance Company. New Delhi.

Appendix 3

39

1. 1.1

Introduction Whereas the Government of India (the Government) recognizes that there is significant deficit in the availability of physical infrastructure across different sectors and that this is hindering economic development. Whereas the development of infrastructure requires debt of longer maturity to supplement the debt funds presently available. Whereas the Government recognizes that such debt is usually not available because of the following constraints. (i) (ii) (iii) Absence of benchmark rates for raising long-term debt from the market. Asset-liability mismatch of the tenor of debt in case of most financial institutions. High cost of long-term debt.

1.2 1.3

1.4

Now, therefore, the Governments has decided to put into effect the following scheme for providing financial support to improve the viability of infrastructure projects. Short Title and Extent The Scheme will be called the Scheme for financing Viable Infrastructure Projects (VIP). It will be administered by the Ministry of Finance (MOF) through IIFCL. The Scheme will come into force with immediate effect. Definitions In this Scheme, unless the context otherwise requires (i) Empowered Committee means a committee set up for the purposes of this Scheme under the chairmanship of the Secretary of Economic Affairs and including the Secretary of Planning Commission, Secretary of Expenditure, and the Secretary of the line ministry dealing with the subject (see Annex 1 for amendment). IIFCL means the India Infrastructure Finance Company Limited (a company to be incorporated under the Companies Act, 1956). Lead Bank means the financial institution (FI) that is funding the infrastructure project by providing debt to an extent not less than 25% of the total project debt and designated as such by an inter-institutional group or consortium of FIs (see Annex 1 for amendment). Long-term Debt means the debt provided by IIFCL to the Project Company where the average maturity for repayment exceeds 10 years. Private Sector Company means a company in which 51% or more of the subscribed and paid-up equity is owned and controlled by private entities. Project Company means the company which is implementing the infrastructure project for which assistance is to be given by the IIFCL.

2. 2.1

2.2 3. 3.1

(ii) (iii)

(iv) (v) (vi)

40

Appendix 3

(vii) (viii)

(ix)

(x)

Project Term means the duration of the contract or concession agreement for a PPP project. PPP Project means a project based on a contract or concession agreement, between a government or a statutory entity on the one side and a Private Sector Company on the other side, for delivering an infrastructure service on payment of user charges. Public Sector Company means a company in which 51% or more of the subscribed and paid-up equity is owned and controlled by the central or a state government, jointly or severally, and includes any undertaking designated as such by the Department of Public Enterprises and company in which majority stake is held by Public Sector Companies other than financial institutions. Total Project Cost means the lower of the total capital cost of the project a. As estimated by the government/statutory entity that owns the project. b. As sanctioned by the lead bank. c. As actually expended but does not include the cost of land incurred by the Government/statutory entity.

4. 4.1

Funding of IIFCL Apart from its equity, the IIFCL shall be funded through a long-term debt raised from the open market. This debt can be any or all of the following. (i) (ii) (iii) Rupee debt raised from the market through suitable instruments created for the purpose, the IIFCL would ordinarily raise debt of maturity of 10 years and beyond. Debt from bilateral or multi-lateral institutions such as the World Bank and Asian Development Bank. Foreign currency debt, including through external commercial borrowings raised with prior approval of the Government.

4.2

The IIFCL would raise funds as and when required, for onlending, in consultation with the Department of Economic Affairs. The magnitude of funds raised would be determined by demand from VIPs. To the extent of any mismatch between the raising of funds and their disbursement, surplus funds would be invested in marketable government securities. The borrowings of IIFCL may be guaranteed by the Government. The extent of guarantees to be provided shall be set at the beginning of each fiscal year by the MOF within the limits available under the Fiscal Responsibility & Budget Management Act. However, bonds issued by IIFCL, unless otherwise directed by the Government, will not be included against Statutory Liquidity Ratio requirements. For FY2005, the extent of guarantee to be provided by the Government will be Rs10,000 crores ($2.54 billion). The guarantee fee payable by the IIFCL would be 0.25% per annum on outstanding balances. The facility of guarantees, including the terms for guarantee, will be reviewed after 5 years and its continuation shall be subject to the outcome of the review.

4.3

4.4 4.5

Appendix 3

41

5. 5.1

Eligibility The IIFCL shall finance only commercially viable projects. Viable projects may also include those projects that will become viable after receiving viability gap funding under a government scheme. In order to be eligible for funding under this Scheme, a project shall meet the following criteria. (i) The project shall be implemented (i.e. developed, financed, and operated for the project term) by (see Annex 1 for amendment) a. a public sector company; b. a private sector company selected under a PPP initiative; or c. a private sector company. Provided that the special purpose vehicle (SPV) shall assign overriding priority to PPP projects that are implemented by private sector companies selected through a competitive bidding process. Provided further that a private sector company, other than that defined in the first proviso above, would not be eligible for direct lending by the SPV and may be funded only through the refinance mode. The total lending for such private projects shall not exceed 20% of the lending program of the SPV in any accounting year. The eligibility for direct lending and/or raising the limit of 20% will be reviewed at the end of one year having regard to the progress made in funding public sector and PPP infrastructure projects. Provided that in case of railway projects that are not amenable to operation by a private sector company, the empowered committee may relax the eligibility criterion relating to operation by such company. The project should be from one of the following sectors. a. roads and bridges, railways, seaports, airports, inland waterways, and other transportation projects; b. power; c. urban transport, water supply, sewage, solid waste management, and other physical infrastructure in urban areas; d. gas pipelines; e. infrastructure projects in special economic zones; and f. international convention centres and other tourism infrastructure projects. Provided that the empowered committee may, with approval of the finance minister, add or delete any sector/subsectors from this list.

5.2

(ii) (iii)

(iv)

(v) 5.3

Only such projects which are implemented through a project company set-up on a non-recourse basis shall be eligible for financing by IIFCL (see Annex 1 and Annex 2 for amendment). In the event that the IIFCL needs any clarification regarding eligibility of a project, it may refer the case to the empowered committee for appropriate directions.

5.4

42

Appendix 3

6. 6.1

Appraisal and Monitoring by Lead Bank The lead bank shall present its appraisal of the project for consideration of the IIFCL. Based on such appraisal, the IIFCL may consider and approve funding to the extent indicated in Article 7 below. The IIFCL will not normally be required to carry-out any independent appraisal of the project. The lead bank shall be responsible for regular monitoring and periodic evaluation of compliance of the project with agreed milestones and performance levels, particularly for purposes of disbursement of IIFCL funds. It shall send periodic progress reports in such form and at such times, as may be prescribed by IIFCL. Lending Terms The IIFCL may fund VIPs through the following modes. (i) (ii) (iii) Long-term debt. Refinance to banks and financial institutions for loans, with tenor exceeding 10 years, granted by them. Any other mode approved by the Government from time to time.

6.2 6.3

7. 7.1

7.2

The project company will have the right to choose any of the modes of lending given above. The terms at which the project company can access long-term debt shall not be inferior to the terms at which refinanced debt is available to the project company. The total lending by the IIFCL to any project company shall not exceed 20% of the total project cost. Loans will be disbursed in proportion to debt disbursements from financial instutions. The rate of interest charged by IIFCL shall be such as to cover all funding costs including administrative costs and guarantee fee, if any. The IIFCL will release funds to the lead bank as and when due. The lead bank/FI consortium will make disbursements on behalf of the IIFCL and seek reimbursement which shall be made within one month of receiving a demand, with necessary particulars, from the lead bank (see Annex 1 for amendment). Recovery of loans advanced by IIFCL shall be the responsibility of the lead bank. Recovery of IIFCL loans shall be pari passu with project debt (other than subordinate debt) up to 80% of the project debt (other than subordinate debt) of the lead bank and FI consortium (inclusive of interest due) has been recovered. Thereafter, the lead bank/FI Consortium would assume the payment risk as guarantors of the IIFCL loan from that stage onwards (see Annex 1 for amendment). The charge on project assets shall be pari passu with project debt (other than subordinate debt) and will continue beyond the tenure of project debt (other than

7.3

7.4 7.5

7.6

7.7

Appendix 3

43

subordinate debt) until such time the amounts lent by IIFCL, together with interest and other charges thereon remain outstanding. 7.8 The IIFCL, the lead bank, and the project company shall enter into a tripartite agreement for purposes of this Scheme. The format of such tripartite agreement shall be prescribed by the empowered committee from time to time (see Annex 1 for amendment). In the first 2 years of operation of the Scheme, projects meeting the eligibility criteria could be funded on a first-come-first-served basis. In later years, if need arises, funding may be provided based on an appropriate formula, to be determined by the empowered committee that balances needs across sectors in a manner that would broad-base sectoral coverage and avoid pre-empting funds by a few large projects. Lending to PPP Projects A project awarded to a private sector company for development, financing, construction, maintenance, and operation through PPP (as defined in the Scheme for Viability Gap Funding) shall be accorded priority for lending under this Scheme. In case of PPP projects, the private sector company shall be selected through a transparent and open competitive bidding process. PPP projects based on standardized/model documents duly approved by the respective government would be preferred. Stand-alone documents may be subjected to detailed scrutiny by the IIFCL. Prior to inviting offers through an open competitive bid, the concerned government or statutory entity may seek in principle approval of the IIFCL for financial assistance under the Scheme. Any indication given by IIFCL at the prebid stage shall not be treated as a final commitment. Actual lending by IIFCL shall be governed by the appraisal of the lead bank carried-out before financial closure of the project. Review of the Scheme The Scheme may be reviewed by the Government at the end of 5 years or earlier if required. The continuation of the Scheme. with or without modifications, will be dependent on the outcome of such a review.

7.9

8. 8.1

8.2 8.3

8.4

9. 9.1

44 B.

Appendix 3

Office Memorandum (Annex 1) F. No. (I/78/2006-IF.I Government of India Ministry of Finance (Banking Division) Jeevan Deep Building, 3rd Floor Sansad Marg, New Delhi Dated April 23, 2007 Office Memorandum

The undersigned is directed to refer to the Scheme for Financing of Infrastructure through India Infrastructure Finance Company Limited (IIFCL), the Scheme being hereafter referred to as SIFTI, as contained in the Ministry of Finance, Department of Economic Affairs O.M. No. 21/12/2005-INF dated 4 January 2006 and to convey the approval of the Government to the following. 1. Amendment in the definition of Lead Bank in Para 3.1 (c) of SIFTI as follows. "3.1(c) Lead Bank means the Financial Institution (FI) that is funding the project and is designated as such by the lnter-Institutional Group or consortium of Financial Institutions provided the risk exposure of IIFCL is less than that of the lead bank in a project." IIFCL would be regulated directly by the Government and a sui generis regulatory regime for IIFCL may be brought into operation at the earliest. In order to avoid frequent references to the Cabinet on procedural matters, modifications to the SIFTI may be made at the level of Empowered Committee already set-up under the Scheme subject to the approval of the Finance Minister and the Prime Minister. The constitution of the Empowered Committee under the Scheme, as contained in para. 3 (1) (a) of SIFTI, would be broad-based and the Secretary (FS) and in his absence, Special Secretary/Additional Secretary (FS) may be included in the Empowered Committee. Para. 5.2 (a) of SIFTI stands clarified so as to enable IIFCL to lend directly to projects set up by private companies subject to the following conditions. (i) (ii) (iii) The service to be provided by the Infrastructure is regulated or the project is being set up under an MOU arrangement with the Central Government, any State Government, or a PSU. The tenor of IIFCL lending should be larger than that of the longest tenor commercial debt by at least 2 years. Direct lending, plus the refinance business, if any, on account of this category of borrowers (private sector companies not selected through a competitive bidding process) should not exceed 20% of the total lending by IIFCL in any accounting year (this limit is the same as the limit currently imposed for the refinance window).

