Document of The World Bank Report No. 15364-IN STAFF APPRAISAL REPORT INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT MARCH 7, 1996 Energy and Infrastructure Operations Division Country Department II South Asia Region CURRENCY EQUIVALENTS (As of February 1996) Currency Unit = India Rupees (Rs) Rs 1.00 = US$0.03 US$1.00 = Rs 35.0 Guarantor's and Borrower's Financial Year April I - March 31 MEASURES AND EQUIVALENTS Metric British/US System I meter (m) = 3.281 feet I square meter (m2) = 10.764 square feet I cubic meter (m2) = 35.3 15 cubit feet I kilometer (km) = 0.621 mile I metric ton = 2,205 pounds I tkm = ton-kilometer (0.621 ton-mile) I pkm = passenger-kilometer(0.621 passenger-mile) ACRONYMS AND ABBREVIATIONS ADB = Asian Development Bank IFP Infrastructure financing project BOT = Build, operate and transfer IL&FS = Infrastructure Leasing and Financial Services Limited CARE = Credit Analysis and Research Ltd. IPO = Initial public offering CAS = Country assistance strategy LIBOR = London interbank offered rate CBI = Central Bank of India MOST = Ministry of Surface Transport CEM Country economic memorandum NBFC Non-banking financial company COD = Committee of directors OD = Operational directive CP = Commercial paper PRP = Performance-related pay DEA = Department of Economic Affairs PWD = Public works department (Ministry of Finance) R&R = Resettlement and rehabilitation ED = Executive Director RBI = Reserve Bank of India ERR = Economic rate of return RMG = Risk management group FYB = First-year benefits SEBI = Security Exchange Board of India GDP = Gross domestic product SEC = Securities and Exchange Commission GOI = Government of India SPV = Special purpose vehicle HDFC = Housing Development Finance USAID = US Agency for International Development Corporation IFC = International Finance Corporation UTI = Unit Trust of India INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT STAFF APPRAISAL REPORT LOAN AND PROJECT SUMMARY I - ECONOMIC AND SECTORAL BACKGROUND ........................ ....................... 2 * India's economic policies and performance ............................................................... 2 * Evolving a policy and an institutional framework for private investment in infrastructure ................................................................ 3 * The Bank's assistance strategy in the infrastructure sector ....................................... 4 11- INFRASTRUCTURE LEASING AND FINANCIAL SERVICES LIMITED (IL&FS) ................................................................6 - The company ............................................................... 6 * Regulations and operating policies ................................................................9 * IL&FS's current operations ............................................................... 10 * Future strategy and financial perfonnance ............................................................... 12 III - THE PROJECT ............................................................... 16 * Project objectives. ................... ............................................ 16 * Project description ............................................................... 16 * Indicative pipeline of subprojects .................................... ........................... 17 * Project cost and financing plan ............................................................... 17 * Project implementation and monitoring ............................................................... 19 * Procurement ............................................................... 20 * Security arrangements ............................................................... 21 * Onlending and disbursement ...................... ......................................... 22 * Environmental and social considerations ............................................................... 24 The project was prepared bv a team composed of Mmes. Joelle Chassard (Task manager, SA2EI), Susan Morse (Financial Consultant), Jelena Pantelic (SA2El), and E. Schaengold (ASTHR), and Messrs. Syed Ahmed (LEGSA), Raul Auzmendi (Transport Consultant), Chandra Godavitarne (SA2RS), Harald Hansen (SA2EI), P. Illangovan (ASTEN), and I. U.B. Reddy (SA2RS). Mmes. A. Armstrong, V. Scott and 0. Valladolid assisted in the production of the report. The peer reviewers were Messrs. Hoon Mok Chung (ASTDR), John Flora (TWUTD), and Michael Klein (PSD). The report was endorsed by Messrs. Heinz Vergin, Director (SA2) and Jean-Fran,ois Bauer, Chief (SA2EI). IV - PROJECT JUSTIFICATION ....................................... ......................... 26 * Project sustainability ............................................................... 26 * Economic analysis ............................................................... 26 * Benefits ............................................................... 27 * Risks ............................................................... 27 V - AGREEMENTS AND RECOMMENDATION .................................................. 30 * Agreements ............................................................... 30 * Recommendation ............................................................... 31 ANNEXES 2.1 IL&FS: composition of the Board of Directors .32 2.2 IL&FS: organization chart .33 2.3 Implementation of a cost accounting system .34 2.4 IL&FS: exposure limits for commercial infrastructure projects and limits to investments in affiliates .35 2.5 IL&FS: income statements, cash flow statements, balance sheets, and selected financial ratios (1991/92 - 2000-01 .36-42 2.6 IL&FS's financial forecast: sensitivity analysis .43-44 3.1 Subproject eligibility criteria .45-47 3.2 Subproject pipeline and implementation schedule .48-55 3.3 IL&FS's proposed training and technical assistance activities (summary) 56-58 3.4 IL,&FS's project ccle .59-61 3.5 Subproject evaluation report .62-64 3.6 Performance monitoring indicators .65 3.7 Supervision plan .66-67 3.8 Selection of BOT operators .68-70 3.9 IL&FS's pari passu security structure .71-73 3.10 IL&FS: foreign exchange risk management and treasury operations 74-75 3.11 Environmiient and social report (ESR) .76-90 INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT LOAN AND PROJECT SUMMARY Borrowers: - India, acting by its President (for the IDA credit) - Infrastructure Leasing and Financial Services Limited (IL&FS) (for the IBRD loan) Guarantor: India, acting by its President (for the loan to IL&FS) Beneficiaries: Public sector agencies; special purpose entities established for the construction and operation of commercial infrastructure projects Poverty: Not applicable Amounts: - SDR3.4 million (US$5 million equivalent) (for the credit to India) - US$200 million (for the loan to IL&FS) Terms: - For the credit to India: repayment over 35 years. - For the loan to IL&FS: repayment over a 20-year period, including 5 years of grace. Standard interest rate for LIBOR- based single currency loans. Commitment fee: - For the credit to India: 0.50% on undisbursed balances, beginning 60 days after signing, less any waiver. - For the loan to IL&FS: 0.75% on undisbursed loan balances, beginning 60 days after signing, less any waiver. Onlending terms: Proceeds of the Bank loan will be onlent either (i) in rupees at a market-determined rate. In this case, IL&FS will bear the foreign exchange risk; or (ii) in US dollars at a variable market- determined rate. The tenor of the subloans will vary between 17 and 20 years. Proceeds of the IDA credit will be onlent on the standard terms and conditions for central assistance to the states applicable at the time. Financing plan: See para. 3.06. Net Present Value: Not applicable - 2 - INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT STAFF APPRAISAL REPORT I - ECONOMIC AND SECTORAL BACKGROUND India's economic policies and performance 1.01 In mid-1991 India's development strategy took a radical turn when, in response to a severe macroeconomic crisis, the new government launched an ambitious program of economic reforms. The program did not limit itself to restoring macroeconomic stability. It also reoriented structural policies governing the investment regime, foreign trade, the financial sector, taxation, and public enterprises. As a result, almost all areas of the economy have been opened to domestic and foreign private investment. Import licensing restrictions on intermediate and capital goods have been virtually eliminated. Tariffs have been significantly reduced and full convertibility has been established for current account transactions. In the financial sector, prudential regulations that meet international standards have been introduced; banks now have significantly more discretion in their lending decisions; financial markets have been liberalized; and entry restrictions have been eliminated. The external accounts have strengthened considerably and, although still a major obstacle to higher growth, central fiscal imbalances have been lowered. The result has been a rebouncing of the economy, helped by an unprecedented sequence of good monsoons and a strong industrial recovery. GDP growth has been steadily increasing, from 1% p.a. in 1991- 92 to an estimated 5.8% in the current financial year. The robust performance of the Indian economy is thus a testimony to the continuing favorable impacts of the liberalization and reform efforts. 1.02 There are daunting challenges ahead. Paramount among them is that of meeting the needs of a rapidly-growing population while reducing the incidence of poverty, in a country with limited land and water resources, limited capital, and enormous social needs. In the next 30 years, even taking into account ongoing family planning efforts, India's population is expected to increase by another 450 million. This "third India" will put enormous additional pressure on the country's natural resources, social programs, and already strained infrastructure. With the pace of urbanization accelerating, the consequences of population growth will be particularly serious in urban areas where the provision of sanitation and public health services as well as infrastructure is already below standard, and the absolute number of poor is increasing. 1.03 The structural reforms introduced over the last four years have gone a long way in reorienting India's development strategy to meet these challenges. For example, the private - 3 - sector now plays a much more important role in India's development process, and an incentive regime more conducive to a pattern of labor-intensive growth is being established. However, there still remains a large "unfinished" reform agenda which will take several more years to implement. Improving the fiscal situation, particularly with regard to states' finances, is of critical importance. Equally important is the need to conclude the process of structural reforms started in 1991 (e.g., in international trade, the financial system, the tax regime, and public enterprises). Finally, reforms need to be extended to key sectors of the economy, an issue where the participation of the states is critical because of their important role in formulating and implementing sector policies. This is the case in agriculture, the social sectors, and particularly infrastructure. Evolving a policy and an institutionalframework/for private investment in infrastructure 1.04 The expansion and efficient use of infrastructure is fast becoming one of India's key development issues. Of grave concern today is the risk that poor infrastructure will undermine severely India's ability to achieve its medium- and long-term objectives of higher and sustainable economic growth. At the root of the problem is a severe absorptive capacity and implementation constraint which, combined with a financial constraint, has led to chronic underinvestment in the sector and a less than optimal use of the funds available. Implementation of public sector infrastructure projects has generally been slow, with frequent cost overruns and inadequate construction quality. Addressing the situation requires, above all, a redefinition of the role of the public sector in the provision of infrastructure and the establishment of an appropriate legal, regulatory and administrative framework for private investment so that the latter can assume a dynamic role in areas from which it has been mostly excluded so far (telecommunications, power, ports, roads, urban infrastructure, water supply). The impetus for change has to come primarily from the central and state governments. A number of legislative steps and policy announcements have already been made in that direction. In September 1991, the Electricity (Supply) Act of 1948 was amended to permit private domestic and foreign investment in power. GOI's Telecom Policy statement of May 1994 launched the liberalization of the telecommunications sector. Finally, the May 1995 amendment to the National Highway Act, 1956 permits private sector participation in the development and maintenance of national highways and expressways. The removal offormal barriers to private investment must now be followed by the establishment of policy and institutional frameworks fully supportive of such investment. 1.05 The existing regulatory framework was formulated with the public sector in mind and is not appropriate to encourage the massive private investments India needs in these areas. Regulations governing entry, pricing in monopolistic conditions, the conduct of regulatory authorities, dispute resolution and arbitration are either aimed at preventing private investment or, in cases where the private sector is allowed, lead to inefficient investment. The lack of finance on terms commensurate with the typical long gestation and revenue- earning capacity of infrastructure projects is also slowing down the pace of private investment in the sector. The Bank's assistance strategy in the infrastructure sector 1.06 Assistance on these policy issues has therefore received growing importance in the Bank's work. The Bank group has pursued it through a variety of means. A substantial amount of technical assistance has been provided in the context of loans or through the administration of bilateral grants. In power for example, through the combination of project preparation (e.g., proposed Orissa state power restructuring project, and similar operations in Haryana, Uttar Pradesh, Bihar and Rajasthan), bilaterally-funded technical assistance programs, the ongoing technical assistance project for private power development, and the preparation of a guarantee framework for private investments in power, considerable progress has been achieved towards fundamental power sector reforms and the removal of essential barriers to private investment. Similarly, in the telecoms sector, bilaterally-funded technical assistance has enabled the Bank to assist in laying the ground for a regulatory framework conducive to private sector entry. A port sector report provided the basis for our policy dialogue in this area. In its sequel, the Bank has extended technical advice on the preparation of international standard tender documents to induce private investment in new facilities and in the management of existing facilities. 