Given the reticence of lenders obsessed with telecom and power projects, fund raising for urban infrastructure and irrigation projects has been difficult. The task has been particularly difficult since 1993 when bonds floated for the purpose lost their statutory liquidity ratio status making them less attractive for banks. But some states, especially the market-savvy ones, have increasingly begun realising that the key to raise funds from debt markets is financial engineering.
Among the most common methods of financing such projects is full-recourse financing. The first state to try out project financing was Gujarat (in the Sardar Sarovar Project) which came out with a Rs 300-crore bond issue carrying a yield of 19 per cent. Key to such efforts is being able to find the right kind of pricing and the right quality of subscribers.
Gujarat traditionally had the advantage since the savings rates are high and the cooperative movement has been strong. The bulk of the subscribers to the Sardar Sarovar' bond issues are regional rural banks, cooperative banks and other cooperative institutions in the region.
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Gujarat created a sinking fund for meeting the repayments by earmarking budgetary resources for the Sardar Sarovar repayment obligations.
This enabled the state to raise funds continuously in the financial markets even before the project became fully operational. When completed, the cost of the project is expected to be in the region of about Rs 14,000 crore inclusive of interest during construction. This method of financing has been copied by Karnataka in the Krishna Jala Bhagya Nigam and Maharastra in the Krishna Valley Development Corporation.
Other states like Andhra Pradesh tried out the build, operate and transfer method for the Hyderabad water supply project costing about Rs 500 crore. This effort proved unsuccessful with bidders insisting on counter-guarantee on cash flows and debt repayments.
The state has now reverted back to the more conventional funding and raised a World Bank loan of $515 million.
But Karnakata has worked out the project on a build own operate and transfer basis. (The fundamental difference between the BOT and BOOT structures is that the latter confers ownership rights over all the project assets during the concession period.) The Rs 400-crore Bangalore water supply project uses a BOOT structure and bids have been invited.
The state has already made it clear that there will be no counter guarantees of any kind but is open to a state government guarantee. Despite this rider, bids have begun pouring and shortlisted bids include those by engineering major Larsen and Toubro, Bechtel's UK based subsidiary and Hume Industries.
The entire project cash flows are expected to come through an escrow of the water taxes of the Bangalore Municipal Corporation which in turn is guaranteed by the state government.
Maharastra has worked out an entirely different method. The entire Pune water supply project is being worked out on a deferred payment basis, through three difference parcels _ construction, maintenance and collection. Yet this project has been facing some resistance and the project already faces pre construction risks.
Others like New Tiruppur Integrated Area Development Programme have used the method of integrated project development and hawking turnkey contracts to companies which recover their dues from the project's cash flows.
For this, Tiruppur water project has so far tied up about $25 million through a 25-year floating rate note issue backed by a US government guarantee, which was swapped with Bank of India for release of matching rupee funds for an equivalent maturity at sub-prime lending rates.
The shortlisted erection, procurement and construction contractor, Mahindra Bechtel is expected to realise its dues through an escrow cover created by receipts from bulk water consumers who include the prosperous textile mills in the region.
In addition to these project financing methods, the municipalities have begun tapping the bond market after securing a rating. All of them have opted for the revenue obligation bond (ROB) route. This essentially implies that the best quality receivables of the municipality will be credited into an escrow account for meeting debt service payments. An alternative route is the General obligation bond (GOB), which essentially implies that the creditor takes the risk on the municipality.
All the issues that have gone into the markets have used the ROB route for raising the funds, and have used credit enhancement mechanisms like state government guarantees for the creation of the escrow account. Ahmedabad Municipal Corporation (AMC) which raised Rs 100 crore with a 15 per cent issue secured a CRISIL "A+" rating on an escrow of Octroi receipts and with a state government guarantee the rating went up to AA.
Others like Bangalore City Corporation and Vijaywada Municipal Corporation also used similar credit enhancement techniques. Bangalore raised Rs 125 crore priced the funds at 15 per cent and Vijaywada raised Rs 30 crore.
But the ability of state government to provide such credit enhancement mechanisms is fast eroding and the only way to make projects bankable would be to improve the rates of return and methods of indexing so that projects always end with a positive net present value.
That realistion has begun and Gujarat and Andhra have begun working out methods of raising water and irrigation tariffs.
Tomorrow, the last part of this five-part series on financial closures of infrastructure projects will focus on railways.