2. 3.

4.

5.

Para. 5.3 of SIFTI is clarified so that only such projects, which are implemented by the borrower company directly, or through a special purpose vehicle, on a non-recourse basis, shall be eligible for financing by IIFCL.

Appendix 3

45

6.

There is no need to insist on guarantee by the Lead Bank as provided in para. 7.6 of SIFTI and on tripartite agreement provided in para. 7.8 of SIFTI, but IIFCL must position on its staff, personnel with expertise in risk assessment and the regulatory norms that should govern IIFCL should be defined and brought into operations at the earliest.

I am further to state that an Oversight Committee of Secretaries would be constituted for reviewing the working of the IIFCL on a bi-annual basis.

(M. Sahu) Under Secretary to the Government of India

46 C.

Appendix 3 (Annex 2)

Ammendments to SIFTI (Annex 2) No. I (76)/2006-IF.I Government of India Ministry of Finance Department of Economic Affairs (Banking Division) Jeevan Deep Building, Sansad Marg, New Delhi, 30 April 2007

Chairman & Managing Director India Infrastructure Finance Company Limited 1201-1207, Naurang House, K.G. Marg, New Delhi 110001 Subject: Amendments to SIFTI Sir: 1. I am directed to refer to our O.M. of even number dated 23 April 2007 communicating amendments to SIFTI. In this regard, I am further to state that the amendments to para. 5.3 of SIFTI would be subject to maintaining an escrow account which may be entrusted to any bank involved in financing of the project and the discretion with regard to the bank would be that of the Board of Directors of IIFCL. 2. I am to request you to ensure compliance with the foregoing in all the proposals. Yours faithfully,

(M. Sahu) Under Secretary (IF.I)

Appendix 4

47

MARKET ANALYSIS OF THE ROLE OF THE INDIA INFRASTRUCTURE FINANCE COMPANY LIMITED A. Introduction

1. The India Infrastructure Finance Company Limited (IIFCL) was incorporated as a special purpose vehicle (SPV) on 5 January 2006 under the Companies Act, 1956 as a 100% government-owned company. IIFCL is a dedicated institution assuming a developmental and catalytic role in the financing of infrastructure in India. The authorized capital of the company is $254.9 million of which the current paid-up capital is $76.3 million. As IIFCL has been incorporated under the Companies Act, 1956, it is not subject to Reserve Bank of India (RBI) regulations and guidelines with respect to capital adequacy norms. Capital requirements on both sides of IIFCLs balance sheet are addressed under its operating model as expressed in the Scheme (Appendix 3). IIFCLs Scheme also articulates the mechanism through which IIFCL will play a catalytic role in the infrastructure finance market in India. B. IIFCLs Operating Paradigm

2. IIFCLs operating paradigm is described in the Scheme. The Scheme governs IIFCLs operations and enables it to play a key role in infrastructure finance in India. Its role is not only to catalyze investments from the private sector through public-private partnership (PPP) but also to draw-in investable long-term resources from the market. The key elements of the Scheme are designed to catalyze complementary financing on the debt and equity side, reduce market risk, draw-in latent long-term resources, and leverage the project development and management skills available in complementary institutions in the market. 3. In the above context, IIFCL does not function in isolation but is central to the coordinated PPP strategy of the Government. The key pillars of this strategy are (i) (ii) (iii) (iv) (v) Establishing PPP cell in the Department of Economic Affairs in the Ministry of Finance for coordinating the mainstreaming of PPPs nationwide. Establishing PPP cells in selected states and central line ministries for identifying PPP opportunities, developing projects, and bringing them to the market for financial closure. Establishing India Infrastructure Project Development Fund for financing PPP project preparation activities such as conduct of feasibility studies. Setting up IIFCL, the Executing Agency for the proposed Facility, for providing long-term funds for infrastructure development. Creating the Viability Gap Fund with a current annual allocation of about $340 million for encouraging PPPs.1

4. In addition to the above, IIFCL is also a strategic partner in private equity infrastructure funds that have been set up. IIFCL has partnered with Blackstone Group, CitiGroup, and Infrastructure Development Finance Company (IDFC) to establish debt and equity funds which will eventually grow to $5 billion through strategic investment. The equity fund is expected to raise $2 billion equity while the debt fund will grow to $3 billion. These funds will invest in infrastructure subprojects set up under PPP modalities. IIFCL has also invested in the equity
1

The Viability Gap Fund can provide catalytic grant assistance of up to 20% of the capital costs through which it expects several subprojects to become bankable, attract private capital, and mobilize private sector efficiencies. This support is especially important for regions and sectors where private sector is not readily forthcoming

48

Appendix 4

fund which is being managed by IDFC and has been designated as the manager of the debt fund. Further, IIFCL is also expected to set up overseas subsidiaries that will channel long-term funds from Indias foreign exchange reserves to eligible infrastructure projects.2 Finally, IIFCL has developed partnership arrangements with National Highway Authority of India (NHAI) for road sector projects and with Infrastructure Leasing and Financial Services (IL&FS) for power sector projects. Taken as a whole, these initiatives, in conjunction with the mechanisms of the Scheme and sector-wide reforms (Appendix 2), will facilitate market financing for infrastructure and catalyze private sector interest. C. Historical Context of Establishing IIFCL

5. IIFCLs role is rooted in Indias past experiences with development finance institutions (DFI), as well as the global experience. DFIs which were originally set up to provide cheap longterm funding to industries have been affected by financial sector reforms.3 In the absence of a well-developed market for long-term capital, DFIs were the vehicles through which corporations met project finance needs. An essential ingredient of Indias previous growth strategy was the provision of long-term funding from the state on concessional terms to DFIs and the directed onlending of funds by them. This was the primary reason for inefficient price discovery and suboptimal capital allocation. As part of financial reforms in FY1991 onwards, subsidized funding was no longer made available and DFIs had to float bonds to meet funding requirements. Since the maturity of available funding became shorter, while industry needs remained long-term, maturity mismatches developed. Locking up funds in projects adversely affected DFIs cash flows in the absence of an efficient secondary market for corporate debt that would have provided exit opportunities. At the same time, liberalization allowed blue chip corporations to raise money abroad, enabling them to source cheaper funds. 6. In response, DFIs moved into the territory of commercial banks. 4 In April 2001, RBI announced that DFIs could become commercial banks if they met prudential and regulatory requirements. The Industrial Credit and Investment Corporation of India (ICICI) was the first to submit a road map for this purpose in late calendar year (CY)2000 and it subsequently merged with ICICI Bank Ltd. and became a commercial bank. In FY2002, the Government approved the conversion of Industrial Development Bank of India (IDBI) into a commercial bank. In FY2005, the restructuring of IDBI was preceded by the repeal of the IDBI Act, 1964 which paved the way for its transition to a commercial bank. 7. With the conversion of DFIs into commercial banks (without a core infrastructure focus) and the limited ability of debt markets to provide long-term debt, financing sources for long-term debt have dried up. Banks largely depend on short-term deposits for funding and do not
2 3

RBI has recently granted an in-principle approval for channeling $5 billion annually from Indias foreign exchange reserves through IIFCLs overseas subsidiaries for infrastructure development. Starting in 1948 and throughout the 1950s and 1960s, the Government established three DFIs to provide long-term finance. These were Industrial Finance Corporation of India (1948), ICICI (1955), and IDBI (1964). RBI and the Government nurtured the DFIs through financial incentives and other policy measures, such as being provided with low-cost funds and guarantees by the Government for bond issuances. RBI allocated a substantial part of its national industrial credit (long-term operations) funds to IDBI. On 8 December 1997, RBI constituted a working group chaired by Mr. S.H. Khan to bring about greater clarity in the respective roles of banks and other financial institutions for greater harmonization of facilities and obligations. The report of the committee on banking sector reforms (the Narasimham committee) had a major bearing on the issues considered by the Khan working group. The Narsimham committee suggested that DFIs should convert ultimately into either commercial banks or non-bank finance companies. The Khan working group also held the view that DFIs should be allowed to become banks at the earliest opportunity. The feedback on the working group recommendations indicated that universal banking is desirable from the point of view of efficient use of resources.

Appendix 4

49

undertake long-term market borrowings. 5 Loan officers of banks are typically not trained to assess the long-term stability of cash flows from a project finance perspective. Further, institutions such as IL&FS and IDFC who have the ability and expertise to finance large subprojects are unable to do so due to capital constraints. 8. While demise of DFIs should have encouraged corporates to go to the market for resources, leading to a vibrant corporate debt market, the corporate debt market remains weak, illiquid, and does not offer long-term financing instruments. In this light, several initiatives are ongoing to develop the long-term corporate debt market. The Government appointed a high level committee (the Patil committee) 6 to recommend measures in developing the corporate debt market. Key recommendations include (i) developing a credit enhancement mechanism for bonds issued by state-owned corporations or other SPVs for financing infrastructure; (ii) recommending affordable levels of stamp duty on debt assignments; and (iii) allowing repossession of corporate bonds. 7 In addition, Securities and Exchange Board of India is providing the regulatory framework for the secondary corporate debt market. RBI has also drafted guidelines on the usage of credit derivatives (specifically credit default swaps).8 9. Illiquid secondary markets put banks at risk by constraining their ability to hive-off risk and have adverse implications for infrastructure financing. (i) Insufficient market maturity and absence of benchmarks. A weak secondary market leads to illiquid interest rate derivatives and hedging mechanisms. In response to these constraints, banks generally charge floating rates which effectively makes loans short in duration instruments. Lack of investor interest. Given investor comfort with protected investments, investors are unwilling to accept a risk of decline in the value of assets in the absence of liquid secondary markets. On the other hand, institutional investors, such as insurance and pension funds, have investment criteria for credit ratings (minimum AA) constraining them to invest in government securities.9

(ii)

10. Further, the bulk of corporate issuances belong to the public sector (81%), in the FY1996FY2006 period through private placements (on the back of a government guarantee). A major reason for low private sector mobilization is regulations that allow market accessibility only to top-rated companies. Of the total issuance of $14.11 billion in FY2004, $13.70 billion was credit-rated, suggesting that credit rating is necessary for market access.10 11. Despite reforms and measure to improve the regulatory environment and develop longterm debt markets, policy, institutional, and market gaps remain as financial and infrastructure sector-wide reforms are still ongoing. The existence of several interlocking factors (regulatory and policy gaps, the conversion of DFIs, illiquid capital markets, higher risk profile of
5

Long-term issuances of government securities are usually absorbed by pension and insurance funds and held until maturity. 6 High Level Committee on Corporate Bonds and Securitization (2005). 7 This measure is to give investors who have illiquid corporate bonds an opportunity to recycle them. 8 Source: RBI, DBOD. NO.BP.1409.157/2006-07, 16 May 2007. 9 At present, except for raising funds for infrastructure projects, banks are not allowed to issue bonds with long maturities. Thus, there are not enough issuers of bonds. Restrictions have also been imposed on the investment activity of life insurance companies and mutual funds and these restrictions are one of the reasons for the lack of growth in bond investment. 10 Investors in corporate debt instruments are excessively safety-conscious, as can be noted from the fact that there is hardly any demand for paper which is rated below AA or its equivalent. Debt instruments with credit rating of BBB (or its equivalent) and above is considered investment grade.