1.07 By contrast, our involvement in assisting in the establishment of an enabling environment for private investment has been comparatively less intensive in the roads, water supply and urban infrastructure sectors, partly because of the diversity of counterparts with whom one needs to work (GOI, state governments, local governments, municipal authorities). This is where the Bank's technical assistance is turning to now. A transport sector report as well as the specific review, in the 1995 Country Economic Memorandum (CEM), of bottlenecks to private investment in the roads sector have provided a valuable opening for a dialogue on these issues. An urban infrastructure review is now under preparation. Discussions are also underway for putting in place a program of assistance to the Ministry of Surface Transport (MOST) to help develop a comprehensive regulatory and administrative framework for private investment in the national highway sector and providing technical advice to GOI for facilitating such private investment. In this sector, however, as well as in water supply and urban infrastructure, much more needs to be done at the state and local levels to enable efficient planning and implementation of private investments. 1.08 In response to a request by Indian authorities, the Bank's latest country assistance strategy (CAS) for FY96-98 proposes to increase the Bank's assistance in establishing an environment conducive to efficient private investment in infrastructure. Direct lending continues to be envisaged to power, roads and urban infrastructure but all loans in these areas would be policy-based investment operations. At the Government's request, in those sectors as well as in telecommunications and ports where there is already considerable private sector willingness to invest, the Bank is considering providing private investors in infrastructure with term financing through financial intermediaries. Such operations are designed to support the establishment of policies and regulations conducive to efficient private investment in infrastructure, using the intermediaries' interest in getting the framework right (as tested in the telecoms sector). They are expected to play a catalytical role in mobilizing - 5 - finance for private investment in infrastructure with more appropriate maturities than those currently available. They will also assist financial intermediaries in developing appraisal and risk evaluation procedures for large private infrastructure projects -- an area in which India's financial sector has limited experience. 1.09 In this context, the first step was taken in September 1995 by restructuring the ongoing Tamil Nadu Urban Development Project (Cr. 1923-IN) and promoting the entry of a private fund manager to commercially manage the mix of public and private sources of finance provided to the Municipal Development Fund. This is the first attempt made in one state to establish a joint public-private partnership in the municipal infrastructure area. This project is expected to provide a replicable regulatory and administrative environment for investment -- public, private or mixed -- in municipal infrastructure. 1.10 The proposed Project is the second initiative. It seizes upon a unique opportunity provided by Infrastructure Leasing and Financial Services Ltd (IL&FS), a 51% privately- owned finance company with strong ties to the public sector. By supporting IL&FS's expansion in this area, the focus of the Bank is to assist first hand in the development of prototype contractual arrangements for private investment in IL&FS's areas of involvement (urban bypasses and bridges, water supply and sewerage, effluent treatment, and other municipal infrastructure), thereby facilitating entry of the private sector on a much larger scale in areas heretofore dominated by the public sector. It is a "process" operation whereby the Bank uses IL&FS as a vehicle to build up India's capacity to attract private investment in infrastructure, pilot-test institutional and contractual arrangements in a variety of subprojects under various administrative and political conditions, and help establish a track record as a pre-requisite for large-scale private investment in the sector. GOI has selected IL&FS as the first financial intermediary to receive the Bank's support given the pioneering role it is already playing in promoting private investment in infrastructure, its exceptional understanding of the synergy required between public and private interests for successful infrastructure development, its highly competent and innovative staff, and its high-quality Board. 1.11 The third and much larger operation is the proposed Infrastructure Financing Project (IFP) (FY98). With the removal of major policy and administrative barriers to private investment in infrastructure through previous lending operations, sector work and TA programs, financing on a much larger scale will then be possible. It is envisaged therefore to expand the scope of the Bank's assistance significantly by involving several public financial institutions and use the IFP as a vehicle to promote financial policy reforms aimed at developing a domestic long-term debt market. The proposed agenda of reforms contains the following key elements: (i) changing the investment guidelines applicable to, and increasing competition among, contractual savings institutions; (ii) fostering the development of benchmark interest rates; (iii) encouraging active management by institutions of their securities portfolios; (iv) reducing transaction taxes; (v) rationalizing debt market regulations; and (vi) establishing a secure clearing and settlement system for corporate debt services. The sequencing and pace of the reforms will influence the speed at which the proposed operation can be processed. - 6 - 11- INFRASTRUCTRE LEASING AND FINANCIAL SERVICES LIMITED (IL&FS) The company 2.01 Ownership. In 1983, the Banking Regulation Act of 1949 was amended to allow Indian commercial banks to enter the leasing business through separate subsidiaries. Central Bank of India (CBI), a major nationalized commercial bank, decided to promote its leasing activities through a joint venture with Unit Trust of India (UTI), a public sector mutual fund management, and Housing Development Finance Corporation Ltd. (HDFC), the country's leading private housing finance institution. The result was the establishment of Infrastructure Leasing and Financial Services Limited (IL&FS) in 1987. Actual operations began in 1988 with the owners contributing Rs.60 million (about US$2 million) in the following proportions: CBI (50.5%), UTI (30.5%), and HDFC (19%). 2.02 IL&FS has since broadened its shareholder base not only to increase capital, but also to strengthen business relationships and develop strategic alliances. For example, the Intemational Finance Corporation (IFC) and, subsequently, ORIX Corporation, a Japanese financial services company, were inducted as new shareholders in 1993 when the original promoters diluted their equity stake in the company. More recently, in order to: (a) raise capital, (b) broaden its name recognition in the public eye for further business development, and (c) establish a "market" price for its shares, IL&FS decided to proceed with an initial public offering (IPO) equivalent to 25% of its enlarged capital. Due to the poor performance of the capital markets, this issue has been temporarily warehoused with UTI; its launching is now expected to take place in mid-1996. Once the IPO is completed, the ownership structure of IL&FS will be as shown in Figure 2. 1. Figure 2.1 - IL&FS's ownership structure (Shareholding of common stock) HDFC IFC IL&FS Orix 9% 9% employees IS% _ 4% Retail Investors 25% UTI 18% CBI 20% 2.03 Board of Directors. The Board of Directors was initially constituted solely by representatives of the three promoting institutions. In 1990, it was broadened to include a number of prominent individuals from both the private and public sectors. It was again - 7 - restructured in 1995 to create 4 executive directorships that were filled by senior management of the company. Annex 2.1 provides the current composition of IL&FS's Board. The Board meets every two months; it takes all policy decisions for the company and considers approvals of business transactions of a significant value. It is well structured, with representatives of all shareholders, government, private sector and employees. As IL&FS's business expands into commercial infrastructure projects, and to enhance the Board's oversight function in this area, it might soon be desirable to appoint to the Board one or two individuals with a strong private sector background in infrastructure development, finance or construction. As a complement, IL&FS may expand the practice of setting up panels of local and international experts to assist Board members and senior management in decision- making and implementation'. Given the significant role the Board plays in the conduct of IL&FS's operations, it would be beneficial to the Bank to be kept informed of the Board's agenda of deliberations. Agreement was reached at negotiations that IL&FS will provide to the Bank, within 30 days after any meeting of its Board, the agenda of such meeting, including all documents that were forwarded and considered at such meeting. 2.04 Management. Day-to-day management of the company, including major credit investment and underwriting proposals subject to Board-established guidelines, is entrusted to the Managing Director, who is assisted by four Executive Directors (EDs), who together form the Committee of Directors (COD). Annex 2.2 provides a summary of the organizational structure of the company. IL&FS is managed in a flexible manner such that assignments are often handled by ad hoc, interdisciplinary task groups. Considerable effort has gone into corporate planning and management philosophy resulting in a well thought-out corporate business plan and well-executed strategic plans (para. 2.14). The management team (which has virtually been intact since the founding of the company) is aware of the strengths and weaknesses of the corporation and has formulated strategies to compete with much larger organizations both for new business and for human resources. One pillar of IL&FS's development strategy has been to forge relationships with a wide array of international partners, either through joint ventures or cooperation agreements, so that the company can position itself as a quality player in its mandated areas of operations and ensure it has access to international technology and training2. 2.05 Staff and training. IL&FS is a relatively lean organization; it employs a total of 189 staff, of which 126 are professional. The company has tended to bring in professionals with substantial experience and has refrained from campus-based recruitment. Professional careers are managed to give individuals varied exposure to the company's activities; to facilitate this, IL&FS has developed a modular organization structure with a high degree of autonomy, and a work ethos which fosters independence and entrepreneurial behavior. To Expert panels are already being established in the area of urban infrastructure and telecoms. Similar panels should be considered for roads and water supply projects for example. 2 One example of such relationship has been the appointment of IL&FS as country advisor to Oppenheimer & Company Inc. (USA) for their offshore country fund, the "India Fund Inc.". In that process, IL&FS has registered with the US Securities and Exchange Commission (SEC) as an "Investment Advisor", an impressive achievement given the rigorous SEC filing criteria. - 8 - motivate and retain competent professionals in a highly-competitive job market, the company has evolved a variety of forward-looking remuneration strategies such as stock options, a performance-related pay (PRP) program involving an appropriation of 5% of yearly net profits -- the first such program to be offered in India by a financial institution -- and career growth through joint ventures. As the company recruits only experienced staff, it does not have a systematic training program for new entrants. However, it does provide training on an ad hoc basis. Until now, training expenditures have remained relatively low. As IL&FS is embarking on a major move into the infrastructure business where little experience has yet been gathered in India, it is building up its institutional capacity and plans to provide its Projects staff with structured training programs to help them in the delivery of their responsibilities, particularly in identification, evaluation, implementation monitoring, and quality assurance functions (para. 3.07). 2.06 Systems and controls. financial reporting and audit. IL&FS has in place well- developed, high-quality accounting systems and internal auditing arrangements. The principal instrument for management control is a budget which is approved by the Board. IL&FS uses a reputable firm of chartered accountants as external auditor. A formal system has been in place since January 1993 to ensure compliance with: (i) the covenants and investment agreements entered into with creditors and shareholders; (ii) the company's credit policies and procedures, including those stipulated in its Operating Framework (para. 2.10); and (iii) statutory and regulatory requirements. Following the establishment of regional offices in Delhi and Bangalore, the company has further strengthened its accounting system to better monitor the operations of its various profit centers from a geographical perspective. It now needs to build up its capacity to carefully monitor the profitability of individual products marketed by the company. This has clearly not been a problem until now: the company has remained of a manageable size, thus enabling its senior management to keep good track of the various business activities and their relative profitability. As the company grows rapidly and the number of product lines multiplies -- as is currently anticipated -- such monitoring will become increasingly difficult and therefore needs to be cast within a more systematic framework. A comprehensive cost accounting system by product line thus needs to be put in place (Annex 2.3 provides details on the general purpose of such a system). During negotiations, agreement was reached that IL&FS will establish and implement a comprehensive cost accounting system by product line no later than March 31, 1997. 2.07 IL&FS follows internationally accepted commercial accounting standards in preparing its financial statements. The latter are presented in a format that meets the requirements of the Indian Companies Act, 1956. These requirements, however, are better suited for manufacturing companies than for financial institutions such as IL&FS and make it more difficult to interpret the company's financial situation. The reports submitted to the Board for the annual budget provide a more comprehensible picture of IL&FS's financial performance. Agreement was reached at negotiations that IL&FS will submit to the Bank by June 30 of each year its annual audited accounts in the format required by the Companies Act as well as its financial statements presented in the budget format and duly certified by the auditor. 9- Regulations and operating policies 2.08 IL&FS is a non-banking financial company (NBFC) regulated by the Reserve Bank of India (RBI) under its NBFC (Reserve Bank) Directions, 1977, as amended (the Directions). In addition, it is a company incorporated under the Indian Companies Act, 1956. IL&FS is recognized as a Category I Merchant Banker under the Security Exchange Board of India (SEBI) Act. Its activities are monitored by the Department of Financial Companies of the RBI, which performs inspections and reviews the portfolio and quarterly reports submitted by IL&FS for capital adequacy, asset quality, etc. IL&FS is in general compliance with all the applicable regulations. 2.09 Under the Directions, IL&FS has been historically classified as an equipment leasing company. In November 1994 it applied to RBI seeking a new NBFC classification given its unique positioning in the infrastructure sector. This initiative was taken by IL&FS as the company is not currently meeting the RBI standards applicable to equipment leasing companies3. In January 1996, RBI informed IL&FS of its decision to retain the existing classification of the company as an equipment leasing company until March 31, 1997 while acknowledging IL&FS's intention to make leasing and infrastructure finance its principal business4. During negotiations, agreement was reached that any material modification to the existing regulatory framework applicable to IL&FS, that adversely affects the operations of the company, will be an event of default under the loan. 2.10 In addition to the guidelines contained in the above-mentioned regulations, IL&FS has developed a comprehensive Operating Framework that spells out (i) the company's operating policy, (ii) its risk management framework and policies, and (iii) guidelines and framework of operations. The Framework was updated in July 1995 to reflect the company's planned expanded involvement in commercial infrastructure projects. In particular, its risk management framework and policies now set out in an extensive manner IL&FS's risk management philosophy and process, provides a detailed analysis of the types of risks associated with its various activities, and proposes an array of risk mitigation measures to be carefully monitored internally through a well-defined allocation of responsibilities5. In general, the Operating Framework sets sound management principles. However, in some instances, investment exposure limits are presented more as guidelines than strict ceilings beyond which no further exposure should be taken. In these cases, the language of the 3 Such companies are required to have at least 50% of their assets in equipment leasing and hire-purchase business taken together and earn at least 50% of their income from such business activities. IL&FS does not wish to undertake hire-purchase activities to meet the 50% requirement as the corporate sector (its main client base) is not amenable to such activity. Given applicable fiscal and accounting norms, it is also not feasible ordinarily for an NBFC to have leased assets equivalent to 50% of its portfolio. 4 As a result. leasing and infrastructure assets will be considered together in the calculation of the applicable standards. 5 Because of the increasing complexity of risk management. IL&FS is planning to institute a "Risk Management System" that would be entrusted to a Risk Management Group (RMG). The responsibility of the RMG, inter alia, would include assisting IL&FS's business managers in evaluating various risks in their business areas, initiate risk mitigation steps. reporting risks to the various management levels for corrective actions, and ensuring compliance of directives laid by the Board or the COD. - 10- Framework needs to be tightened accordingly. Furthermore, three specific aspects related to the company's investment in commercial infrastructure projects need to be revised: (i) because of the inherent risks associated with this type of projects, particularly with India's and IL&FS's limited track record in this area, it is considered more prudent that IL&FS limit its credit exposure to infrastructure projects to one third of the company's total credit exposure (instead of the 40% of total assets currently provided for in the Framework). This would ensure a careful balance between leaving enough room for IL&FS to develop its infrastructure business and ensuring that, as a result, it does not take excessive risks that could threaten its fundamentally sound financial position; (ii) it is important to preserve the integrity of lending decisions in those cases where IL&FS may be both a significant equity investor in and a lender to the same commercial infrastructure project entities; thus the sum total of investments (including equity, loans and guarantees) in affiliates of the company should not exceed 30% of IL&FS's net worth; and (iii) when considering IL&FS's total equity investments -- which should not exceed its net worth -- all expenditures incurred by IL&FS on commercial infrastructure projects prior to financial closure should be treated as equity. In close consultation with IFC, the Bank discussed with IL&FS a proposal for revising the related sections of the risk management framework that reflects the specific conditions under which these projects will be implemented and the risks they will entail. The agreed version is presented in Annex 2.4. During negotiations, agreement was reached that, as a condition of loan effectiveness, IL&FS will revise its Operating Framework to (i) set definite investment exposure limits instead of guidelines, (ii) limit to one third of its total credit exposure, IL&FS's credit exposure to infrastructure projects, as calculated in accordance with a methodology satisfactory to the Bank, (iii) limit to 30% of the company's net worth its aggregate investments in entities in which its share in the paid-in capital is more than 33 1/3%, and (iv) treat as equity all expenditures incurred by IL&FS on infrastructure projects prior to financial closure. In addition, agreement was reached that (i) IL&FS will continue to conduct its operations in accordance with the principles and procedures enunciated in its revised Operating Framework, and (ii) any material modification to the Operating Framework, without prior approval of the Bank, will be an event of default under the loan. IL&FS's current operations 2.11 Assets. IL&FS is engaged in lease and loan financing -- which constitutes its core business -- as well as merchant banking and other financial activities. It is today one of the 5 largest and best regarded non-bank finance companies (NBFCs) in India; it is currently rated "AAA" by Credit Analysis and Research Ltd. (CARE), one of the 3 Indian credit rating agencies. Since the company was founded, revenues and net profit after tax have increased at an average annual rate of 56% and 57%, respectively. Its assets have grown from Rs.734 million (US$44 million) in its first year of operation (FY88/89) to Rs. 13.2 billion (US$418 million) in FY94/95 -- an impressive growth rate of over 50% per year in local currency and over 40% in US$ dollar terms. It has successfully built up its balance sheet with a safe, but not overly profitable, lending and leasing business. As of March 31, 1995, loans and leases accounted for 77% of the company's total assets and 76% of its income. The leasing business is attractive to IL&FS as the company benefits from accelerated tax depreciation on - Il - its leased assets6. The core lending and leasing business is restricted to the country's top 60 corporate groups as well as creditworthy public sector agencies, which has meant that, although risks are low, competition in this segment has limited profitability. IL&FS tries to differentiate itself from its competitors by providing products which are customized to client needs. The quality of the lease and loan portfolio is good and has seen a marked improvement over the last three years; it reflects not only the large, high-quality client base, but also the company's tight credit control and portfolio management.7 In parallel with the core business of lending and leasing, an investment banking business has evolved since IL&FS's inception. Asset-based investment banking activities are mainly securities investment and trading, and property development. A growing area of business for IL&FS is now its fee-based investment banking activities: asset management, corporate and project advisory work, and underwriting and issue management. To date, the contribution of the bottom line of these activities has been modest, but its growth is a key component of IL&FS's business strategy (para. 2.15). IL&FS is also engaged in the development of various new businesses -- through the establishment of joint ventures -- most of which are a logical extension of current activities that will give rise to new financial products or will increase investment banking services that IL&FS can offer. The breakdown of IL&FS's assets as of March 31, 1995 is presented in Figure 2.2 below. Figure 2.2 - Breakdown of IL&FS's assets (as of March 31, 1995) Investment Infrast. devt Joint banking & financing ventures assets 1% 4% Others 16l 7% Leasing Loans & 25% debentures 47% 2.12 Funding. Historically, IL&FS has sourced its resource requirements through the induction of new shareholders, and through its credit lines from commercial banks, Indian financial institutions and multilateral agencies. Over the past few years, it has dramatically changed its resource base. IL&FS began as a subsidiary of a bank (CBI), which, along with 6 The volume of leasing in each year is set in order to bring IL&FS's taxable income to zero. 7 As of March 3 I. 1995, arrears on leases over 90 days represented 0.3% of total lease receivables; arrears on loans over 90 days accounted for 0. 1% of total loan receivables. Loans and leases affected by arrears over 90 days represented 2.2% and 1.5% of total loan and leasing assets respectively. - 12- the company's other major shareholders, served as the main source of funds. The opening of its capital to new strategic shareholders (IFC and ORIX) not only broadened its equity base but also facilitated the company's access to a wider range of debt funds. At present, IL&FS borrows from multilaterals8 (IFC and the Asian Development Bank), local banks (it has obtained renewable credit lines from a consortium of 19 banks), domestic financial and investmnent institutions and insurance companies (an important source of medium- to long- term fimds9). IL&FS has also been successful in mobilizing funds through the placement of commercial paper (CP) and issue of debentures to select corporate groups in an attempt to diversify its resource base. Figure 2.3 presents IL&FS's liability profile as of March 31, 1995. Figure 2.3 -- IL&FS's liability profile (as of March 31, 1995) Short-term Others Borrowings 5% 33% Equity Capital 5% Reservs & Surplus 16% Long-term Borrowings 41% Future strategy andfinancial performance 2.13 One of IL&FS 's primary mandates was to establish itself as a premier institution to structure and finance, both directly and through syndication, private infrastructure projects. The fulfilment of this objective was deferred to allow the company to build up its balance sheet to a size sufficient to enable it to take on the requisite risks associated with lumpy infrastructure investments. With total assets estimated to reach Rs. 16,307 million (US$470 million) at the end of the current financial year and a net worth of Rs.3,732 million (US$110 million), it is now in a position to start financing infrastructure projects. To reinforce this state of readiness is the strength derived from a unique combination of public and private sector influences that have defined the company's development until now. IL&FS has consistently built upon the special position it has enjoyed from having been promoted by public-sector institutions and being overseen by an influential Board of Directors. At the same time, its management and professional staff, having been recruited largely from the 8 The average tenor of these borrowings, which are mainly for lending towards import of capital assets, is 10 years. 9 The tenor of these facilities is typically between 5 and 8 years. - 13 - private sector rather than the promoting institutions, have left the company with a distinctly private sector culture. This unique characteristic is seen as a key strength to enable IL&FS to enter the commercial infrastructure business in a major way. It has started to position itself as the leader in developing the concept for commercializing infrastructure projects, the associated legal framework as well as financing alternatives. Over the last few years, IL&FS has been actively engaged in creating and developing frameworks to enable such commercialization, and has been in continuous dialogue with the relevant authorities in order to develop policy as well as the recommended legislative changes that promote such intent. The sectors chosen by IL&FS for initial development were power and telecommunications, surface transport and transportation systems. As explained earlier (para. 1.06), power and telecommunications are somewhat better positioned for commercial implementation; IL&FS's initial focus in these sectors has therefore been towards providing investment banking services. The surface transport sector has been far different in that IL&FS has had to develop models which are sought to be replicable across the sector and structured to facilitate market borrowings. Thus, in these areas, IL&FS has been required to undertake a multiplicity of roles in a project, including initial conceptualization, development, financing, implementation and management. Its record to date in this area is limited to the successful implementation of a small toll road in Madhya Pradesh (the 11.5-km Rau-Pithampur bypass); it has also advanced significantly the preparation of three additional projects, two of which (Delhi-NOIDA bridge and Panvel bypass) are in the final stages of development. 