50

Appendix 4

infrastructure subprojects, inadequate risk capital,11 and suboptimal risk allocation) requires an innovative response to address market gaps. The establishment of IIFCL and the elements of its operating paradigm (the Scheme) are a reflection of the Governments response to these interlocking factors and a part of the ongoing reform agenda in the financial sector and infrastructure space. D. Market Justification for IIFCLs Operating Model

12. The key elements of IIFCLs Scheme have a specific role in promoting an enabling environment for PPP and infrastructure development, and filling the gaps as described in para. 11. Specifically, these are described below. 13. Guarantee Arrangement. Through its operating paradigm, IIFCL fills the gaps in the market for infrastructure finance. The individual investor in India is very risk averse and, even at very large negative real returns, prefers risk-free investments to risky ones. The same is the case for pension and insurance funds. Thus, there is a need for intermediaries and markets that are able to perform the three functions of risk, maturity, and duration transformation, and attract funds from the above-mentioned sources by providing an additional layer of credit enhancement. In this context, government guarantees, as provided to IIFCL, can be a viable mechanism of providing the required risk capital in an environment where the Government is seeking to remain within its fiscal limits.12 Typically such credit enhancements should come from the market, through specialized guarantee mechanisms or credit derivatives. However, this is not possible in the current Indian context as the markets are not fully developed and the reform process is ongoing. 14. As suggested above (para. 13), the justification for the guarantee comes from the state of available risk mitigation mechanisms. Credit derivatives have not become fully established in India while banks are not permitted to trade in equity and commodity derivatives.13 Further, the market for interest rate derivatives is limited as there are strict restrictions on the participation of banks in exchange-traded derivatives. While over-the-counter derivatives may be traded by banks, public sector banks are largely absent from the market. Insurance companies (the other natural counterparties to infrastructure providers) have not received permission from the
11

The risk capital required in the infrastructure sector can be understood as the explicit capital brought in as equity by the subproject sponsors and the implicit risk capital provided by the lenders to subprojects. Implicit risk capital is therefore the credit enhancement provided to retail and long-term investors to draw in funds for infrastructure. Implicit capital providers seek to manage their risk-return reward by ensuring availability of adequate explicit capital and diversification across various projects. Given this profile of explicit capital, greater flow of risk capital can be ensured by removing the effects of controllable uncertainties in the policy environment and making available the benefits of diversification through alternate mechanisms. New sources of this risk capital can be sourced by (i) providing risk guarantees (through IIFCLs Scheme), (ii) the formation of highly capitalized financial intermediaries (unlikely in a fiscally constrained regime), and (iii) encouraging securitization transactions. 12 In the United States (US) markets, monocline insurance companies like MBIA Inc. provide such credit enhancements for urban local bodies and other borrowers. MBIA is a US-based financial guarantee insurance company and is rated AAA by ratings agency Standard&Poors. It has been providing AAA credit enhancement for municipal and structured debt obligations since 1974. It has guaranteed more than 35,000 municipal and assetbacked transactions with a total value exceeding $1.5 trillion. 13 As a consequence, banks which have lent against the security of shares have been unable to hedge their exposure in falling markets and have lost money. Further, insurance companies which largely have very long duration and fixed income liabilities have lost value almost every month as interest rates have fallen and they have been unable to hedge their exposure. Finally, banks and DFIs which have lent to companies engaged in commodity businesses, such as cement, paper, and steel have been unable to lay off the underlying commodity exposures in the international market and have lost value as commodity cycles have turned against them. Studies suggest that interest rate risk exposure inherent in the balance sheet of most banks is very high.

Appendix 4

51

Insurance Regulatory and Development Authority14 to enter the market in the absence of credit enhancing instruments. 15. Thinly capitalized entities from a risk-weighted perspective that focus on infrastructure finance are unlikely to maintain viability if they finance subprojects without exposure limits. These limits will impose a budget constraint on subprojects given long gestation periods and length of debt ammortizations of subprojects. Further, no single entity will have sufficient capital to meet all infrastructure finance requirements. Thus, spreading the risk amongst a large number of investors for each of whom this represents only a small exposure is the only way this risk capital can be sourced. In the context of IIFCLs guarantee, this amounts to commoditizing risk as a public good (as it is borne by the Government). This credit enhancement mechanism stems from the recommendations of the Patil committee. 16. Exposure Limit. By financing only 20% of the capital costs of a project, IIFCL will function as part of a lending consortium and will only finance projects deemed by the market to be commercially viable. The limited project financing provided by IIFCL will ensure that it builds a diversified portfolio and does not suffer from a lumpy investment profile that caused distress to IDFC earlier. In this respect, IIFCL will benefit from the PPP development initiatives currently underway. Thus, IIFCL functions under a different paradigm from earlier DFIs, and does not undertake subproject origination and does not have directed lending requirements. 17. Efficient Capital Allocation. The presence of IIFCL results in efficient capital allocation in financial institutions engaged in infrastructure finance. With IIFCL providing an independent source of funding, financial institutions may take exposures to projects in line with their risk return capital allocation framework. While the combined exposures of financiers may be insufficient to meet project needs, an additional independent source of funding through IIFCL would likely fill the financing gap. The optimal capital allocation and risk-based return on capital promoted through this framework will provide additional benchmarks for the pricing of infrastructure risk in the market. 18. Long-Term Financing. IIFCL will offer long-term financing for tenors not currently being offered by the market. This is expected to improve the bidding mechanism and the quality of bids. As project sponsors will have better cash flow projections, the bidding process will be facilitated and will not normally include anomalies on notional hedging costs to account for repricing uncertainties. Long tenor financing of over 20-year maturities will enable IIFCL to take an exposure to projects in line with the length of the concession agreements. Thus, potential investors in subproject SPVs/concessionaires will be provided with an additional layer of comfort given debt exposure to a subproject that matches the length of equity exposure. Thus, IIFCL will also catalyze explicit risk capital (private equity share in subproject SPVs) in addition to its other market enhancing roles. IIFCL will onlend to subprojects based on market borrowing. Thus, unlike the older DFIs, IIFCL does not have subsidized financing sources. 19. Establishing Market Benchmarks. The risk-based pricing of subloans to subprojects will establish benchmarks for long-term pricing. This will form the basis through which long-term
14

As per the Insurance Regulatory and Development Authority regulations, life insurance and general insurance companies are required to invest minimum amounts (20% for general insurance and 25% for life insurance) in different combinations of state and central government securities (without any quota for state governments). Further, while there are stipulations for investments in infrastructure and social sectors (15% for life insurance and 10% for general insurance sectors), the stipulation of a minimum rating of AA for such investments makes availability of such funds very limited. If such stipulation cannot be removed, the case for a First Loss Deficiency Guarantee backed investment becomes compelling.

52

Appendix 4

debt can be structured for project finance by sourcing financing from insurance and pension funds. The critical element of this mechanism is the pricing of loans given that IIFCL does not have sufficient capital to price loans on a Risk Adjusted Return on Capital15 principle. Given this constraint, an efficient pricing principle, as a first approximation, could be to benchmark loans against spreads of corporate paper of similar risk characteristics. This could be achieved by observing corporate paper that resembles the risk profiles for the SPV being considered for financing. If similar paper is unavailable in the domestic market (given limited market liquidity), the international market will be assessed for comparable paper and adjustments made for country spread differential. E. Role of IIFCL in Promoting PPP

20. IIFCL will seek to leverage the available resources in the market to improve the viability of projects by reducing financing risk. In this context, IIFCL has developed partnerships with project developers such as IDFC and IL&FS as well as with concession awarding agencies such as NHAI. The role played by IIFCL in PPP development is provided in Figure A4.1. 21. As can be seen from Figure A4.1 below, IIFCL will play a complementary role in the infrastructure finance market. The ways by which it addresses market gaps for encouraging PPP are as follows (i) draw-in equity funds; (ii) provide long-term debt; (iii) partner with complementary project development agencies; and (iv) promote capital efficiency in the consortium institutions. Thus, IIFCLs presence in the market allows the financing of projects that would otherwise have been denied financing. The role played by IIFCL can be further seen from the way which PPP-type subprojects are brought to the market and opreationalized. This is provided in Figure A4.2 below.

15

As it became clearer that banks needed to add an appropriate capital charge in the pricing process, the concept of risk adjusting the return or risk adjusting the capital arose. The value-producing capacity of an asset (or a business) is expressed as a ratio that allows comparisons to be made between assets (or businesses) of varying sizes and risk characteristics. The ratio is based either on the size of the asset or the size of the capital allocated to it. When an institution can observe asset prices directly (and/or infer risk from observable asset prices), then it can determines how much capital to hold based on the volatility of the asset. Risk Adjusted Return on Capital principle allocates a capital charge to a transaction or a line of business at an amount equal to the maximum expected loss (at a 99% confidence level) over a year on an after-tax basis. As may be expected, the higher the volatility of the returns, the more capital is allocated. The higher capital allocation means that the transaction has to generate cash flows large enough to offset the volatility of returns, which results from the credit risk, market risk, and other risks taken.

54

Appendix 4

22. As described in the above schematic, IIFCL is being positioned as an apex agency for infrastructure development. It has partnership arrangements with (i) project developers such as IDFC and IL&FS to provide debt financing for projects developed by them; and (ii) NHAI to fund projects being developed by SPVs which have been granted concessions by NHAI in the road sector. It has also invested in private equity funds along with Blackstone Group and CitiGroup which will invest in SPVs. IIFCLs presence in the equity fund are expected to catalyze other investors to invest in the fund. This fund will provide the market with explicit risk capital. F. Assessment of IIFCLs Operations

23. In a relatively short period, IIFCL has achieved a market presence and has built up a portfolio of projects. IIFCL has sanctioned funds for 64 projects and another 6070 are expected to come into its portfolio in the next financial year. A list of sanctioned projects is provided in Supplementary Appendix D. 24. As a result of the guarantee, IIFCL has the highest credit rating in the domestic market (AAA). Further, on the basis of its market standing, IIFCL has issued a 10-year paper at 80 basis points above comparable government security and around 15 basis points below other prevailing AAA-rated paper for similar maturities. Thus, IIFCL appears to be successfully leveraging the guarantee to access the market at competitive rates and investors have accepted the quality of the guarantee. 25. Taken as a whole, IIFCLs balance sheet is expected to grow to around $6 billion$8 billion in the next few years. Based on this understanding of IIFCLs operations and its role in infrastructure financing, a consortium of development partners, including the Japan Bank for International Cooperation for 70.5 billion ($600 million), Kreditanstalt fr Wiederaufbau of Germany for 280 million ($395 million), and the World Bank for $500 million and the are considering providing IIFCL with a line of credit for onlending to eligible projects. The line of credit will complement IIFCLs other sources of borrowings including (i) an issuance of a $127 million bond (10-year bullet repayment) in the domestic market in September 2006; (ii) a $51 million loan from the State Bank of Travencore; and (iii) $26 million from other state-owned banks. IIFCL is also contemplating accessing the international capital markets with a $500 million bond issuance. IIFCLs balance sheet is provided in Table A4. Table A4: Provisional Unaudited Balance Sheet ($ million)
Particulars A. Sources of funds Share capital Reserve and surplus Loan funds (secured) Loan funds (unsecured) Deferred tax liability Total Application of funds Deferred tax assets Loans Fixed assets Investments Current assets (A) Less: Current liabilities and provisions (B) Net current assets Schedule No. I II III IV V V VI VIII VII IX X (A) (B) As at 30 September 2007 76.30 4.01 171.17 251.48 0.005 138.78 0.06 109.92 6.23 3.94 2.29 As at 31 March 2007 25.43 1.74 17.70 154.47 0.15 199.49 0.005 36.23 0.07 164.94 5.56 7.75 (2.19)

B.

C. D.

Appendix 4

55

Particulars

Schedule No.

Miscellaneous expenditures Total = no data, ( ) = negative. Source: India Infrastructure Finance Company Limited.

As at 30 September 2007 0.42 251.48

As at 31 March 2007 0.44 199.49

G.