2.14 Corporate business plan. IL&FS has developed a comprehensive corporate business plan for the next five years to manage a successful move into infrastructure. The plan has been conceived in the light of the prevailing economic environment in India, and IL&FS's perception that the changes over the last few years would continue into the foreseeable future. It reflects IL&FS's keen interest in preserving its position in the market as a prudently managed, commercially oriented and profitable institution, and maintaining its track record of innovation and delivery. A summary of IL&FS's projected financial performance is presented in Table 2.1 below. Past and projected income statements, cash flow statements and balance sheets are provided in Annex 2.5. - 14- Table 2.1 - Summary of IL&FS's projectedfinancial performance 1995/96-2000/01 (Rs. million, unless otherwise indicated) 1995-96 1996-97 1997-98 1998-99 1999-000 2000-01 Total Assets 16,307 19,619 26,640 33,860 39,599 44,866 Infr. Project Assets 275 1,331 3,108 6,239 8,313 9,863 of which: - debt 51 980 2,383 5,135 6,935 8,207 - equity 224 351 724 1,104 1,378 1,656 Long-tenn debt 8,807 10,062 15,005 18,775 22,210 24,573 Net worth 3,742 4,283 4,944 6,944 8,420 10,178 of which: - share capital 894 894 863 949 949 949 - reserves and surplus 2,848 3,389 4,081 5,995 7,471 9,229 Total Income 2,439 3,191 4,063 5,417 6,668 7,593 of which: - interest income 1,344 1,474 2,028 2,965 3,746 4,333 - lease income 946 1,315 1,528 1,805 2,144 2,378 - fee income 125 230 278 333 400 488 Interest and finance charges 1,472 1,740 2,319 3,056 3,606 4,048 Ratios: Project Assets as a % of total assets 1.69 6.78 11.67 18.43 20.99 21.98 Debt: equity ratio 3.06 3.09 3.72 3.16 3.01 2.74 Debt service coverage ratio 1.47 2.14 2.00 2.10 2.24 2.45 Retumnonnetworth(%) 12.71 18.18 19.08 19.55 21.91 21.12 Return on total assets (%) 3.09 3.99 3.74 4.10 4.54 4.61 2.15 The main thrust of IL&FS's growth over the next 5 years will be the dramatic expansion of its commercial infrastructure project portfolio, which, for the moment, is limited to the Rau-Pithampur toll road'". Commercial infrastructure assets are projected to amount to about Rs.9.863 million (US$280 million) by the end of 2000/01 as compared to Rs.275 million (US$8 million) as of March 31, 1995. To sustain this growth, IL&FS has forecasted a robust expansion of its core loan and leasing business that would increase by about 24% p.a. over the period, a pace considered achievable in light of the projected overall economic and industrial growth in India. Another important feature of IL&FS's corporate plan is the significant growth in non-fund based business derived from a conscious effort at developing a wide range of advisory services". The impact of such development would be 0 The Rau-Pithampur toll road, being the first commercial infrastructure project arranged by IL&FS, was actually implemented by the company acting as project developer; the total cost of the project appears therefore as an asset on IL&FS's balance sheet. IL&FS has just received approval to domicile the asset into a special purpose vehicle in which the Government of Madhya Pradesh will take a 20% stake. The SPV will then issue toll revenue bonds, a first for India. l IL&FS plans to offer a range of advisory services encompassing: (i) corporate advisory services (structured finance, capital markets, project financing), (ii) securities management, and (iii) infrastructure advisory services. For example, with the experience gained as country advisor to the Oppenheimer "India Fund", is now spearheading the - 15 - reflected in a relatively rapid growth in fee income (28% p.a.). Finally, the plan assumes that the existing fiscal regime applicable to leasing activities would be maintained. In the event the prevailing incentives are either reduced or eliminated, IL&FS could, to a certain extent, pass on the associated additional costs through an increase in its spread. However, it would also likely face stiffer competition and see a slower growth in its leasing assets. To evaluate the impact of possible events on IL&FS's financial performance, a sensitivity analysis was carried out using different scenarios (Annex2..6). If IL&FS's growth in assets were significantly curtailed as compared to the base case scenario presented above, and and if there were no income from capital gains and no growth in fee income -- a worst case scenario -- the company's return on net worth would basically remain at its present level (about 14- 15%), while its debt service capability, as measured by its debt service coverage ratio, would actually improve as a result of lower funding requirements. 2.16 The company's move into the infrastructure sector means that the average maturity of its assets will grow. In order to manage its liquidity risk, the average maturity of its borrowings must also be increased. IL&FS is therefore looking to take up more medium- and long-term debt. Although it is already raising medium-term funding from domestic commercial banks, their capacity to provide longer maturity debt is limited. In the absence of a well-functioning long-term debt market in India, IL&FS has no other option but tap foreign sources for long-term funds. IFC is not in a position to provide additional funds with maturities and on the substantially-increased scale that is now being sought by the company - - IL&FS is already the largest exposure of IFC's Asia Capital Markets Department. The Bank is thus considered to be the main source of funds to meet the pressing needs for long- term financing. In addition to the Bank loan, USAID has approved a US$25 million line of credit to IL&FS in support of one of the projects in the pipeline (Tirupur integrated area development program). The company is discussing further non-rupee lines with other foreign agencies (DEG of Germany, USEximbank, FMO of Holland) as well as a number of international commercial banks interested in the Indian market (ING Bank, Bank of America, Chase Manhattan, Societe Generale, Fuji Bank and Deutsche Bank). While the potential sources of foreign funding are wide and numerous, a significant constraint may be the ability to swap these funds into rupees. 2.17 The development of IL&FS's infrastructure business will modify the risk profile of what is currently a very prudently managed enterprise. The prudential guidelines embedded in RBI's Directions are certainly appropriate for IL&FS's current set of activities, essentially low-risk lending and leasing to top Indian corporates, but they are insufficient for higher-risk and lumpier infrastructure development and financing. IL&FS's risk management framework addresses by and large this concern (para. 2. 10). As a complement, agreement was reached during negotiations on the following two financial performance targets for IL&FS: (i) maintain at all times a debt service coverage ratio of not less than 1.25; and (ii) maintain at all times a debt to equity ratio of not more than 6:1. development of specialty funds for the infrastructure sector, the first of which is being established with American Insurance Group (AIG) (USA). The first tranche of US$70 million was closed on January 10, 1996 and included anchor investors such as ADB, Orix and Tata Industries; the second, of US$80 million, is expected to close in April 1996. - 16- III - THE PROJECT Project objectives 3.01 The Project aims to develop prototype contractual arrangements for private investment in IL&FS's areas of involvement, thereby facilitating entry of the private sector on a much larger scale in areas heretore dominated by the public sector. In the process, it would build up India's capacity to attract private investment in infrastructure, pilot-test institutional and contractual arrangements in a variety of subprojects under various administrative and political conditions, and help establish a track record as a prerequisite for large scale private investment in the sector. The Project would also meet the pressing needs of commercial infrastructure project entities for long-term rupee financing. pending the implementation of financial sector reforms for the development of a domestic long-term debt market, currently under preparation. Equally important, it would foster efficiency in the delivery and use of selected infrastructure services, encourage the establishment of more efficient practices in the construction and operation of infrastructure project, and assist in alleviating the severe financial and institutional constraints to the expansion of infrastructure in India. Project description 3.02 The Project will assist IL&FS in financing infrastructure subprojects such as major bridges, urban bypasses, port facilities, water supply and effluent treatment schemes, and integrated area development projects, to be implemented on a build-operate-and-transfer (BOT) basis (or a variation thereof) and expected to be started within the next three years. It consists of three interrelated components: + an investment component in the forn of a line of credit to IL&FS, the proceeds of which will be used to provide long-term finance to special purpose entities established for the construction and operation of commercial infrastructure projects in IL&FS's pipeline (para. 3.04); * a subproject preparation component to cover specialized consultancy services to advise the public authorities granting the subproject concessions or to assist project developers in preparing their subprojects (para. 3.05); and * a training and technical assistance component to cover (i) IL&FS's staff development for its staff, (ii) specific studies that IL&FS is undertaking to facilitate the evaluation and implementation of commercial infrastructure projects (e.g., legal and regulatory framework applicable to BOT projects in sectors of IL&FS's interest, innovative financing for environmental infrastructure in medium-sized cities and townships, traffic forecasting, willingness to pay and fixation of user charges for water supply and road projects) (para. 3.07). - 17- Indicative pipeline of subprojects 3.03 IL&FS has identified a long list of subprojects which it may eventually consider for financing and which provides valuable information on the potential size of the market. However, it is clear that some of the projects in that list may either slip or not be executed at all, while new subprojects may be incorporated at a later date. In the course of preparing the Project, the Bank and IL&FS agreed that, to achieve the maximum results, it would be best to focus on certain priority sectors and establish a track record in India, that would then facilitate replicability in future. A set of eligibility criteria for the line of credit has thus been developed and is presented in Annex 3.1. Agreement was reached at negotiations that these eligibility criteria will be applicable to all subprojects to be funded under the line of credit unless otherwise agreed by the Bank on a case-by-case basis. 3.04 Given the above criteria and after reviewing the state of preparedness of each subproject, IL&FS has drawn up an indicative pipeline of subprojects (Annex 3.2) tentatively considered for financing under the Project. It is a scaled-down version of the above-mentioned list, bearing in mind that (i) commercial infrastructure projects take a considerable time to develop, and (ii) IL&FS can only gradually build up its capacity to handle the correspondingly large volume of appraisal work. The pipeline includes 18 geographically dispersed subprojects, distributed as follows: (i) 10 are in transport (urban bypasses and bridges, roads and highways, railways), (ii) 6 are area development projects (including a combination of water supply, effluent treatment, power supply and road development schemes). (iii) one is a port facility, and (iv) the last one is a large area development project to be developed in stages (Bay of Cambay). Some of the subprojects are at a relatively advanced stage of preparation and have a high probability of being implemented under the Project, they are expected to start construction within the next 18 months. By contrast, others are only at the preliminary development stage and the probability that they will be ready for implementation within the next three years is, at the moment, somewhat lower. Any slippage on these projects is expected to be made up by other projects currently under development and not included in the pipeline. Project cost and financing plan 3.05 The aggregate cost of the subprojects in the pipeline (including development costs) is estimated at about Rs.58,000 million (US$1.6 billion). The figures indicated above provide an order of magnitude of the investments envisaged. Out of this aggregate cost, development expenses for projects still at their initial stage of development and envisaged to be financed under the Project are estimated at about US$19 million, US$5 million of which would correspond to the cost of advisory services (including computer hardware and software) which public sector authorities (e.g., GOI, state governments, municipalities) could avail of to select BOT operators and negotiate concession agreements. It is proposed to finance this latter subcomponent through an IDA credit to GOI, the proceeds of which would be utilized by the concerned GOI or state government agencies. Agreement was reached at negotiations that the IDA credit will become effective only once the loan to IL&FS has been made - 18- effective. It is still too early to provide a reasonable estimate of the breakdown of costs between local and direct or indirect foreign currrency expenditures; this will likely vary considerably from subproject to subproject, depending on the nature of the subproject, the BOT operator, and the extent to which the contractor imports construction equipment. Given the experience gathered so far on the first two subprojects in the pipeline, the foreign cost component is likely to be higher than for public sector projects as great emphasis is placed in introducing best international practices through a careful selection of consortium members for the special purpose entities. It has thus been assumed that about 40% of the subproject costs would be in foreign currency. 3.06 The subprojects would be developed with a mix of financing comprising: equity from project sponsors and other partners such as institutional investors (through specialty equity funds), debt financing from contractors or suppliers, term financing from other domestic financial institutions, banks and the domestic markets (e.g., through the offering of "toll revenue bonds"), and long-term financing from multilateral agencies such as the proposed Bank loan and bilateral funds such as the US$25 million line of credit from USAID. As part of its review of each individual subproject (paras. 3.08 and 3.13), the Bank will also assess whether a World Bank guarantee might be an appropriate vehicle for Bank support to the subproject, either as a complement to or a substitute for a subloan from IL&FS. The amnount of the Bank loan has been deliberately set at a relatively conservative level to reflect uncertainties as to the pace of implementation of the subprojects and hence of disbursement from the loan. However, should the subprojects materialize more rapidly than anticipated, additional commitments could be envisaged through guarantees and/or a second line of credit to IL&FS. Bringing the subprojects to financial closure will require a mix of project development expertise and relatively novel and complex financial engineering. IL&FS is expected to play a key catalytic role in the process. It will build on its proven record of success in investment banking and financial services, and the strategic alliances it has established with foreign institutional investors'2. For all subprojects in its pipeline, IL&FS is also laying great emphasis on aligning the interests of the major stakeholders and the local governments in the success of the projects. Table 3.1 below provides an indicative project cost and financing plan. 12 For example, IL&FS will offer to the AIG equity fund all the infrastructure projects it is aware of. It has also been in discussion with General Electric Capital Corporation (GECC) for a relationship for infrastructure deal referrals for which IL&FS would receive a fee. - 19 - Table 3.1 - Indicative project cost andfinancing plan (millions of US dollars) Cost Foreign Local Total Investment 675 905 1,555 Subproject preparation 1 0 9 19 Training and tech. assist. I - 1 Total 686 914 1,600 Financing IBRD 200 - 200 IDA 5 - 5 IL&FS - 44 44 Indian fin. institutions/banks - 430 430 Capital markets 150 150 State governments & agencies - 100 100 Export credit agencies 200 - 200 Bilateral funds 75 - 75 Project sponsors & others 206 190 396 Total 686 914 1,600 Project implementation and monitoring 3.07 The Project will be implemented by IL&FS, acting as equity investor and lender to the special purpose entities. During project preparation, the Bank reviewed in detail IL&FS's project appraisal procedures and capabilities and suggested a number of adjustments to be made in the company's organizational structure, staffing and processes so that it would be better equipped to handle the anticipated large volume of infrastructure business. Key reassignment and recruitment decisions were subsequently made by IL&FS's management, internal processes and procedures have since been clearly formulated, and greater recourse is being made to outside expertise to assist in project appraisal. In addition, a comprehensive planning exercise has been carried out by IL&FS to assess the manpower requirements -- both internal and external -- of its infrastructure business, evaluate training needs and estimate the cost of consultancy services. A summary of the training program and technical assistance activities envisaged by IL&FS is provided in Annex 3.3. 3.08 IL&FS has designed a comprehensive system of steps and procedures to be followed by its staff for appraising subprojects and evaluating subloan applications. The resulting project cycle is an elaborate and well-thought out project evaluation system (Annx3.4). However, for IL&FS, some of the subproject appraisal activities will be undertaken for the - 20 - first time in a structured format. Systems must therefore be in place that are of a standard and quality that can withstand the scrutiny of all potential financiers. Because of the size, relative complexity and novelty of the subprojects which the proposed loan will finance, it is highly desirable that all subproject appraisal activities be carried out in close consultation with the Bank. It has been agreed with IL&FS that, for the first two subprojects in each sector category (e.g., roads, water supply, integrated area development)'3, there would be close interaction with the Bank as appraisal of infrastructure projects is still an area where the company has least experience and where the Bank can contribute most. In particular, the full documentation on the contractual framework for the subprojects (e.g., concession agreement, construction contract, O&M contract, lenders' agreement, shareholders' agreement) will be reviewed in detail by the Bank for their risk mitigation aspects. This is critical as IL&FS is breaking new grounds in India and is thereby setting precedents that may potentially become government policies. For all subprojects, IL&FS will prepare a detailed subproject evaluation report, an outline of which is provided in Annex 3.5. These arrangements were confirmed during loan negotiations. 3.09 Performance monitoring indicators have been established that will provide tools for monitoring progress of the Project and the extent to which it is meeting its development objectives (Annex 3.6). A comprehensive management review of all aspects of the Project, including IL&FS's operations, financial performance and annual budget, will be carried out before April 30 of each year. In addition, a mid-term review of the Project will be held before April 30, 1998 to take stock of the progress to date and identify any appropriate measures to improve implementation of the Project, as the need may arise. These arrangements were confirmed during loan negotiations. Given the Bank's expected intensive involvement throughout the life of the Project, and especially in the first two years where considerable efforts will be deployed to put in place an appropriate contractual framework that would be replicated for subsequent projects, unusually large supervision resources will be required to monitor project implementation. An indicative supervision plan is provided in Annex 3.7; it may be reviewed and updated as appropriate during project implementation. Procurement 3.10 In line with the Bank's revised procurement guidelines, two courses of action are envisaged for the procurement of goods and services under the Project. Whenever possible, and particularly for those subprojects in which IL&FS's involvement is identified at an early stage, it is envisaged that BOT operators will be selected through international competitive bidding, following which the selected operator will be free to procure goods, works and services required for the facility using its own procedures. As part of the advisory services IL&FS is providing to state and local governments for the preparation of subprojects, IL&FS has sought consultants' advice to develop the basic documentation for selecting a BOT operator. It is also looking to the Bank for assistance in developing acceptable procedures for 13 Namely, the Panvel bypass, the Delhi-NOIDA bridge, the Tirupur area development program and the Dewas water supply scheme. - 21 - inviting and evaluating proposals. During project preparation, the Bank already provided some inputs. General guidelines were discussed with IL&FS which, in some instances, is acting as advisor to state governments or other public agencies that will eventually manage the competitive bidding process (Annex 3.8). Given the diversity of subprojects, the lack of experience with competitive selection of private infrastructure operators in India and the limited availability of reference documents in the Bank to guide IL&FS in carrying out such procurement, it is anticipated that extensive work will be required in this area in the early stage of project implementation. In those cases where the BOT operator will not be selected on a competitive basis, construction contracts or supply of construction materials and equipment will be procured following normal World Bank ICB procedures, unless otherwise agreed with the Bank on a case-by-case basis. During project preparation, the Bank reviewed the procurement and contracting activities for two of such cases and suggested a number of improvements to be made in the area of procurement procedures and bid documentation to ensure that IL&FS adopts international best practices. Technical assistance and consultancy services would be procured in accordance with the provisions of the Bank's guidelines for the use of consultants. Table 3.2 below provides a summary of the procurement arrangements envisaged under the project. Table 3.2 - Summary of Procurement Arrangements'4 (indicative) (in millions of US dollars) ICB Others Total Subprojects 110 75 185 Technical assistance - Implementation support - 19 19 - Policy support - 0.5 0.5 - Capacity building - 0.5 0.5 Total 110 95 205 Security arrangements 3.11 The Bank loan will be a US$ LIBOR-based loan. It will be extended directly to IL&FS and guaranteed by GOI. The provision of GOI guarantees in support of infrastructure development in general is under active consideration by a high-powered working group within the Ministry of Finance. Its recommendations are expected to be submitted before the end of March 1996. At that time only will the detailed terms and conditions of GOI's guarantee of the Bank loan to IL&FS be finalized. However, agreement was reached at negotiations that GOI will levy a guarantee fee of not less than 1.2% on the 4 The amounts shown correspond to IBRD/IDA financing; as of the appraisal date the respective total cost of the individual subprojects is not known and therefore not shown in the procurement table. - 22 - amounts outstanding and disbursed, a level considered appropriate considering the pioneering role IL&FS is expected to play in establishing a track record for India in the area of private investment in infrastructure. Agreement was also reached that, as a condition of loan effectiveness, GOI and IL&FS will enter into an indemnity agreement on terms and conditions satisfactory to the Bank. In addition to the GOI guarantee, the Bank will take a pari passu interest in the security structure currently in force in respect of the present lenders to IL&FS (Annex 3.9). To complete the security package, an inter-creditor agreement needs to be in place. IL&FS has finalized the agreement to the satisfaction of the Bank and will circulate it shortly to all the other lenders for their comments. Agreement was reached at negotiations that, as a condition of loan effectiveness, the security arrangements for the World Bank loan will be completed, including the placement of the loan under the mortgage shared equally with other lenders and the execution of the inter-creditor agreement. Onlending and disbursement 3.12 The proposed loan to IL&FS is meant to meet the pressing needs of commercial infrastructure project entities for long-term rupee financing, pending the implementation of financial sector reforms for the development of a domestic long-term debt market (para. 1. 11). Furthermore, given the intrinsic risks of infrastructure projects and the fact that cost recovery will, in most if not all cases, be in local currency, it is considered more prudent not to pass on the foreign exchange risk to the final beneficiaries of the loan so as to preserve the financial viability of the subprojects. Proceeds of the loan to IL&FS will therefore be onlent to the subproject entities, mainly in the form of rupee term loans with maturities matching that of the original loan to IL&FS as closely as possible (17-20 years) and a market- determined rate'5. Only in exceptional cases will IL&FS onlend in US dollars in which case it will charge a market-determined variable rate'6. These onlending arrangements were confirmed at negotiations. For subloans made in rupees, IL&FS will bear the foreign exchange risk. The company plans to hedge the currency risk by swapping the proceeds of the Bank loan into back-to-back rupee-denominated loans with the same repayment structures as the Bank loan. For this to be cost-effective in the absence of a swap market in India, IL&FS will need to do it in amounts of at least US$25 million at the minimum. To enable IL&FS to arrange these swap transactions, a Special Account, with an authorized allocation of US$25 million, will be established in a commercial bank, on terms and conditions satisfactory to the Bank. The amounts deposited in the Special Account will be used exclusively for executing the swap transactions, and the rupees obtained therefrom will be deposited into a Swap Account, to be used for eligible expenditures. Annex 3.1 0 provides further details on such arrangements. They were confirmed at negotiations. Depending on the terms of the swap agreement, IL&FS may onlend the proceeds of the loan at a fixed or variable rate. In either event IL&FS will not bear the interest rate risk. The IDA credit will 5 IL&FS estimates that, under prevailing conditions, it would onlend at a spread of 400 basis points over the lending rate obtained from the swap counterparty. 16 Under present conditions and given the cost of the funds to IL&FS, the company reckons that it would onlend at a spread of 400 basis points over LIBOR. - 23 - be onlent on the standard terms and conditions applicable to central assistance to the states at the time. 3.13 As indicated earlier, subprojects financed by the line of credit will need to meet specific eligibility criteria (para. 3.03). In particular, subprojects will need to comply with the following financial performance benchmarks: * a capital structure for the SPV of no more than 75% debt, with the promoter's contribution representing at least 25% of the paid-in capital; * a project debt service coverage ratio of no less than 1.25 on an annual cash-flow basis; and * the entire financing package to have been finalized (committed or raised) or promoter guarantees of high quality to have been provided prior to the finalization of the financial package. These will need to be fully documented in the subproject evaluation report prepared by IL&FS, which will form the basis for the Bank's review of individual subprojects. Agreement was reached at negotiations that, as conditions of disbursement for the investment component, (i) IL&FS will submit to the Bank, for its review and approval, the final project evaluation report, including the environmental and social (EA/SA) assessment reports, and (ii) the contracts for the financing of the subproject will have been executed together with all the other contracts associated with the implementation of the subproject. 