Conclusion

26. IIFCLs role should be seen in the context of the overall market for infrastructure financing in India occupying a niche position in the market by channeling long-term funds to the infrastructure sector and filling significant institutional and market-related gaps. Through IIFCL, the Government seeks to play the role of facilitator in infrastructure financing, and is expected to function as a bridge between the needs of the borrowers and lenders or investors by providing an additional layer of credit enhancement to channel liquidity. Going forward, market development is a key to widening the investor base and bringing more PPP projects into the market.

56

Appendix 5

CORPORATE GOVERNANCE FRAMEWORK FOR THE INDIA INFRASTRUCTURE FINANCE COMPANY LIMITED A. Introduction

1. The India Infrastructure Finance Company Limited (IIFCL) is a unique entity established by the Government of India (the Government) under the Companies Act, 1956. As such, its corporate governance structure is dictated by the provisions of the Act. IIFCL is also subject to the provisions of the Depositories Act, 1996.1 The application of the Companies Act, 1956 to IIFCL is laid down in IIFCLs Memorandum and Articles of Association (Supplementary Appendix F). IIFCLs operating model and functional modalities are provided in its Scheme which articulates IIFCLs business case and provides functional guidance under the provisions of the Companies Act, 1956. Finally, its comprehensive business plan (CBP) provides its road map for adopting best practices. B. Implications of the Companies Act, 1956 for IIFCL

2. The Companies Act, 1956, amended from time to time, is the most important piece of legislation that empowers the central government to regulate the formation and functioning of companies. The Companies Act is administered by the central government through the Ministry of Corporate Affairs and the offices of bodies such as the Registrar of Companies, 2 Official Liquidators, Public Trustee, Company Law Board, and Director of Inspection. 3. The Companies Act, 1956 states that a company is "a company formed and registered under the Act or an existing company, i.e., a company formed or registered under any of the previous company laws." The basic objectives of the law are to (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) Enforce a minimum standard of good behavior and business honesty in company promotion and management. Provide due recognition of the legitimate interest of shareholders and creditors and of the duty of managements not to jeopardize those interests. Provide effective control and voice in the management for shareholders. Ensure fair and true disclosure of the companys affairs in its annual published balance sheet and profit and loss accounts. Ensure adoption of proper standards of accounting and auditing. Accord recognition to the rights of shareholders to receive reasonable information and facilities for exercising an intelligent judgment with reference to the management. Prescribe a ceiling on the share of profits payable to management as remuneration for services rendered. Institute a system of checks and balances on transactions where there is a possibility of conflict of duty and interest.

1 2

Depository means a company formed and registered under the Companies Act, 1956 and which has been granted a certificate of registration to act as a depository under the Securities and Exchange Board of India Act, 1992. Registrars of companies appointed under Section 609 of the Companies Act covering the various states and union territories are vested with the primary duty of registering companies floated in the respective states and the union territories and ensuring that such companies comply with statutory requirements under the Act. These offices function as a registry of records relating to the companies registered with them and the records are available for inspection by members of public on payment of the prescribed fee. The central government exercises administrative control over these offices through the respective regional directors.

Appendix 5

57

(ix) (x)

Provide investigation into the affairs of any company managed in a manner oppressive to a minority of the shareholders or prejudicial to the interest of the company as a whole. Enforcement of the performance of their duties by those engaged in the management of public companies or subsidiaries of public companies by providing sanctions in the case of breach and subjecting management to more restrictive provisions of law applicable to public companies.

4. Important amendments introduced in FY2000 to Sections 217 and 292 of the Companies Act (made applicable from 13 December 2000) set the tone for corporate governance in the country. The changes relate to paras. 510 below. C. Directors Responsibility Statement (Section 217 [2AA])

5. With a view to increasing the accountability of directors, a company is required to include a Directors Responsibility Statement in the Report of the Board of Directors which should affirm the following. (i) (ii) (iii) (iv) D. Annual accounts have been prepared in accordance with applicable accounting standards with proper explanation relating to material departures. The selection and application of accounting policies by the directors is consistent and prudent so as to give a true and fair view of the state of affairs of the company. Proper and sufficient care has been taken by the directors for the maintenance of adequate accounting records for safeguarding the assets of the company and for preventing and detecting frauds and irregularities. The annual accounts of the company are prepared on an ongoing concern basis.

Formation and Role of Audit Committee

6. Section 292-A of the Companies Act, 1956 requires every limited public company having paid-up capital of not less than $1.27 million to constitute an audit committee at the board level. The audit committee should have a minimum of three directors and two thirds of the total number of audit committee members shall be the directors other than managing or full-time directors. The terms of reference of the audit committee include all matters related to financial reporting and the audit of financial reports, including efficacy of the internal control system. The statutory requirement of having audit committees brings into sharp focus the primacy of independent directors in corporate governance and the critical role of financial reporting in satisfying the expectations of stakeholders. 7. The second amendment (FY2002) 3 of the Companies Act, 1956 reflects the Governments response to the changing business environment. Amongst other things it (i) seeks to provide more transparency in corporate governance; (ii) places more responsibility and accountability on company directors; (iii) makes small companies comply with accounting discipline; and (iv) protects the interest of small investors and depositors and debenture holders. 8. Further, the CBP stipulates that IIFCL will constitute an audit committee having nonexecutive directors as members, and a 50% representation of independent directors. At
3

The second amendment (FY2002) of the Companies Act, 1956 came into effect on 13 January 2003.

58

Appendix 5

least one member of the audit committee will possess accounting or financial management expertise. 9. The role of the audit committee will primarily include the following. (i) (ii) (iii) (iv) Oversight of IIFCLs financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient, and credible. Reviewing with the management the adequacy of internal control systems. Reviewing the adequacy of the internal audit function. Reviewing the companys financial and risk management policies.

10. In addition, IIFCL undertakes three levels of audit (i) concurrent internal audit by a firm of chartered accountants, (ii) statutory audit by an independent firm of chartered accountants appointed by the comptroller and auditor general of India, and (iii) supplementary audit by the comptroller and auditor general of India. E. Corporate Governance Structure of IIFCL

11. The peak policy-making body of IIFCL is the Empowered Committee of Secretaries which is authorized to make changes to the Scheme. The committee is independent of IIFCLs board, with minimal duplication of membership, and includes one member (secretary) from the line ministry which will be impacted by, or which has sought changes to, the Scheme (i.e., the empowered committee could have one floating member based on the subject under consideration). This mechanism ensures separation between policy making and implementation and minimizes potential conflict of interest and the possibility of structuring the Scheme to favor a particular subsector or lending modality. Further to the Empowered Committee, an Oversight Committee has been established to implement the regulatory process. The composition of the oversight committee is independent and distinct of the Empowered Committee, and the two committees do not have any common members. 12. As per IIFCLs Memorandum and Articles of Association, the number of directors will not be less than three nor more than thirteen, or such number as may be determined from time to time by IIFCL in its general meeting in accordance with the aforesaid limit and provisions of the Companies Act, 1956. As per the Memorandum and Articles of Association, the board of directors will consist of the following. (i) (ii) (iii) (iv) Two full-time directors (one of whom shall be chairman and managing director) who shall not be liable to retire on rotation. Two directors who may be officials of the Government, nominated by the Government. Three part-time directors who will be experts from outside the Government. Such number of directors elected by the members other than the Government, as follows. a. Where the total amount of equity share capital issued to such shareholders is 25% or less of the total issued equity capital, two directors. b. Where the total amount of equity share capital issued to such shareholders is more than 25% but less than 40% of the total equity share capital, four directors.

Appendix 5

59

c.

Where the total amount of equity share capital issued to such shareholders is 40% or more of the total issued equity capital, six directors.

13. Further, as per Chapter 10 of its CBP, IIFCL will adopt best practice which requires a fair percentage of independent directors4 to serve the following purposes. (i) (ii) Independent directors appointed from varied fields of specialization and knowledge will bring expertise and competence to IIFCL. IIFCL is fully owned by the Government. However, given the magnitude of infrastructure projects to be financed by IIFCL, the Government stakeholders of IIFCL would be from different departments and ministries. Thus, independent directors who are in a position to make objective decisions are required to represent various nongovernment stakeholders.

14. Powers of Directors. As per IIFCLs Memorandum and Articles of Association, the board will exercise the following powers on behalf of the company and it will do so only by means of resolutions passed at its meetings. (i) (ii) (iii) (iv) (v) (vi) Make calls on shareholders in respect of money unpaid on their shares. Authorize the buy-back of shares. Issue debentures. Borrow money by means other than debentures. Invest the funds of the company. Make loans.

15. Provided that a resolution is passed at a meeting, the board may delegate to any committee of directors, the chairman, and such other persons as the board may specify, the fulltime director, or any other officer of the company, the powers specified in items (iv), (v), and (vi) to the extent specified in the Companies Act, 1956. 16. Board Procedures. As per the CBP, the following prudent board procedures are proposed. (i) (ii) (iii) Board meetings will be held at least four times a year, with a maximum interval of 4 months between any two meetings. A director shall not be a member of more than 10 committees or act as chairman of more than five committees across all companies in which he or she is a director. The information provided to the board periodically shall include, but not be limited to (a) annual operating and resources plans; (b) quarterly results; (c) minutes of meetings of the audit committee and other board committees; (d) information on recruitment and remuneration of senior management; (e) details of any collaboration agreements, signed memoranda of understandings; and

The CBP suggests one third of the board shall consist of independent directors.

60

Appendix 5

(f)

credit risk and portfolio analysis, market risk reports including interest rate sensitivity statements, and statements on foreign exchange exposure and hedging.

17. Disclosures. The CBP emphasizes transparency in IIFCL operations through an appropriate disclosure and communication plan as follows. (i) (ii) (iii) (iv) All pecuniary relationship or transactions of the nonexecutive directors with IIFCL will be disclosed in the annual report. In addition, compensation levels of all the directors will be disclosed. Management will make disclosure to the board relating to all material financial and commercial transactions where they have personal interest that may have a potential conflict with the interest of the company at large. Management will provide a clear description of each material contingent liability and its risks to be accompanied by auditors comments. IIFCL will aim to include (as part of the directors report in the annual report or as an addition thereto) a management discussion on, among other things, (a) financial performance, (b) risks and concerns, (c) internal control systems and their adequacy, and (d) material developments in human resources including the number of people employed. IIFCL shall present its corporate governance framework in a separate section in its annual report along with a compliance report.

(v)

18. IIFCLs Management Structure. The organization of IIFCL is separated to ensure that loan appraisal, resource mobilization and treasury, and loan recovery functions are separate. The functional segregation is based on minimizing conflict of interest and ensuring independence in loan evaluation, pricing, and risk evaluation (e.g., the risk management function has no lending targets and performance is assessed on the basis of documentation and data integrity). Further, the responsible officers have been selected on the basis of their experience in the banking sector and are drawn from various commercial banks. Figure A5 details the IIFCL operating structure.

62

Appendix 6

ADB ASSISTANCE TO THE INFRASTRUCTURE SECTOR (As of 31 March 2007)

Number of Projects ADB Assistance A. Loan 1. Energy a. Conventional Energy Generation (other than hydropower) OCR ADF Subtotal (a) b. Energy Sector Development OCR ADF Subtotal (b) c. Hydropower Generation OCR ADF Subtotal (c) d. Renewable Energy Generation OCR ADF Subtotal (d) e. Transmission and Distribution OCR ADF Subtotal (e) Subtotal (A1) 2. Transport and Communications a. Civil Aviation OCR ADF Subtotal (a) b. Multi-modal Transport & Sector Development OCR ADF Subtotal (b) c. Ports, Waterways, and Shipping OCR ADF Subtotal (c) d. Railways OCR ADF Subtotal (d) e. Roads and Highways OCR ADF Subtotal (e) f. Telecommunications and Communications OCR ADF ADB India ADB Amount ($ million) India

42 22 64 46 13 59 28 19 47 4 0 4 78 52 130 304 8 14 22 1 0 1 45 19 64 21 7 28 131 96 227 13 11

8 0 8 9 0 9 1 0 1 1 0 1 6 0 6 25 0 0 0 0 0 0 5 0 5 3 0 3 15 0 15 2 0

3,736.77 682.06 4,418.83 6,679.23 325.60 7,004.83 1,738.90 453.85 2,192.75 321.70 0.00 321.70 7,272.65 2,202.42 9,475.07 23,413.18 430.30 196.72 627.02 30.60 0.00 30.60 2,031.35 147.24 2,178.59 3,930.00 391.00 4,321.00 15,671.20 4.396.78 20,067.98 1,305.18 100.62

1,767.00 0.00 1,767.00 1,397.00 0.00 1,397.00 41.92 0.00 41.92 100.00 0.00 100.0 1,525.00 0.00 1,525.00 4,830.92 0.00 0.00 0.00 0.00 0.00 0.00 614.60 0.00 614.60 728.60 0.00 728.60 3,433.00 0.00 3,433.00 253.00 0.00

Appendix 6

63

Number of Projects ADB Assistance Subtotal (f) Subtotal (A2) Total (A1+A2) Technical Assistance 1. Energy a. Conventional Energy Generation (other than hydropower) b. Energy Sector Development c. Hydropower Generation d. Renewable Energy Generation e. Transmission and Distribution Subtotal (B1) 2. Transport and Communications a. Civil Aviation b. Multi-modal Transport & Sector Development c. Ports, Waterways, and Shipping d. Railways e. Roads and Highways f. Telecommunications and Communications Subtotal (B2) Total (B1+B2) ADB 24 366 670 77 246 60 27 110 520 32 42 114 66 364 36 654 1,174 India 2 25 50 13 30 2 2 3 50 0 2 11 5 41 5 64 114

Amount ($ million) ADB 1,405.80 28,630.99 52,044.17 28.95 110.27 29.16 12.92 50.35 231.65 13.60 21.86 39.78 32.02 173.48 15.20 295.94 527.59 India 253.00 5,029.20 9,860.12 5.24 15.01 0.50 0.95 1.80 23.50 0.00 1.15 6.71 3.24 20.28 1.42 32.80 56.30

B.

ADB = Asian Development Bank, ADF = Asian Development Fund, OCR = ordinary capital resources. Sources: ADB's loan, technical assistance, and equity approvals.

64

Appendix 7

EXTERNAL ASSISTANCE TO THE INFRASTRUCTURE SECTOR Table A7.1: World Bank

Amount Project Name A. Rural Andra Pradesh Community Forest Management Andra Pradesh Rural Poverty Reduction Assam Agriculture Competitiveness Chattisgarh District Rural Poverty Global Environment Facility Biosafety Project Hydrology II Karnataka Tank Management Karnataka Watershed Maharashtra Water Sector Mid-Himalayan Watersheds Madhya Pradesh District Poverty Madya Pradesh Water Sector National Agrarian Innovation Rajasthan District Poverty Initiatives Rajasthan Water Sector Tamil Nadu Empower & Poverty Reduction Tamil Nadu Irrigation Agriculture Uttar Pradesh Water Sector Uttaranchal Watershed Subtotal (A) B. Energy Power System Development III Renewable Energy II Subtotal (B) C. Rural Water Karnataka Rural Water Supply Kerala Rural Water Supply Maharashtra Rural Water Punjab Rural Water Supply and Sanitation Uttaranchal Rural Water Supply and Sanitation Subtotal (C) D. Transport Allahabad Bypass Grand Trunk Road Gujarat Highways Karnataka Highways Kerala State Transport Lucknow-Muzaffarpur National Highway Mizoram Roads Mumbai Urban Transport National Highways III Punjab State Roads Project Rural Roads Project Tamil Nadu Roads Uttar Pradesh Roads Subtotal (D) E. Urban Water Gujarat Emergency Earthquake Karnataka Municipal Reforms
($ million)

Date Approved 16 July 2002 20 Feb 2003 14 Dec 2004 24 Apr 2003 23 Jul 2003 24 Aug 2004 25 Apr 2002 21 Jun 2001 23 Jun 2005 13 Dec 2005 07 Nov 2000 07 Sep 2004 18 Apr 2006 25 Apr 2000 19 Feb 2002 12 Jul 2005 23 Jan 2007 19 Feb 2002 20 May 2004 19 Jan 2006 27 Jun 2000 18 Dec 2001 07 Nov 2000 26 Aug 2003 14 Dec 2006 05 Sep 2006 14 Oct 2003 21 Jun 2001 05 Sep 2000 24 May 2001 14 Mar 2002 21 Dec 2004 14 Mar 2002 18 Jun 2002 08 Jun 2000 05 Dec 2006 23 Sep 2004 17 Jun 2003 19 Dec 2002 02 May 2002 14 Mar 2006

108.0 150.0 154.0 92.5 1.0 105.0 73.8 80.3 325.0 60.0 90.0 394.0 200.0 100.5 125.0 120.0 485.0 109.1 69.6 2,842.8 400.0 104.0 504.0 136.6 53.2 181.0 154.0 120.0 644.8 240.0 576.5 280.0 360.0 255.0 620.0 60.0 542.0 490.8 250.0 399.5 348.0 488.0 4,909.8 327.6 216.0

Appendix 7

65

Amount Project Name Karnataka Urban Water Improvement Tamil Nadu Urban III Tsunami Emergency Recons Subtotal (E) Total (A+B+C+D+E)
Source: World Bank. ($ million)

Date Approved 08 Apr 2004 05 July 2005 03 May 2005

39.5 300.0 465.0 1,348.1 10,249.5

Available: http://www.worldbank.org.in/WBSITE/EXTERNAL/COUNTRIES/SOUTHASIAEXT/INDIAEXTN/0, contentMDK:20195738

Table A7.2: Japan Bank for International Cooperation

Project Name A. Electric Power and Gas Simhadri Thermal Power Station Project (II) Simhadri Thermal Power Station Project (V) Simhadri and Vizag Transmission System Project (II) West Bengal Transmission System Project (II) Simhadri Thermal Power Station Project (IV) Bakreswar Thermal Power Station Units Extension Project Purulia Pumped Storage Project (II) Dhauliganga Hydro-electric Power Plant Construction Project (III) Umiam Stage II Hydro-Power Station Renovation and Modernization Project North Karanpura Super Thermal Power Project (I) Purulia Pumped Storage Project (III) Rural Electrification Project Subtotal (A) B. Transportation Delhi Mass Rapid Transport System Project (II) Delhi Mass Rapid Transport System Project (III) Delhi Mass Rapid Transport System Project (IV) Delhi Mass Rapid Transport System Project (V) Delhi Mass Rapid Transport System Project (VI) Visakhapatnam Port Expansion Project (E/S) Delhi Mass Rapid Transport System Project (Phase2) (I) Bangalore Metro Rail Project Subtotal (B) Total (A+B) Amount ( million) 12,194.0 27,473.0 6,400.0 3,127.0 5,684.0 36,771.0 23,578.0 13,890.0 1,964.0 15,916.0 17,963.0 20,629.0 185,589.0 6,732.0 28,659.0 34,012.0 59,296.0 19,292.0 161.0 14,900.0 44,704.0 207,756.0 393,345.0 Date Approved 30 Mar 2001 13 Feb 2002 10 May 2002 10 May 2002 31 Mar 2003 31 Mar 2003 31 Mar 2004 31 Mar 2004 31 Mar 2004 31 Mar 2005 31 Mar 2006 31 Mar 2006 30 Mar 2001 13 Feb 2002 31 Mar 2003 31 Mar 2004 31 Mar 2005 31 Mar 2006 31 Mar 2006 31 Mar 2006

Source: JBIC. Available: http://www.jbic.go.jp/english/oec/project/yen_loan_list.php

Table A7.3: Kreditanstalt fr Wiederaufbau

Project Name Renewable Energy Programme (PFC II) REC Energy Efficiency Programme Promotion of Private Sector Infrastructure Projects (cofinancing with ADB PSIF II) Development Credit Facility (ICICI I)* Development Credit Facility (ICICI II)* Amount ( million) 100.56 loan + 3.3 grant 70 loan + 500,000 grant 54 loan + 750.000 grant 50 loan 50 loan Date Approved 2005 2006 2005 2001 2003

ADB = Asian Development Bank, ICICI = Industrial Credit and Investment Corporation of India, PFC = Power Finance Corporation, REC = Rural Electrification Corporation, PSIF = Private Sector Infrastructure Projects, *Promotional loans, which are not classified as oficial development assistance. Source: KfW. Available: http://www.kfw.de/EN_Home/index.jsp

66
Appendix 8

ILLUSTRATIVE LIST OF SUBPROJECTS FOR TRANCHE 1 (Rs10 million)

Sl. No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Project BandraWorli Sealink Project Widening of NagpurKondhali Road Road Project from Adloor Yellareddy to Bowenpally on NH-7 Road Project between Jadcherla and Kotakatta on NH-7 Road Project from Agra to Bharatpur on NH11 Widening of MeerutMuzaffarnagar Road on NH-58 75.07 km Road Project from Lucknow to Sitapur on NH-24 Road Project from Orai to Bhognipur on NH25 and BhognipurBarah on NH-2 Widening of KumarpalyamChengapally Road Widening of SalemKumarpalyam Road Widening of DindigulSamyanallore Road on NH-7 Widening of NamakkalKarur Road on NH-7 Road Project from Ulunderpet to Padalur on NH-45 Four lane upgrade of the ThanjavurTrichy section of NH-67 Road Project from Tindivanum to Ulunderpet on NH-45 Four lane road upgrade project from Omallur to Namakkal on NH-7 Upgrade to four lanes of a road section project from Padalur to Trichy on NH 45 Project Cost 1,360.00 226.24 690.10 373.33 224.00 535.00 450.41 585.00 421.00 501.00 415.00 344.76 747.56 390.00 795.00 256.30 411.00 Loan Sanctioned by IIFCL 150.00 45.00 135.00 74.00 40.00 105.00 50.00 75.00 80.00 75.00 80.00 65.00 145.00 75.00 150.00 50.00 80.00 Loan Allocated to IIFCL Not yet finalized 40.00 Not yet finalized 40.00 30.00 105.00 47.00 38.00 49.00 33.00 75.00 30.00 55.92 50.00 77.00 40.00 50.00 LOI Issued Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Loan Documents Signed No 24-11-06 No 10-8-06 29-12-06 30-8-06 08-12-06 19-10-06 14-9-06 14-9-06 09-09-06 09-09-06 22-11-06 2-12-06 16-10-06 No 18-11-06 Disbursement 0.00 10.55 0.00 3.58 0.00 14.66 0.00 0.00 3.89 2.27 6.14 3.49 0.00 3.83 0.00 0.00 0.00

Sl. No. 18 19 20 21 22 23 24

Project Road Project from Vadodara to Bharuch on NH-8 76 km Road Project from Palanpur to Swaroopganj on NH-14 Road Project from Indore to Khalaghat on NH3 Upgrade to four lanes of AurangRaipur Section of NH-6 ThrissurEdapalli Highway Project on NH-47 Upgrade to four lanes of existing 76 km twolane ring road around Ahmedabad Upgrade to four lanes on NH-6 (Kondhali Talegaon Section) in Maharashtra Total In $ million

Project Cost 1,450.00 553.76 650.00 286.00 565.00 514.96 317.84 13,063.26 3,322.23

Loan Sanctioned by IIFCL 275.00 100.00 130.00 50.00 100.00 100.00 50.00 2,279.00 579.60

Loan Allocated to IIFCL 100.00 100.00 130.00 40.00 100.00 50.00 50.00 1,329.92 338.23

LOI Issued Yes Yes Yes Yes Yes Yes Yes

Loan Documents Signed 13-12-06 19-9-06 26-3-07 19-10-06 7-3-07 28-12-06

Disbursement 40.38 0.00 0.00 0.00 0.00 4.78 0.00

IIFCL = India Infrastructure Finance Company Limited, LOI = letter of intent, KM = kilometer, NH = national highway, SI = serial number. Note: Dates are given in the day-month-year format. Source: India Infrastructure Finance Company Limited.