3.14 Drawdowns from each subloan will be contingent on the SPV meeting conditions precedent relative to progress of construction. Such conditions would be specified in the lender's agreement between IL&FS and the SPV and would be spelled out in the evaluation report submitted by IL&FS to the Bank. Disbursements under the loan will be made for 100% of the amounts paid by IL&FS for expenditures incurred under eligible subloans; disbursements for consultancy services and training will be for 100% of expenditures. Disbursements under the credit will be for: (i) 100% of expenditures for consultancy services, and (ii) for equipment and software, 100% of foreign expenditures, 100% of local expenditures (ex-factory cost) and 80% of local expenditures for other items procured locally. As indicated in the eligibility criteria, proceeds of the Bank loan would not cover more than 25% of the total cost of individual subprojects. The loan is expected to disburse over a five- year period. An indicative schedule of disbursements has been assumed in the financial projections for IL&FS (Annex 2.5). The cut-off date for new loan commitments to be financed under the Project would be December 31, 1998. The Project would be completed by March 31, 2001 and the closing date for the loan would be September 30, 2001. - 24 - Environmental and social considerations 3.15 IL&FS, with assistance from an NGO, has prepared an Environmental and Social Report (ESR), the objective of which was to put in place an environmental and social assessment process which adequately responds to GOI requirements and, for subprojects involving Bank financing, the Bank's operational directives (ODs). Organized in 3 volumes'7, the ESR: (a) states the company's environmental and social goals; (b) provides the contextual setting for the environmental and social assessment process; (c) identifies the major issues in the priority sectors; (d) details the environmental assessment and social assessment (EA/SA) process that IL&FS will follow when appraising suprojects; (e) outlines methods to moderate risks and liabilities due to environmental and social factors; (f) specifies the organizational arrangements in IL&FS to manage the environmental and social assessment process; and (g) spells out the staff development plan. Relevant regulations, guidelines (including the Bank's relevant operational directives), checklists and protocols are provided as an attachment to the report. Land acquisition and resettlement procedures described in the ESR will apply only to land acquired, whether by public or private sector agencies, on or after June 15, 1995 (the date of commencement of preparation of the ESR). During project preparation, the Bank "field-tested" the ESR approach in the context of one subproject (para. 3.17) and met with various government officials and NGOs to assess their concurrence with the approach proposed in the ESR. The Executive Summary of the ESR is presented in Annex 3.1 1. 3.16 In the process of preparing the document, IL&FS's management has demonstrated a strong commitment to implement the ESR and taken a proactive stand for tackling environmental and social issues. IL&FS clearly sees the EA/SA process as an integral part of its risk management framework: specific environmental and social risks are identified upfront and mitigation measures fully integrated into the project design, thereby reducing the risks of delays during contruction and operation that could threaten the project's financial viability. It also enables IL&FS to screen projects and avoid financing investments for which, for example, land acquisition may result in costly resettlement and rehabilitation (R&R). IL&FS has brought a few innovative features into the environmental and social assessment process, such as the establishment of neighbourhood committees or the preparation of annual environmental and social audits for the company. It has set an example of best practice that might well be considered for other operations supported by the Bank in India and elsewhere. 3.17 IL&FS, with the assistance of local consultants, prepared an environmental and social assessment for the proposed Delhi-NOIDA link bridge subproject. The draft report was reviewed by the Bank and the final version incorporates all the comments. The Delhi Administration, NOIDA and the project SPV have all committed to implement the mitigation actions. Air pollution and noise have emerged as the major environmental issues in certain localities adjacent to the project location. A greenbelt, noise barriers and air quality 7 Volunie I is the Executive Summary; Volume 11 is the main report; and Volume 111 is a compilation of reference documents. - 25 - monitoring are included in the project design. Five per cent of the total landfall area is under dispute, the remaining is unencumbered land. A negotiated settlement with the affected people is being pursued by the Delhi Administration. The compensation will be based on the entitlement framework contained in the ESR. - 26 - IV - PROJECT JUSTIFICATION Project sustainability 4.01 In this particular case, project sustainability must be looked at from three inter-related angles: (i) from the point of the individual subprojects; (ii) from the institutional IL&FS viewpoint; and (iii) from a broad sectoral perspective. The proposed project will support the implementation of commercial infrastructure projects which IL&FS is and will continue to be carefully screening for their financial, economic, technical, environmental and social merits. Among the eligibility criteria agreed with the Bank, IL&FS has set a minimum real financial rate of return of 14% which it considers to be the minimum for attracting private finance. The subprojects are structured to generate sufficient revenues to recover capital as well as operating and maintenance costs through the duration of the concessions. Particular attention is also given by IL&FS for establishing an appropriate institutional framework for the implementation of the individual projects, through a pro-active dialogue with GOI on regulatory and legal issues and by encouraging public/private partnerships with state governments and their agencies. Since the financial viability of the proposed investments depends on the cost-effective design, implementation and operation of individual projects, the incentives for sustainability are greater than in the case of similar investments implemented by the public sector. The agreed procedures for Bank review of subprojects (paras. 3.08, 3.09 and 3.13) should also enhance the likelihood of sustainability of the subprojects. 4.02 With regard to IL&FS's sustainability, the company has developed an Operating Framework which inter alia sets out a risk management framework and related policies as well as the company's guidelines and framework of operations (para. 2. 10). To ensure that IL&FS's expanded involvement in infrastructure is sustainable in the long run, the Project includes the following safeguards: (i) IL&FS's risk management framework, as revised, will set prudent limits to the company's exposure to infrastructure projects; (ii) financial covenants will provide additional prudential guidelines for IL&FS's overall operations; and (iii) the agreed financial eligibility criteria for onlending to individual subprojects are expected to contain the credit risks of individual subprojects. 4.03 By supporting IL&FS' efforts in the development of private infrastructure investments, in collaboration with the concerned agencies of GOI and individual states, the project will assist in defining an improved regulatory and institutional framework for the sector and hence establishing the sustainability of private infrastructure investments in India. Economic analysis 4.04 The economic analysis of the Project will be carried out at the subproject level, on an investment-by-investment basis. As indicated earlier, each subproject will be subject to both a detailed financial analysis and a conventional economic evaluation by IL&FS, assisted, as necessary, by specialized consultants. During project preparation, the Bank reviewed the preliminary economic evaluations carried out by IL&FS for a sample of subprojects in the - 27 - transport and water supply sectors. While IL&FS's staff demonstrated extensive knowledge of the principles of economic analysis of projects, some improvements were suggested to enhance the coverage, thoroughness and rigor of the evaluations. The Bank agreed with IL&FS a methodology to be followed for investments in each sector, including: (i) a clear articulation of the underlying rationale for the choice of each subproject, (ii) the consistency of the subproject within future sectoral development plans, (iii) the identification of the expected beneficiary groups, (iv) the valuation of economic benefits and costs using appropriate shadow prices, (vi) the identification of the risks of the subproject and the associated mitigation measures, (vii) the establishment of a minimum economic rate of return (ERR), (viii) the test of first-year benefits (FYB) to check appropriate timing of the investment, and (ix) the use of incremental analysis in the context of a phased project. During loan negotiations IL&FS confirmed that it will follow an acceptable methodology when carrying out the economic evaluation of subprojects and that it will fully document such analysis in the evaluation report to be submitted to the Bank for each subproject. Benefits 4.05 At the subproject level, the project will achieve the benefits normally attributed to specific infrastructure projects; these will be clearly identified and measured on a case-by- case basis in the economic evaluation of individual subprojects. At the macroeconomic level, the Project should be seen as a precursor for greater involvement of domestic financial institutions and the capital markets in the infrastructure sector. It will help overcome one of the major obstacles to a satisfactory market response to GOI's economic reform efforts and promote increased capital availability for infrastructure, improved efficiency in the use of these resources and overall faster economic growth. The Project will enable IL&FS to promote commercially-viable infrastructure projects on a much wider scale than heretofore. By giving such investments a clear commercial orientation, the concept adopted by IL&FS for their implementation is expected to induce better cost recovery, faster construction, the application of improved maintenance policies, the introduction of technological improvements, better utilization of the infrastructure capacity, and better interaction between users and providers of services. The project will also provide the company with the appropriate institution-building and technical assistance support required to develop it into a successful infrastructure company. IL&FS will thus have become a rare institution in the developing world, achieving what it does as a purely indigenous enterprise. Risks 4.06 The Project -- innovative in its concept and design -- entails certain risks which are proposed to be mitigated in the following manner: * first, the Project is breaking new grounds. The pioneering of commercial infrastructure projects in India in itself constitutes a key risk, particularly in the absence of a well- established administrative, legal and regulatory regime. To mitigate this risk, IL&FS is using great care in selecting ("cherry-picking") only those projects which it considers - 28 - commercially viable, in establishing close partnerships with local authorities and other stakeholders, and spending significant resources in developing appropriate contractual frameworks (e.g., concession agreements) for these projects. The Project will also ensure that the public contracting parties will have access, whenever required, to expert advisory services to ensure that the subprojects supported under the operation are the result of a fair and responsible contracting and negotiating process; secondly, BOT-type infrastructure projects are still relatively new to IL&FS and raise credit risk issues quite different from the more traditional corporate finance and investment banking business in which IL&FS has so far excelled. IL&FS is building up a core team of professional staff and has agreed to build into its appraisal process a greater degree of reliance on outside consultants to complement its own resources. Systems are being put in place to ensure careful and comprehensive appraisal of projects which will be reinforced by a close interaction with the Bank and specific financial eligibility criteria; thirdly, there is a risk that IL&FS may have set excessively optimistic targets for implementation of the subprojects in its pipeline. Thus, embedded in the project is also a risk of delays in disbursing the proposed loan. This could in turn induce IL&FS to either shift towards simpler and less productive projects or rush the procedures and deviate from a proper contractual framework. A reasonable degree of conservatism has been built into the financial projections discussed in Chapter 11. The close working relationship between the Bank and IL&FS, the proposed covenants and onlending arrangements, including milestone provisions for disbursements, and Bank reviews and approvals of individual subprojects should also minimize the risk of IL&FS deviating from the priority sector and project types as well as the agreed procedures. In addition, to secure an effective role for the Bank in monitoring progress of implementation of the project, the supervision plan provides for a significantly enhanced supervision effort by the Bank, particularly during the first two years of project implementation. (para. 3.09); fourthly, IL&FS's involvement in a number of large and relatively complex projects, raises the risk of too rapid an expansion of its infrastructure operations. While it has followed until now prudent management practices, it must continue to maintain a proper balance between growth and sound investments. The financial covenants proposed for this project should provide appropriate checks on IL&FS's growth in infrastructure assets and future exposure to infrastructure projects; finally, the loan to IL&FS includes a new feature whereby the company will be allowed to use proceeds from the loan account and immediately swap them into Rupees in order to protect itself from the foreign exchange risk on repayment of the loan. Appropriate safeguards have been built into the terms and conditions of such Special Account and the associated Swap Account so that the funds disbursed from the loan account are used exclusively for the Project. - 29 - 4.07 It is also worth noting that IL&FS itself, as a commercial entity, is well aware of the issues related to risks and risk management; this has been extensively reflected in its Operating Framework (para. 2.09). The risk management framework and policies set out in detail (i) IL&FS' risk management philosophy; (ii) the objectives of risk management; (iii) the company's risk management process; (iv) the internal allocation of responsibilities; and (v) definition and types of risks incurred in IL&FS's various business activities. - 30 - V - AGREEMENTS AND RECOMMENDATIONS Agreements 5.01 Agreement has been reached with IL&FS that: (i) it will provide to the Bank, on a timely basis, all important documents and information submitted to the Board for its consideration (para. 2.03); (ii) it will implement a comprehensive cost accounting system by product line to be fully operational by March 31, 1997 (para. 2.06); (iii) it will submit its annual audited accounts to the Bank by June 30 of each year (para. 2.07); (iv) any material modification to the existing regulatory framework applicable to IL&FS, that adversely affects the operations of the company, will be an event of default under the loan (para. 2.09); (v) it will continue to conduct its operations in accordance with the principles and procedures enunciated in its Operating Framework, as suitably revised, and that any material modification to the Operating Framework, without prior approval of the Bank, will be an event of default under the loan (para. 2.10); (vi) it will maintain at all times a debt service coverage ratio of not less than 1.25 (para. 2.17); (vii) it will maintain at all times a debt to equity ratio of not more than 6:1 (para. 2.17); (viii) it will apply eligibility criteria, acceptable to the Bank, to all subprojects to be financed under the loan (para. 3.03); (ix) it will onlend the proceeds of the loan on terms and conditions acceptable to the Bank (para. 3.12); (x) it will use the amounts deposited in the Special Account exclusively for executing swap transactions, on terms and conditions acceptable to the Bank, and it will deposit the rupees obtained thereby in a Swap Account, payments out of which will be used exclusively for eligible expenditures under the Project (para. 3.12); and (xi) it will follow a methodology acceptable to the Bank for the economic analysis of subprojects (para. 4.04). - 31- 5.02 Agreement has been reached with GOI that it will guarantee the proposed loan to IL&FS under terms and conditions satisfactory to the Bank, including the levy of a guarantee fee of not less than 1.2% on amounts outstanding and disbursed (para. 3.11). 