Appendix 8

67

68
Appendix 9

IMPLEMENTATION SCHEDULE
Activity 1. 1.1 1.2 1.3 1.4 1.5 1.6 2. 2.1 2.2 2.3 2.4 2.5 2.6 3. 3.1 3.2 3.3 3.4 3.5 Developing ESSF and implementation capacity Recruitment of ESSF consultants Development of common ESSF Acceptance of ESSF by IIFCL Training of IIFCL staff on ESSF Training of IIFCL staff on procedures for screening projects in line with the ESSF Conduct due dilligence of subprojects by ESSF consultants for determining project compliance Assigning international credit rating to IIFCL (issuer rating) Selection of international credit rating agency Preparation of data requests for rating analysis Rating Agency's evaluation of IIFCL's financials, corporate governance norms, and business plan Rating Agency's evaluation of government guarantee as per the Scheme Issuance of covenants for maintenance and/or improvement of ratings Assignment of issuer rating to IIFCL Enhancement of resources management capacity in IIFCL Preparation of TA documents by ADB Identification of organization wide capacity gaps Appointment of consultants for strengthening resources management capacity Identification of gaps with respect to resources management Preparation of required resources management documents (in line with business plan) such as: 3.5.1 Financial Policies 3.5.2 Investment Policies 3.5.3 Credit Risk and Subsector Exposure Norms Development of ALM policy guidelines Procurement of systems Training of staff Preparation of documents, formats for resources management Development of risk mitigation products for subproject risk assesment Development of pricing tools for subloans Integration of pricing tools with ALM systems Tranche release First Tranche Release Second Tranche Release 2007 2008 2009 2010 2011
5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12

3.6 3.7 3.8 3.9 3.10 3.11 3.12 4. 4.1 4.2

ADB = Asian Development Bank, ALM = asset-liability management, ESSF = Environmental and Social Safeguards Framework, IIFCL = India Infrastructure Finance Company Limited, TA = technical assistance. Source: ADB estimates.

Appendix 10

69

SUMMARY ENVIRONMENTAL AND SOCIAL SAFEGUARDS FRAMEWORK A. Introduction

1. The Environmental and Social Safeguards Framework (ESSF) comprises the Environmental Management System (EMS) and the Social Safeguards Framework (SSF). The provisions for environmental and social safeguards and assessment and mitigation measures contained in the EMS and SSF are applicable for all subprojects financed by resources from Asian Development Bank (ADB) by India Infrastructure Finance Company Limited (IIFCL), either for direct lending or refinance operations and to both public and private sector companies. All subborrowers interested in seeking financial assistance from IIFCL, where finance from ADB is used, will therefore need to conduct business in a manner that allows IIFCL to be compliant with this EMS and SSF. 1. Purpose of the EMS

2. The EMS defines policy procedures, roles, and responsibilities for managing adverse environmental impacts/risks due to subprojects that are financed by IIFCL. The EMS has been prepared as part of IIFCLs commitment to comply with Government of India (the Government) policies, law and regulations, as well as, to follow the development partners (e.g., ADB, World Bank [WB], Kreditanstalt fr Wiederaufbau [KfW], and Japan Bank for International Cooperation [JBIC]) safeguard policies. 2. Purpose of the SSF

3. The SSF outlines policies, procedures, roles, and responsibilities for managing involuntary resettlement (IR) impacts and risks, and effects on indigenous (tribal) peoples of subprojects that are financed by IIFCL using ADB funds. The SSF is part of IIFCLs commitment to comply with the Governments policies, laws and regulations, and to comply with the safeguards policies of the development partners. B. Environmental Management System 1. 4. Objectives

The objectives of EMS are (i) (ii) (iii) (iv) To avoid and minimize adverse environmental impacts from subprojects financed by IIFCL using ADB funds, especially in environmentally sensitive locations. To ensure that adverse environmental impacts are well-mitigated to achieve applicable environmental standards. To comply with applicable Government, state laws and regulations, and environmental safeguards requirements of development partners. To provide guidance to lead banks/designated lead syndicator and subborrowers in preparing subprojects for appraisal at IIFCL and in conducting subsequent monitoring, reporting, and in undertaking corrective actions.

5. IIFCLs EMS is based on the Governments Environmental Policy and Regulatory Framework and considers the environmental and social safeguards (ESS) requirements of the development partners.

70

Appendix 10

2.

Structure of IIFCLs EMS

6. As per the ESS requirements in the development partners (especially World Bank [WB] and ADB), IIFCL falls into Financial Intermediary category and is obligated to develop and operate an EMS and develop adequate institutional capacity to ensure satisfactory implementation of the environmental safeguards of the development partners. 7. Accordingly, an EMS needs to be developed, guided by environmental policy and procedures that will ensure that all subprojects processed and financed by IIFCL are compliant with applicable environmental laws and regulations, and do not result in unmitigated and adverse environmental impacts. Given the requirement of compliance and considering the comprehensiveness of the Governments Environment Impact Assessment (EIA) and Environment Clearance (EC) system, IIFCLs EMS has been developed around the Governments environmental policy and regulatory framework. IIFCLs EMS follows subproject categorization as per the Government (e.g., A/B1/B2) as well as its processes, scoping, public hearing, review, and monitoring requirements. It mainstreams key outcomes like Environmental Management Plans (EMP) in the project design and implementation. 3. Operational Steps of IIFCLs EMS

8. The Governments Ministry of Environment and Forests (MoEF) notification on EC follows a subproject classification scheme as A, B1, and B2. This classification factors project type, size, and sensitivity of location. IIFCLs EMS will use this categorization to prioritize the appraisal and monitoring process followed by the EMS. 9. Subprojects under category A and B1 require EIA and are processed for EC at MoEF at the central level by the State Department of Environment at the state-level. Category B2 does not require EIA but needs information to be submitted in a prescribed format to the State Department of Environment for review. Subprojects under category B1 may get re-categorized into category A if general conditions on site sensitivity are violated that consider site sensitivity. 10. The operational steps of IIFCLs EMS consider two scenarios. (i) (ii) 11. Case A. Subprojects that have been appraised and agreed to be financed before establishment and operation of EMS. Case B. Subprojects that have not yet committed for finance and will undergo EMS.

For case A subprojects, the following steps will be taken. (i) (ii) (iii) (iv) (v) Categorize subprojects as per A/B1/B2 following guidelines of MoEF. Categorize subprojects as per ESSF guidelines. If more than one development partner is involved, the strictest guidelines will apply. In the event of a difference in categorization carried out by MoEFs EIA notification and categorization by ESSF, the stricter guidelines will be followed. Wherever there is no clear guidance available in MoEFs EIA notification for subproject categorization, then the ESSF scheme of categorization will be followed. During review on environmental compliance, focus will be on verifying consent from State Pollution Control Board to establish and operate the subproject, environmental and forest clearances from State Department of

Appendix 10

71

(vi) (vii) (viii) (ix)

(x) (xi) 12.

Environment/MoEF and costal regulation authorities, and whether processes and procedures, relating to public consultation and disclosure are followed. IIFCL will ensure that subproject proponent conduct consultation with affected groups and local nongovernment organizations (NGO) at least twice during subproject preparationonce during the early stage of executing agency (EA)s preparation and when the draft EA report is available. Consultation should be conducted during implementation. IIFCL will ensure that the subborrower provides relevant information on the subprojects environmental issues in form and language(s) accessible to those being consulted. IIFCL will also ensure compliance with the 120-day disclosure requirement for category A or B subprojects deemed sensitive. Compliance should also address conformity with standards and approaches recommended by Pollution Prevention and Abatement Handbook of the WB. In case the subproject EA report recommends adoption of alternative emission levels and approaches for pollution prevention and abatement to reflect national legislation and local conditions, the EA report must justify the levels and the approaches chosen for the subproject. IIFCL will identify gaps, if any, on environmental compliance. If there are no gaps, EIA reports and adequacy of EMPs will be reviewed. For category A and B1 subprojects field visits will be conducted to check for compliance. In the event of non-compliance, IIFCL will direct subborrowers to take action to attain compliance. Disbursements will be withheld until compliance is achieved. IIFCL will review compliance measures to monitor if they are satisfactorily met. If measures are consistently unsatisfactory, further disbursements will be cancelled. For compliant subprojects, if review of environment management plan shows appropriate reflection in subproject costs, legal documents will be updated to reflect applicability of IIFCLs EMS as binding during the period of engagement. Appropriate approval of the board will be taken. If review of EMP suggests inadequate reflection in subproject costs, the subproject implementation plan will be updated as well as the financial appraisal to reflect the new EMP. Commercial viability of the subproject will be reassessed. IIFCL will obtain board approval for revisions. Legal documents will be updated to reflect applicability of IIFCLs EMS as binding during the engagement period.

Figure A10.1 describes the above steps.

Appendix 10

73

(vi) (vii) (viii) (ix)

(x)

relating to public consultation and disclosure are followed. IIFCL will ensure that subproject proponent conduct consultation with affected groups and local nongovernment organizations at least twice during subproject preparationonce during the early stage of EA preparation and when the draft EA report is available. Consultation should be conducted during implementation. IIFCL will ensure that the subborrower provides relevant information on the subprojects environmental issues in form and language(s) accessible to those being consulted. IIFCL will also ensure compliance with the 120-day disclosure requirement for category A or B subprojects deemed sensitive. Compliance should also address conformity with standards and approaches recommended by the Pollution Prevention and Abatement Handbook of the World Bank. In case the subproject EA report recommends adoption of alternative emission levels and approaches for pollution prevention and abatement to reflect national legislation and local conditions, the EA report must justify the levels and the approaches chosen for the subproject. IIFCL will identify gaps, if any, on environmental compliance. If there are no gaps, EIA reports and adequacy of EMPs will be reviewed. For category A and B1 subprojects, field visits will be conducted. In the event of non-compliance, IIFCL will direct subborrowers to take action to attain compliance. Disbursements will be withheld until compliance is achieved. IIFCL will review compliance measures to monitor if they are satisfactorily met. If measures are consistently unsatisfactory, further disbursements will be cancelled. For compliant subprojects, IIFCL will review EMP for adequacy and appropriate reflection of project costs. If EMP is satisfactory, IIFCL will prepare memo to the board with additional recommendations. IIFCL will ensure that legal documents reflecting applicability of IIFCLs EMS as binding during the period of engagement. Take appropriate approval of board. If review of EMP shows inadequacies and/or inappropriate reflection in project costs, IIFCL will direct the lead banks/special purpose vehicle to update the subproject information memorandum (PIM) as well as the financial appraisal to reflect the strengthened/improved EMP. A further assessment of the commercial viability of the subproject will be made based on revised subproject costs. Board memo will be prepared on the basis of revisions. IIFCL will ensure that legal documents reflect applicability of IIFCLs EMS as binding during the period of engagement.

14.

Figure A10.2 describes the above steps.

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4.

Institutional Structure to Operate the EMS

15. Keeping this in mind and considering the operational steps of EMS, it is proposed to set up an Environmental and Social Management Unit (ESMU) at IIFCL. ESMU will comprise fulltime staff that are either on deputation to IIFCL or are directly recruited. Staff should have adequate qualification in conducting environmental and social assessments of subprojects. 5. Conduct of Annual Environmental Audit and its Disclosure

16. IIFCL will conduct annual environmental and social audit through independent consultants. The audit process will consider subproject categories for better focus and optimization. Consultants will conduct an annual environmental and social audit with the help of Senior Environmental and Social Specialists using a combination of data reported by lead syndicator/subborrowers and field visits. 6. Reporting to Development Partners Requirements

17. Apart from the annual environmental audit reports, IIFCL will need to prepare reports, from time to time, as required by development partners. While making Periodic Finance Request to ADB, for instance, reporting on environmental performance of past subprojects and correction action plans may be required apart from management of environmental issues of proposed subprojects that are under preparation. 18. Such reports will be prepared by the ESMU of IIFCL in consultation with development partners building on the regular monitoring and review process under EMS as well as annual environmental audit. C. Social Safeguards Framework 1. Context a. Objectives

19. The primary objective of the SSF is to provide guidance to subborrowers in preparing subprojects for appraisal by IIFCL and in conducting subsequent monitoring, reporting, and in undertaking corrective actions. In such cases, relevant Government legislation and policies would apply as would either or both of the lenders IR and IP policies (as reflected in this framework). 20. Other key objectives for this SSF are to ensure that subproject-affected people benefit from the proposed subprojects and are consulted on the subproject throughout its life. 21. The IIFCL will ensure that IR impacts of any subproject submitted for financing under the facility are dealt with in accordance with the following. (i) (ii) Applicable central and state laws and regulations governing land acquisition, compensation, relocation, and resettlement. IR policies of the development partners.

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2.

Outline of Social Safeguard Activities a. Two Pathways for Social Safeguards Due Diligence

22. Two pathways for social safeguards due diligence are established. The first applies to all subprojects not yet committed to by IIFCL at the time of the functioning of the ESMU in IIFCL (within 90 days of its establishment). The procedures for such subprojects are set out below. (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) Screening of subprojects for resettlement effects and impact on tribal peoples. Preparation of resettlement plan (short or full), if necessary, and submission as part of the PIM. Preparation of Tribal Development Plan (TDP) (short or full), if necessary, and submission as part of PIM. Appraisal of Resettlement Plan (RP) and/or TDP, revisions, if necessary. Setting of loan conditionality to include social (resettlement and tribal peoples) safeguard covenants. Revision of RP and/or TDP on completion of detailed subproject design. Implementation of RP and/or TDP. Monitoring of RP and TDP. Subproject closure shall be linked to satisfactory completion of social activities undertaken for a RP and/or TDP.

23. The second path applies to all subprojects already sanctioned by the IIFCL board at the time of the functioning of the ESMU (within 90 days of its establishment). For such subprojects, the process would be as follows. (i) (ii) (iii) (iv) (v) (vi) Categorize the effects of the subprojects as to whether they warrant the equivalent of a full or short RP/a full or short TDP. Check for social compliance based on the above categorization(s). Identify gaps, if any, in social compliance. If there are no gaps, then review all relevant RP/TDP reports. For full Resettlement and/or TDPs, include field visit of social safeguards specialist. If case of gaps in social compliance, direct subborrowers with time-bound actions to attain compliance. Hold disbursements until compliance is achieved. Monitor and review whether the agreed gap measures are satisfactorily met. If case of consistent default, cancel further disbursements. For compliant subprojects, if review of plan(s) shows adequate and appropriate reflection in the subproject costs, then update legal documents to reflect applicability of IIFCLs commitment to the RP/TDP as binding during the period of engagement. Take appropriate approval of the board. If review of the RP/TDP shows inadequacies in project costs, update PIM and redo financial appraisal to reflect strengthened/improved social safeguard plans. Re-assess commercial viability of the subproject. Obtain board approval for the revisions. Update legal documents that reflect applicability of IIFCLs social safeguard plans as binding during the period of engagement. Revise RP/TDP on completion of detailed subproject design, as necessary. Implement RP/TDP. Monitor RP/TDP. Link subproject closure to satisfactory completion of social activities undertaken for an RP/TDP.

(vii)

(viii) (ix) (x) (xi)

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b.

Social Safeguards Screening

24. When a subborrower submits a subproject for financing to the lead bank for financing and if the IIFCL is a contributor to that financing, IIFCL will review the feasibility study reports which include social and environmental safeguard studies. The IIFCL will, in consultation with the subborrower, decide whether any activities of the prospective subproject may cause IR/have significant impacts on tribal peoples. A checklist for assessing potential IR impacts forms Table A10.1, while Table A10.2 includes a similar checklist for effects on tribal peoples. In the event that such screening by IIFCL indicates that either IR or tribal peoples effects appear likely, IIFCL will require, from the subborrower, adequate safeguard planning instruments such as an RP/tribal people development plan prepared in accordance with this SSF. 25. IIFCL, based on reports received from the subborrower, will assess the magnitude of IR impacts and determine whether a short or full RP is required for the subproject. A full RP will be required where resettlement is significant.1 26. Similarly, as regards impacts on tribal peoples, a determination will be made as to the magnitude of the significance of impacts and whether a short or full TDP is required.2 c. PIM guidelines for the preparation of Social Safeguards Planning Documents i. Procedure for Prospective Investments with IR/Significant Effects on Tribal Peoples

27. The subproject sponsor, in consultation with the ESMU, will prepare an RP/TDP as described below and include such plans as part of the PIM to be submitted to IIFCL for review. ii. 28. Plan Principles

The subborrower will prepare an RP according to agreed principles for IR including (i) (ii) (iii) (iv) Draft National Policy on Resettlement and Rehabilitation, 2006. The Land Acquisition Act of 1894 and as amended. Relevant state laws and regulations. IR policies of development partners.

29. The subborrower will prepare a TDP plan according to agreed principles for tribal peoples development including (i) (ii) (iii) (iv) The Governments forestry, minerals, and mines legislations and regulations. The Governments common property rights and legislation. Relevant state laws and regulations. Draft National Tribal Policy: A Policy for the Scheduled Tribes of India, proposed by the Governments Ministry of Tribal Affairs in 2006.

1 2

IR is significant when 200 or more people will experience major impacts which are defined as being physically displaced from housing or losing 10% or more of their productive assets (income generating). The impacts of subprojects on tribal peoples will be considered significant if they positively or negatively (i) affect their customary rights of use and access to land and natural resources; (ii) change their socioeconomic status; (iii) affect their cultural and communal integrity; (iv) affect their health, education, livelihood, and social security status; or (v) alter or undermine the recognition of indigenous knowledge.

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(v)

IP policies of the development partners.

30. Given varying standards in applicable policies (central and state governments development partners), the strictest provisions will be applicable to mitigate subproject impacts. iii. Resettlement Plans

31. The subborrower will prepare either a short or a full RP, depending on the magnitude and complexity of resettlement as determined by the social safeguards screening process. 32. In the formulation of an RP for a subproject, the following issues should be addressed. (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) (xi) (xii) (xiii) The subproject should explore alternatives to avoid IR and if avoidance is not feasible, to minimize land acquisition and IR. The policy application should not be too restrictive. Significance of resettlement impacts will guide planning. The plan should include all subproject-affected people irrespective of whether they are property owners or not. The cut-off date for eligibility should be the date of first notification for land acquisition. Compensation for loss of assets must be at replacement value. A comprehensive entitlement matrix is formulated to describe entitlements of each category of affected persons. Full compensation must be paid prior to taking over the land and other assets. The plan must clearly focus on income/livelihoods improvement in the postresettlement period. Information should be disseminated in a timely fashion, consultations held with all affected persons, and plan versions and monitoring reports disclosed at regular intervals in local languages. Independent monitoring system should be incorporated in the plan. Impact assessment must be clearly focused. Detailed timetable for RP implementation. Detailed budget and sources of budget for compensation, relocation, and rehabilitation of affected persons.

33. Key elements of an RP include (i) loan or investment description, with the likely scope, extent, and magnitude of the resettlement effects; (ii) screening procedures for pipeline investments or components; (iii) resettlement policy principles and eligibility criteria that are consistent with the policy and cover all investments, subprojects, and components under the loan; (iv) resettlement entitlements; (v) resettlement design criteria; and (vi) administrative, resourcing, and financing arrangements for preparation, approval, implementation, monitoring, and evaluation of full or short RPs. iv. Tribal Development Plans

34. The subborrower will prepare either a short or a full TDP depending on the magnitude and complexity of project impacts as determined by the social safeguards screening process. 35. An acceptable TDP addresses the (i) aspirations, needs, and preferred options of the affected tribal peoples; (ii) local social organizations, cultural beliefs, ancestral territory, and resource use patterns among the affected tribal peoples; (iii) process of free, prior, and informed

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consultations; (iv) potential positive and negative impacts on tribal peoples; (v) measures to avoid, mitigate, or compensate for the adverse project effects; (vi) measures to ensure project benefits will accrue to tribal peoples; (vii) an action plan of measures to ensure that tribal people receive social and economic benefits that are culturally appropriate; (viii) accessibility of procedures for grievance redress; (ix) benchmarks for evaluating the outcomes of the TDP; (x) measures to strengthen social, legal and technical capabilities of government institutions to address tribal peoples issues; (xi) possibility of involving local organizations and NGOs with expertise in tribal peoples issues; and (xii) budget allocation and monitoring issues. v. Complaints and Grievance Procedures

36. Both the RP and the TDP will separately outline procedures to handle grievances. Grievance redress mechanisms for affected people will be established with adequate representation of affected people and genders. The grievances will be redressed at the local level in a consultative manner and with full participation of the affected households, or their representatives, along with project officials and local government representatives. In case the grievances are resolved within 15 days of their filing, the complainants will forward the same to IIFCL. In case the grievances still remain unresolved within 20 days of their filing, or the decision of the subborrower is not acceptable to the household, the aggrieved party may forward their complaints to a court of law. All costs incurred in resolving the complaints will be borne by the subborrower. IIFCL will document all complaints received. vi. Consultation and Disclosure

37. Subborrowers will conduct consultations with stakeholders during subproject development and implementation. The objectives of such consultations are to (i) engage stakeholders in selection of RP and/or TDP priorities and program design (i.e., goals, objectives, activities, etc.), and (ii) provide stakeholders with opportunities to assess the subproject. Subproject consultations on program design and implementation involving stakeholders including government, NGOs, civil society organizations, and affected communities. These consultations occur on a formal and informal basis and may involve (i) pre-design consultations to ensure that the program reflects priorities, needs, experiences, and lessons learned of stakeholders; and (ii) consultations with target groups/beneficiaries as part of program design and implementation. 38. Wherever an RP is required, affected people will be consulted on compensation/resettlement options, including relocation sites, and socioeconomic rehabilitation. Pertinent resettlement information will be disclosed to the affected people at key points in their own language(s), and specific opportunities provided for them to participate in choosing planning and implementation options. The disclosure will be in a manner accessible to the affected people where there are differing levels of literacy. Grievance redressal mechanisms for affected people will be established with adequate representation of affected people and with an adequate multi-gender presence. The RP will be made available to them prior to its implementation in their own language(s) with details on their entitlements. 39. Whenever a TDP is required, tribal peoples will be consulted during the preparation of the plan. They will be informed of subproject details, subproject benefits, possible adverse impacts, and the mitigation measures proposed. Their views will be taken into account in finalizing the plan. The TDP will be translated into the tribal language and made available to the affected people before implementation. The disclosure will be in a manner accessible to the