5.03 Agreement has been reached with GOI and IL&FS that annual management reviews of the Project will be carried out by April 30 of each year and that a mid-term review of the Project will be carried out no later than April 30, 1998 (para. 3.09). 5.04 Conditions of effectiveness of the loan to IL&FS will be that: (i) IL&FS's Operating Framework has been revised to (a) set definite investment exposure limits instead of guidelines, (b) limit to one third of its total credit exposure, IL&FS's credit exposure to infrastructure projects, as suitably defined, (c) limit to 30% of the company's net worth its aggregate investments in affiliates, as suitably defined, and (d) treat as equity all expenditures incurred by IL&FS on infrastructure projects prior to their financial closure (para. 2.10); (ii) GOI and IL&FS have entered into an indemnity agreement on terms and conditions satisfactory to the Bank (para. 3.1 1); and (iii) the security arrangements for the loan have been completed by IL&FS, including the placement of the loan under the mortgage shared equally with other lenders and the execution of the intercreditor agreement (para. 3.1 1). 5.05 A condition of effectiveness of the development credit will be that the loan to IL&FS has been made effective (para. 3.05). 5.06 Conditions of disbursement for the investment component of the loan to IL&FS will be, with respect to all subprojects, that the Bank will have reviewed and approved each subproject and that all contracts associated with the implementation of the subproject will have been executed (para. 3.13). Recommendation 5.06 With the above assurances, agreements and conditions, the proposed Project would be suitable for a Bank loan of US$200 million to IL&FS, to be repaid over a period of 20 years (including 5 years of grace) at the Bank's standard interest rate for LIBOR-based single currency loans, and an IDA credit of SDR3.4 million (US$5 million equivalent) to India, to be repaid over 35 years. -32- ANNEX 2.1 INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT IL&FS: Composition of the Board of Directors The Board of Directors has 18 members comprising the Chairman, the Vice Chairman and Managing Director, I I non-executive directors and 4 executive directors. The present Chairman is also Chairman of HDFC. Other than the Chairman, 6 of the non-executive directors are shareholder representatives including 2 from CBI, I from UTI, 2 from ORIX Corporation, and I from IFC. Two other non-executive directors are prominent Indian industrialists, including the chairman of the Mahindra group. The remaining three are current or former GOI secretaries. Current members of the board are: Messrs. - Deepak Parekh Chairman Chairman, HDFC - Yoshihiko Miyauchi President, ORIX Corporation - Yoshiaki Ishida Managing Director, ORIX Corporation - Irving Kuczynski Director, IFC - Keshub Mahindra Chairman, Mahindra Group - K.M. Birla Chairman, Birla Group - RK Bhargava Secretary (Ret'd), GOI - RC Bhargava Chairman & Managing Director, Maruti Udyog Ltd. - K Padmanabhiah Secretary, Ministry of Home Affairs - C Ramachandran Secretary, Ministry of Urban Affairs and Employment - DK Contractor Executive Director (Ret'd) CBI - KC Chowdhary Executive Director, CBI - BG Daga Chief General Manager, UTI - Ravi Parthasarathy Vice Chairman & Managing Director, IL&FS - Vimal Bhandari Executive Director - Ashok Totlani Executive Director - Infrastructure - Arun K Saha Executive Director & Company Secretary - Gopal Rajagopalan Executive Director - New Initiatives INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT IL&FS organization chart C.d l- W. M.,m'' , m . I an |~~~~~~~~ ;~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~02 $BMM MM 9" W3 X ff -34- ANNEX 2.3 INDIA PROPOSED PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT Implementation of a cost accounting system 1. IL&FS has in place well-developed high-quality accounting systems and internal auditing arrangements. Following the establishment of regional offices in Delhi and Bangalore, the company has further strengthened its accounting system to better monitor the operations of its various profit centers from a geographical perspective. What is needed however is the capacity to carefully monitor the profitability of individual products marketed by the company. This has clearly not been a problem until now as the company has remained of a manageable size, thus enabling its senior management to keep good track of the various business activities and their relative profitability, but not yet in a systematic manner. As the company grows rapidly and the number of product lines multiplies -- as is currently anticipated -- such monitoring will become increasingly difficult. It is therefore necessary that, in anticipation of future growth, IL&FS start implementing a comprehensive cost accounting system by product line so that it is fully operational by 3/31/97. 2. On an annual basis, the company's statutory auditor should certify to the Bank that an adequate system of accounting for costs per product line is in place (to be certified as of 3/31/97). Such system shall be throughout the company for all major product lines and shall make available to senior management, division managers and the Board (as well as the Bank) sufficient information to determine "gross" and "net" spreads per major product line. Such a system shall take into account overhead costs, including marketing, product and project development, finanncing costs and other administrative burdens and shall require the development of a transfer pricing model or other formula for appropriate allocations. The "gross" spreads shall be before the allocation of overhead expenditures. If appropriate, IL&FS shall work with its statutory auditor or others to develop an appropriate transfer pricing model to determine such spreads. -35- ANNEX 2.4 INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT IL&FS: exposure limits for commercial infrastructure projects and limits to investments in affiliates * With regard to infrastructure investments, credits extended to infrastructure projects will not exceed one third (33 1/3%) of the Company's total credit exposure. Infrastructure investments are those projects of a utility nature (e.g., power generation, power distribution; water supply, water distribution, transport facilities including roads, bridges, tunnels; airports, port facilities, water and air transport operators or systems, passenger and freight handling facilities, rail systems and railway operators; telecommunication operators, equipment and systems) which bear a greenfield startup/major expansion risk or where the pricing of output or services is subject to Government approval. Excluded from this list will be infrastructure investments extended to creditworthy industrial houses where the infrastructure investment constitutes no more than 25% of the assets of the industrial house, or for which full and unconditional guarantees have been given by such industrial houses. Total credit exposure will include all forms of investment which are made by means of instruments (including loans', lease contracts, guarantees, debt underwritings and other similar financial obligations) which are not counted as equity (as defined elsewhere in the risk management framework). Appropriate adjustments to a credit exposure will be made to reflect the proportion of debt service coverage met by a firm offtake contract of a creditworthy industrial house. Compliance with this covenant will be reviewed in its entirety annually. * Aggregate investments (including total credit exposure and equity as referred to above) in affiliates of IL&FS will not exceed 30% of IL&FS's paid-in share capital and unimpaired reserves. For purposes of this section, an IL&FS affiliate is to be defined as an entity where IL&FS's share of the paid in equity capital is more than 33 1/3%. Excluded from this limit are long-term strategic investments made by IL&FS in developing its business activities2. including subordinated loans. 2 These include investments in the share capital of its stock-broking venture, asset management venture, auto finance venture, Kampsax India, Transroute. -36- ANNEX 2.5 Page 1 of 7 INDIA PRIVATE INFRASTRUCTRE FINANCE (IL&FS) PROJECT IL&FS: income statements, cash-flow statements, balance sheets, and selected financial ratios (1991/92-2000/01) INDIA PRIVATE INFRASTRUCTURE FINANCING (IL&FS) PROJECT IL&FS: Income Statement (Rs. Million) 1991-92 1992-94 1994-95 1995-96 1996-97 1997-98 1998-99 199910 200-01 L Income Interest Income Liquid Investments 99 28 80 126 89 97 104 112 119 Current Maturities 200 314 260 372 396 444 607 717 853 Corporate Bonds 208 448 181 222 244 241 216 212 210 Loans & Advances Infrastructure 15 78 55 153 290 425 560 670 760 Others 53 81 371 414 344 413 574 741 888 Investment in Venture Capital 0 0 7 38 38 38 38 38 38 Dividend on Corp Investments 0 0 0 18 27 27 27 27 27 ifrastructureIncomeProject 0 9 6 0 46 306 725 1,153 1,361 Bandra Kurla Complex 0 138 0 0 0 39 113 76 76 Total Interest Income 575 1,094 961 1,344 1,474 2,028 2,965 3,746 4,333 Lease Income Lease Advance - Infrastructure Interest 18 15 32 141 144 160 179 207 222 Lease Management Fee 5 4 3 9 12 15 17 20 21 Lease Advance - Others Interest 33 32 7 23 23 26 29 34 36 Lease Management Fee 10 6 6 2 2 2 3 3 3 Lease Rentals 411 1,120 721 730 1,055 1,226 1,396 1,618 1,793 Lease Rentals - Panvel 0 0 0 0 0 0 61 122 122 Toll Income 0 2 3 2 3 3 4 4 4 OperatingAssets 0 0 0 38 76 96 116 136 176 Total Lease Income 477 1,179 771 946 1,315 1,528 1,805 2,144 2,378 Fee Income to Advisory Fees 84 90 113 125 230 278 333 400 488 Project Management Fees 0 0 4 0 7 17 26 12 2 t Project Merchant Banking Fees 0 0 0 0 0 0 22 39 0 Total 84 90 118 125 237 295 380 450 490 Profit on Sale of Investments Quoted Investments 139 137 158 0 166 213 266 328 393 Liquid Investments 0 0 0 24 0 0 0 0 0 Total Profit on Sale of Investments 139 137 158 24 166 213 266 328 393 Total Income 1,275 2,499 2,008 2,439 3,191 4,063 5,417 6,668 7,593 IL&FS: Income Statement 1991-92 1992-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 IL Expenses Interest and Finance Charges Existing Borrowings 997 1,623 1,161 1,290 1,054 929 901 768 610 New Borrowings 0 0 0 291 854 1,498 2,188 2,838 3,438 Less: Interest Capitalized -96 -101 -73 -109 -168 -109 -32 0 0 Net Interest Expenses 901 1,523 1,088 1,472 1,740 2,319 3,056 3,606 4,048 Administrative & General Expenses 54 119 154 167 195 234 281 337 404 Depreciation Leased Assets 234 577 345 303 469 566 669 798 922 Toll Road 0 0 1 1 1 1 62 123 123 Fixed Assets (Own) 13 29 23 32 42 46 72 97 96 Operating Assets 0 0 0 14 27 32 36 41 51 Total Depreciation 247 606 369 350 539 646 840 1,059 1,193 Total Expenses 1,202 2,247 1,611 1,988 2,474 3,199 4,177 5,002 5,645 Profit 73 251 397 451 717 865 1,240 1,666 1,948 H0 TINIAL PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT HAFS: Cash Flow Statement (Rs. Million) 1991-92 1992-94 1994-95 1995-96 199697. s:1.997-9" 1998-9q9 199IM00O Sources of Funds Profit for the year- 7 3 251 397 451 717 865 1,240 1,666 198 ~ 3 Depreciation 247 606 369 350 539 6.46 840 1,059 1,193 4f Lease Termunal A/C 0 2 3 4 1 90 286 491 517 727 913 Lease Rent Suspense -152 -240 2 1 3 3 112 90 103 113 5 947 Increase in Share Capital 102 217 98 176 0 0 86 0 0 Share Premiuum 0 600 980 510 0 0 863 0 0 New Borrowings 4,069 2,867 3,257 4,998 4,179 7,198 6,276 6,800 6,092 $4 Repayment of Bridge Finance 431 1,335 1,879 1,098 2,270 1,710 3,032 3,530 4,220 14762: Repayment ofbLoanis &Advances 350 774 2,056 1,894 1,054 965 1,371 2,1482,6 Sale of Corporate Bonds 0 906 228 196 275 594 568 512 562: Z$ Sale of hinvestmnents 0 22 1,053 362 0 0 0 00 Panvel SPC Deposit 0 0 0 0 388 500 1,184 -104 -104:::...165 Working Capital 210 -82 169 168 139 -51 -367 -139 -23 -.44.. 5,331 7,278 10,548 10,324 9,960 13,007 15,714 16,311 17,528 Application of Funds Bridge Finance Disbursement 141 1,706 2,369 2,050 1,500 2,960 3,530 4,220 5,000::::.'" Loans & Advances Disbursement 840 1,569 3,401 2,000 1,700 2,650 3,050 3,600 3,900 1,0 Marketable Securities HI1 136 242 236 210 235 260 285 285 1,7 Corporate Bonds 913 93 870 300 350 400 450 500 500:.:,:,:: Lease Disbursemecnt 859 1,178 1,078 1,200 1,400 1,600 1,800 2,100 2,200::. Own Assets 171 154 45 336 264 296 133 92 75:. Rau Piaiampur 0 68 0 1 7 0 0 0 0 0 ( Operating Assets 0 0 59 550 0 250 0 250 250:, Repayment of Borrowings (Old) 1,828 1,681 586 3,003 1,849 393 694 1,027 1,016 47 Repayment of Borrowings (New) 0 0 0 0 575 1,613 2,063 2,338 2,563 Redeinption of Preference Shares 0 21 0 0 0 31 0 0 0_ hivestment in Projects 0 0 6 1 0 1,056 1,777 3,131 2,074 1,550:'... Investments 371 496 1,552 363 0 0 0 0 0. 0...... Institutional Complex 0 191 0 261 260 129 -522 -359 0.42 Panvel Bypass 0 0 0 0 620 500 952 00 Dividend 26 27 132 132 176 176 173 19019 Cash 71 -41 152 -124 0 -3 0 -5 1 5,331 7,278 10,548 10,324 9,960 13,007 15,714 16,311 17,528 4R INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT HL&FS: Balance Sheet (Rs. Million) 1991-92 1992-94 1994-95 1995-96 19967 . 