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affected people where there are differing levels of literacy. Tribal institutions and organizations in the affected area will also be involved in implementing the TDP and resolving disputes. 40. Both drafts, RP and TDP, will be made publicly available upon submission to the IIFCL as part of the PIM as will the final versions of the plans prior to their implementation. Plans may be revised after submission as part of the PIM in response to (i) requests for revision during the appraisal process, and/or (ii) significant changes in the subproject during implementation. Such revised plans will also be made available both to the plan-affected people and to the public. vii. Plan Budgets and Financing

41. The Facility is committed to safeguarding the social effects of the various subprojects upon the lives and livelihoods of affected peoples. Adequate provision for financing both the RP and the TDP from the subproject annual budget will be made. The budget will include costs of compensation, relocation and rehabilitation, social preparation, benefits-sharing, and livelihood programs, as well as costs for planning, management, supervision, monitoring, and evaluation, land taxes, land fees, and physical and price contingencies. Similarly, resettlement plans should also reflect the timeframe for resettlement planning and implementation. viii. RP/TDP Appraisal Guidelines

42. The IIFCL (or its agent) will appraise the RP/TDP submitted by the subborrowers as part of the PIM against the requirements for plans. ix. Conditionality and Covenants

43. Loan disbursal shall be contingent on satisfactory compliance with the obligations incurred through adoption of an RP and/or TDP. These arrangements for loan covenants will be reflected in the board note approving subprojects. To be covenanted also are the remedial procedures to be followed to bring the plan(s) into compliance if monitoring discloses that RP or TDP are not in compliance with the safeguards in the SSF. x. Monitoring and Evaluation

44. Monitoring and evaluation requirements will be defined as part of each RP/TDP. In addition, each subborrower will engage an external independent monitoring agent to undertake external monitoring of the plan(s). Annual external monitoring reports will be submitted to development partners. A key function of the external monitoring would be to ascertain whether any unanticipated impacts on tribal peoples or unanticipated resettlement effects become apparent during project implementation. In such cases, the external monitor would assist the subborrower to assess the significance of the impacts and identify measures to mitigate any adverse impacts and ensure that benefits accrue to the tribal peoples. IIFCLs ESMU would be informed of and review such measures and their implementation. The external monitor would also certify compliance with the requirements of the RP/TDP. xi. 45. Reporting

ESMU will prepare an annual report to participating development partners summarizing (i) Progress reports based on each subborrowers operations which have IR impacts and/or impacts on tribal people.

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(ii)

List of pipeline investments, with likely IR or tribal peoples impacts, for the forthcoming year. Capacity and Implementing Arrangements a. Environment and Social Safeguards Management Unit

3.

46. The ESMU will be trained in (i) screening prospective subprojects for IR and tribal effects, (ii) plan preparation and appraisal, (iii) plan monitoring, and (iii) reporting. The ESMU initially will have consultants to assist it in reviewing project proposals. It may also contract with an external agency to carry out the social safeguard assessment, guidance, appraisal, monitoring, and reporting functions for which IIFCL will be responsible. Table A10.1: Resettlement Screening Checklist
Not Impact Known Is the PSC undertaking or likely to undertake any land acquisition? Is the PSC acquiring land through willing buyer to willing seller transactions? Does the PSC have any agreements or is it likely to enter into agreements with the government for provision of sites or land or rights to land? Is any of the land used by the PSC (or likely to be used by the PSC) compulsorily acquired? Will any PSC activities involve restrictions of use on adjoining land? Are the sites for land acquisition known? What is the ownership status of the land? Are non-titled persons present? Will tenants, lessees, share farmers, or other third party users be affected? Will there be loss of housing? Will there be loss of crops, trees, and other fixed assets? Will there be loss of incomes and livelihoods? Will access to facilities, services, or resources be lost? Will there be loss of businesses or enterprises? Will any social or economic activities be affected by land use related changes? If involuntary resettlement impacts are expected: Are local laws and regulations compatible with ADBs involuntary resettlement policy? Will land be acquired through the government or by the PSC? Do PSC agreements with the government (if any) specify involuntary resettlement will be conducted in accordance with international standards? Does the government executing agency/PSC have sufficient skilled resources for resettlement Indication of scope (no. of affected people, land area, land use, structures, etc.)

Yes

No

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Impact planning and implementation? Are training and capacity building required prior to resettlement planning and implementation?

Not Known

Yes

No

Indication of scope (no. of affected people, land area, land use, structures, etc.)

ADB = Asian Development Bank, PSC = prospective subproject company.

Table A10.2: Tribal Peoples Effects Screening Checklist

Impact on tribal peoples Are there tribal groups present in project locations? Do they maintain distinctive customs or economic activities that may make them vulnerable to hardship? Will the subproject restrict their economic and social activity and make them particularly vulnerable in the context of project? Will the subproject change their socioeconomic and cultural integrity?a Will the subproject disrupt their community life? Will the subproject positively affect their health, education, livelihood, or social security status? Will the subproject negatively affect their health, education, livelihood, or social security status? Will the subproject alter or undermine the recognition of their knowledge, preclude customary behaviors, or undermine customary institutions? In case there is no disruption of tribal community life as a whole, will there be loss of housing, loss of land, crops, trees, and other fixed assets owned or controlled by individual tribal households? Not Known Yes No Remarks or identified problems, if any

That is, undermine their production systems and the maintenance and transmission of their cultural patterns.

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SUMMARY OF POVERTY REDUCTION AND SOCIAL STRATEGY

A. Linkages to the Country Poverty Analysis Yes No Is the sector identified as a national priority in country poverty partnership agreement? Yes No

Is the sector identified as a national priority in country poverty analysis?

Contribution of the sector or subsector to reduce poverty in India: Development of infrastructure contributes to economic growth, which in turn contributes to infrastructure development through increased demand for infrastructure services. Moreover, investments in human capital and in infrastructure interact, thus increasing the returns to each investment. Investment in infrastructure services can contribute to sustainable growth by (i) reducing transaction costs and facilitating trade flows within and across borders; (ii) enabling economic agentsindividuals, firms, and governments to respond to new types of demand in different geographies; (iii) lowering inputs costs in the production of almost all goods and services; (iv) opening new opportunities for entrepreneurs or making existing businesses more profitable; and (v) creating employment in public works. In this regard, the World Bank business climate survey ranks the following as key constraints to doing business in India: (i) power breakdown, (ii) voltage fluctuation, (iii) telecommunications failure, (iv) poor quality of roads, (v) inadequate land and industrial space, (vi) erratic water supply and waste disposal, and (vii) limited availability of freight services. There is also direct evidence regarding the importance of adequate infrastructure services in providing an enabling environment for business. For example, small businesses could expand after additional telephone lines are installed, requiring additional manpower and fixed assets. The absence of local infrastructure is most critically felt by the poor who are acutely effective by inadequate infrastructure on their livelihoods. Shocks to the national economy such as the rationing of electricity, are particularly evident to large numbers of people dependent on employment in small enterprises in the informal sector. While indirect benefits are harder for poor people to perceive, it is clear that the development and maintenance of national infrastructure is essential if India is to secure the potential gains from globalization. Improving availability at the local level alone is unlikely to transform the economy and developmental benefits will not be fully realized unless simultaneous improvements at the local and the national level are introduced and managed. The proposed intervention seeks to expand the availability of funding sources to the India Infrastructure Finance Company Limited (IIFCL) and simultaneously improve IIFCLs capacity in accessing market sources of finance. The availability of additional resources will significantly assist IIFCL in fulfilling its mandate of expanding the availability of high quality infrastructure in India. Finally, the proposed assistance will also result in subprojects being priced on competitive terms, thereby reducing financing risk and rationalizing pricing of services to the end borrower. Targeting Classification: General intervention

B.

Poverty Analysis

What type of poverty analysis is needed? A poverty and social analysis will be required to identify the socioeconomic profile of the population in the subproject areas, expected benefits and constraints, and ability of the poor and vulnerable groups to benefit from the subproject. The analysis will have to identify ways to incorporate the needs of the poor and minimize and/or compensate for adverse impacts on them. This will be done through a review of existing studies on poverty and social analysis, focus group discussions and information gathering interviews with primary and secondary stakeholders, and an additional socioeconomic survey of the subproject area, if required. In order to assess whether benefits are reaching the most vulnerable groups, attention will be required to profile the beneficiaries with gender-disaggregated demographic, economic

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and social analysis. The same would be supported by further analysis on the incidence of poverty, identification of vulnerable groups, ability and willingness-to-pay of targeted beneficiaries for cost recovery, and any adverse impacts anticipated from the subproject. The key anticipated impact on poverty will be through greater affordability of high quality infrastructure. With more efficient and lower cost infrastructure, analysis would be necessary to establish if this translates into greater affordability and higher usage. This in turn, is expected to lead to greater incidence of compliance with tariffs and reduction in leakages.

C.

Participation Process Yes Yes No No

Is there a stakeholder analysis? Is there a participation strategy?

For subprojects that will be funded by IIFCL, compliance requirements will necessarily include conduct of stakeholder consultations on both environmental and social safeguards issues. The consultations will assist the subproject developer in establishing an environmental impact assessment or the subproject information memorandum. Based on these, an environmental action plan, a resettlement plan, and a tribal development plan will be prepared with mitigations, wherever necessary.

D.

Gender Development

Strategy to maximize impacts on women: Women will benefit from the subproject through improved access to various infrastructure services and more affordable pricing of the same. This is also true for women entrepreneurs who have suffered due to the lack of high quality infrastructure, such as regular power supply for production units, and roads for market access requiring the need to walk through difficult terrain. Further, regular water supply and adequate drainage improves working conditions for women employees. Moreover, high quality infrastructure will assist women and other vulnerable groups through better quality health care and education. Finally, women will benefit from subprojects that conform to required environmental standards. Yes No

Has an output been prepared? E. Item

Social Safeguards and Other Social Risks Significant/ Not Significant/ None Significant Not significant None Plan Required Full Short None

Strategy to Address Issues A social safeguards framework has been formulated to assess and address social issues, particularly involuntary resettlement impacts of subprojects, if any. Based on the framework, appropriate resettlement plans will be prepared for each subproject based on the resettlement impact.

Resettlement

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Item

Significant/ Not Significant/ None Significant Not significant None

Strategy to Address Issues The costs of services provided by infrastructure subprojects financed under the proposed Facility are expected to be competitive. This is due to the design of the proposed Facility as well as the Scheme for Financing Viable Infrastructure Projects through India Infrastructure Finance Company Limited (IIFCLs operating paradigm). Through the proposed Facility, a longer tenor loan will be provided requiring repayments over a longer period, making the cost of services affordable. India Infrastructure Finance Company Limiteds Scheme emphasizes public-private partnership subprojects which are bid for on a competitive basis, further ensuring competitive pricing. The subprojects financed through the proposed Facility are expected to result in significant increases in employment opportunities especially in the road sector. It is estimated that in the road sector itself, the National Highway Development Program alone has led to the creation of direct employment for up to 250,000 construction workers and 10,000 supervisors per day. The National Highway Development Program is estimated to have created employment of close to 180 million person-days up until December 2003. The Social Safeguards Framework covers the basic requirement of screening and planning to address any tribal (indigenous) population issues arising from any subproject. Appropriate tribal peoples development plan will be prepared for each subproject which has an impact on tribal people. The subprojects will be fully compliant with the Asian Development Banks environmental and social safeguards policies, and policies of other development partners, as well as those of the Government. Further, subprojects will be required to provide adequate environment protection and social safeguard plans. Further, the subproject developers will have to ensure that civil works contractors do not employ children or discriminate against women and disseminate information on sexually transmitted diseases.

Plan Required Yes No

Affordability

Labor

Significant Not significant None

Yes No

Indigenous Peoples

Significant Not significant None Significant Not significant None

Yes No

Other Risks and/or Vulnerabilities

Yes No