1.99-98 1998-99 1l999-00 2000-1: ASSETS Fixed Assets Fixed Assets (Own) 311 465 603 939 1,203 1,499 1,632 1,724 1,799 LeasedAssets 1,663 2,641 3,217 4,585 5,977 7,525 9,262 11,271 13,424 Leased WIP 216 321 624 456 1,084 1,636 579 670 717 Operating Assets 0 0 0 550 550 800 800 1,050 1,300 Project Assets 0 259 299 577 837 966 2,517 2,157 2,157 Less: Accumulated Depreciation -478 -989 -1,211 -1,561 -2,100 -2,746 -3,586 -4,644 -5,838 Total Fixed Assets 1,713 2,697 3,532 5,546 7,551 9,681 11,204 12,228 13,560 Long Term Investments Premises Deposits 31 56 109 130 155 180 210 250 250 Deb/Bonds/Govt Securities 1,627 806 1,751 1,896 2,001 1,837 1,748 1,767 1,735 Unquoted Sbares 41 16 16 16 16 16 16 16 161 .. ..... .. . ..~~~~~~~~~~~~~~~~~~. NewProjects-Debt 0 0 51 51 980 2,383 5,135 6,935 8,207p NewProjects-Equity 3 11 224 224 351 724 1,104 1,378 1,656 Loans&LAdvances 1,013 2,962 4,730 6,237 6,144 9,112 11,315 13,649 15,660 Venture Capital 0 127 150 150 150 150 150 150 150 Total Long Term Investments 2,715 3,978 7,031 8,704 9,798 14,402 19,679 24,144 27,674 Short Tern Investments Bills of Exchange 786 425 354 281 250 218 191 0 0 Quoted Trade Investments 152 298 337 500 650 825 1,025 1,250 1,475 Units of Mutual Fund 303 344 509 179 209 239 269 299 329 Total Short Term Investments 1,241 1,067 1,199 961 1,109 1,282 1,486 1,549 1,804 Current Assets Cash & Bank Balances 67 26 220 96 96 93 93 88 881,79 Trade Debtors 192 230 216 206 358 440 574 691 781342 Interest Accrued 86 24 63 254 279 398 580 761 880 AccruedRentalsnot due 316 557 536 503 390 301 198 85 26 Advance Tax 206 153 40 25 25 30 35 40 40 PrepaidExpenses 2 2 133 13 13 13 13 13 13 Total Current Assets 869 992 1,086 1,096 1,161 1,275 1,492 1,678 1,828 TOTAL ASSETS 6,538 8,733 12,849 16,307 19,619 26,640 33,860 39,599 44,866 IL&FS: Balance Sheet (Rs. Million) 1991-92 1992-94 1994-95 1995-96 1996-97 197-98 1998-9 19990 200041 LIABILITIES Net Worth Equity Shares 222 588 686 863 863 863 949 949 949 Preference Shares 52 31 31 31 31 0 0 0 0 P&L Surplus 109 119 106 380 921 1,613 2,663 4,140 5,898 DebentureRedemptionReserve 0 8 12 12 12 12 12 12 12 General Reserve 51 41 200 200 200 200 200 200 200 Investment Allowance Reserve 36 36 36 36 36 36 36 36 36 Share Premium 14 614 1,594 2,104 2,104 2,104 2,967 2,967 2,967 Contingency Reserve 0 67 117 117 117 117 117 117 117 Total Net Worth 484 1,503 2,781 3,742 4,283 4,944 6,944 8,420 10,178 Long Term Borrowings Bank Term Loan 0 250 900 0 0 0 0 0 0 Fl Term Loan 1,942 2,098 2,432 1,633 1,282 1,868 2,253 2,405 2,547 I Multilateral Agencies 272 272 1,056 2,042 2,740 3,519 4,047 4,876 5,804 4 IBRD Borrowing 0 0 0 0 929 2,332 4,208 6,008 7,000 OtherTermLoans 138 260 135 0 0 0 0 0 0 Deferred Credit 358 225 128 79 20 0 0 0 0 Fixed Deposits 10 4 3 253 625 1,125 1,375 1,750 1,875 Bank Overdraft 380 714 1,652 3,800 2,666 3,361 2,991 2,270 1,447 Floating Rate Bonds 0 0 0 500 900 900 1,000 1,000 1,250 Deposit from SPC 0 0 0 0 388 888 2,072 1,968 1,865 Total Long Term Borrowings 3,099 3,823 6,306 8,307 9,550 13,993 17,947 20,278 21,788 Current Liabilities Short Term Loans 2,511 1,868 1,506 1,000 1,500 1,750 1,500 1,500 1,650 Debentures 0 1,105 1,656 2,156 2,556 3,556 4,556 5,556 6,306 Provision for Interest 111 129 88 395 477 607 772 902 1,012 IV Sundry Creditors 277 45 63 103 385 435 253 328 403 Misc. Liabilities 18 107 193 304 568 1,059 1,576 2,302 3,216 H Proposed Dividend 27 123 132 176 176 173 190 190 190 Customer Advance 10 24 56 56 56 56 56 56 56 Provision for Non Performing Assets 0 6 24 24 24 24 24 24 24 Provision for Investment Valuation 0 0 43 43 43 43 43 43 43 Total Current Liabilities 2,955 3,407 3,762 4,258 5,786 7,703 8,970 10,901 12,900 TOTAL LIABILITIES 6,538 8,733 12,849 16,307 19,619 26,640 33,860 39,599 44,866 IL&FS selected financial ratios _- - -- -- Debt:equity ratio 11.83 4.61 3.40 3.06 3.09 3.72 3.16 3.01 2.74 Debt service coverage ratio n.a. n.a. 2.21 1.47 2.14 2.00 2.10 2.24 2.45 Return on net worth (%) 24.16 14.96 19.60 12.71 18.18 19.08 19.55 21.91 21.12 Return on total assets 1.40 3.29 3.68 3.9 3.99 3.74 4.10 4.54 4.61 -43- ANNEX 2.6 Pikc of 2 INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT IL&FS's financial forecast: sensitivity analysis A sensitivity analysis was carried out on IL&FS's financial forecast to assess the impact of certain events on its future financial performance, as compared to the base case scenario discussed in Chapter II and Annex 2.5. The following scenarios are presented below. Their respective outcomes are summarized in Attachment 1. Scenario A: (a) commercial infrastructure assets grow at a slower pace to reach Rs. 7,923 million (US$226 million) by March 31, 2001; US$150 million, instead of the projected US$200 million, is disbursed from the Bank loan; (b) fee income increases by Rs. 150 million only over the 1995/96 figures; (c) no income provision is made for capital gains on the proprietary portfolio, the size of which remains the same over the entire period; (d) leasing and investment banking assets are 20% lower than in the base case through the entire period. Scenario B: (a) same as above; (b) fee income increases by Rs.65 million over 1995/96 (the establishment of the AIG fund has already secured the receipt of such additional income); (c) same as above; (d) leasing and investment banking assets are one third lower than in the base case. Scenario C: (a) same as above; (b) no increase in fee income as compared to 1995/96 results; (c) same as above; (d) leasing and investment banking assets are 50% lower than in the base case. -44- ANNEX 2.6 Attachment 1 Page 2 of 2 INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT Sensitivity Analysis Summary Results 1995/96 1996/97 1997/98 1998/99 1999/2000 2000/01 Scenario A Debt: equity ratio 3.06 2.86 3.33 2.80 2.77 2.66 Debtservicecoverageratio 1.47 2.01 2.19 2.18 2.44 2.66 Retumonnetworth(%/o) 12.71 15.94 15.87 15.52 17.00 16.10 Retumontotalassets(%/6) 3.09 3.60 3.32 3.51 3.71 3.58 Scenario B Debt: equity ratio 3.06 2.76 3.22 2.72 2.71 2.64 Debt service coverage ratio 1.47 1.96 2.25 2.20 2.52 2.92 Retum onnetworth(%/o) 12.71 14.40 13.12 13.25 15.49 14.78 Retum on total assets (%/6) 3.09 3.29 2.80 3.05 3.41 3.28 Scenario C Debt: equity ratio 3.06 2.64 3.00 2.45 2.40 2.33 Debt service coverage ratio 1.47 1.89 2.26 2.27 2.70 3.01 Retum on net worth (%/6) 12.71 12.02 11.40 12.57 15.07 14.17 Retum on total assets (%/o) 3.09 2.78 2.52 3.06 3.53 3.38 ANNEX 3.1 Page 1 of 3 INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT Subproject eligibility criteria 1. IL&FS, through a specialized group called Infrastructure Project Advisory Services, is constantly developing a pipeline of projects, which constitutes the source of future business for its investment banking activities. The identification of potential investments is made through permanent contacts held by the company with major actors in the infrastructure field. Their action could be characterized as follows: (i) the continuous infrastructure needs search conducted, on a regular basis, by relevant agencies in GOI and State governments; (ii) the identification work being carried out by regional and local organizations, private as well as public, which also detect deficiencies and/or identify infrastructure requirements; and (iii) proposals raised by private groups interested in developing a certain undertaking which already has a tentative official approval. Upon receipt of the different ideas, IL&FS will screen the identified projects, and start with the project appraisal cycle. 2. For the proposed Bank loan, eligibility criteria (Attachment 1) have been developed to sort out priorities for Bank lending and ensure replicability of subprojects. The latter will simplify the processing of onlending requests, through obvious economies of scales that would undoubtedly occur. The eligibility criteria will be applicable to all subprojects to be funded with the assistance of the proposed line of credit to IL&FS, unless otherwise agreed by the Bank on a case-by-case basis. These subprojects would involve private investments for capacity augmentation and/or new facilities. The criteria specify, as an illustration, the priority sectors and give examples of the types of subprojects in each sector. They also include essential financial eligibility criteria for onlending. -46- ANNEX 3.1 Attachment 1 Page 2 of 3 ELIGIBILITY CRITERIA FOR BANK-FINANCED SUBPROJECTS Priority Sectors integrated urban infrastructure: (i) provision of urban infrastructure facilities and services for municipalities and similar authorities in an integrated manner; (ii) provision of infrastructure services for industrial estates and/or economic zones. t transport sector: (i) toll bridges; (ii) toll urban bypases; (iii) other toll roads where there is an alternative non- tolled road. * water supply and sanitation sector: (i) water source augmentation and distribution; (ii) sewerage works and domestic sewage and industrial waste treatment and disposal; (iii) utility management with augmentation and rehabilitation; (iv) solid waste management. * DSubprject Size Maximum of US$200 million and minimum of US$1 0 million. O Capital Struture No more than 75% debt (senior and subordinated). eof he SPV Promoter's contribution to represent at least 25% of the. equity. Subproject debt service coverage ratio of no less than 1.25 on an annual cash-flow basis. * Development Subprojects should have been developed within prudent gidelines& project development guidelines, including experienced participants (e.g., construction consortium, O&M operator), turnkey fixed price contract with specific performance and adequate liquidated damage provisions, prudent contracts for offtake sales or concession agreements, operating agreements, linkage among the contracts to reduce risk, adequate insurance, and adequate protection for minority equity owners (such as IL&FS). * IBRD Financial Maximum 25% of individual subproject cost. Proceeds of Participation the Bank loan would be onlent only to those projects in which the entire financing package has been finalized (committed or raised) or in which promoter guarantees of high quality have been provided prior to the finalization of C________________ ;the completion of the financial package. -47- ~~~~ANNEX 3.1 Attachment 1 Page 3 of 3 * Financial IRR Minimum real FRR of 14% required for each subproject. * Econonic IRR Minimum ERR of 12% required for each subproject, and test of optimum investment time through first year benefit/cost > 12%, or its equivalent maximum net present value at i=12%. * Environmental and Subprojects shall conforn to environmental and social Social Requirements (R&R) requirements of GOI and IBRD. Subproject appraisal, approval, construction and operation consistent with IL&FS environmental and social policy and operational procedures. * Institutional & The contractual agreements, in form and substance Contractual satisfactory to the Bank, should clearly lay down the mutual Arrangements rights and obligations of the various participants to the subproject, and reflect a fair and reasonable allocation of risks among them. In addition, there should be no explicit or implicit government guarantee in support of the subproject. * Implementation For subprojects < US$60 million, a maximum Period implementation period of three years; else, a maximum of five years. -48- ANNEX3.2 Page 1 of 8 INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT Subproject pipeline and implementation schedule 1. IL&FS has identified a long list of projects in transport, mass transit systems, power, telecommunications, water supply, sewage and effluent treatment and integrated area development1. Some of these projects are large, like the multi-purpose road bridge across the Gulf of Cambay connecting the eastern and western regions of the State of Gujarat (total estimated cost when all phases are completed: US$1.6 billion), or the Bangalore Mass Rapid Transit System involving the construction of 90 km of light rail at a total estimated cost of US$1.4 billion. However, the more typical IL&FS project ranges from about US$60 million (Delhi-Noida bridge, Panvel bypass) to around US$200 million (Tirupur, Mangalore area development projects). The projects vary also with respect to project preparation, with some already reaching the final stages prior to start of construction (Panvel bypass and, to a lesser extent, Delhi-Noida bridge), while others are still at a preliminary stage (Adityapur intra-city link, Gujarat roads and Mangalore area development). Most of the projects are being promoted by state governmnents. Some, for example, are promoted by a group of industries to enhance the infrastructure facilities within and around their location; this is the case, for example, of the Tirupur area development progran, which is promoted by the Tirupur Exporters' Association (combined annual turnover: US$1 billion), or the Dewas water supply project, promoted by a large pharmaceutical company. 2. The company is aware that some of these projects may either slip or not be executed at all, while new subprojects may be incorporated in the course of implementing the proposed Project. The atttached indicative pipeline of subprojects form the core group of investments identified for possible financing under the Project. It is a scaled down version of the above- mentioned list, bearing in mind that (a) commercial infrastructure projects take a considerable time to develop, and (b) IL&FS can only gradually build up its capacity to handle the correspondingly large volume of appraisal work. This pipeline should be considered as indicative as further changes may occur during the implementation of the Project. 3. The attached tables show the individual projects with a brief description, the estimated cost, the current status and the planned construction period. Each table includes projects to be started in three successive IL&FS fiscal years, the first one covering the period April 1, 1996 to March 31, 1997. Subprojects in the 1996/97 group, for example, are quite advanced in general and have a high probability of being implemented soon: this is the case, for example, of the Panvel bypass and the Delhi-NOIDA bridge where IL&FS is acting as project sponsor and setting up joint ventures with other parties (contractors, toll operators) for the Normally, it means the development of an area to facilitate industrial growth. Typically, an integrated area development program envisages the provision of several infrastructure services such as: surface transport, power, telecom, water supply, drainage and effluent treatment, and commercial and/or housing development. -49- A1NNEX 3.2 Page 2 of 8 implementation of the projects. Subprojects in the latter two groups vary in their degree of complexity of preparation; hence the probability of their being started within the implementation period of the Project varies significantly. INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT INDIATIY PROJECT PIPELINE 1996-97 No Name Description Cost Status Implementation (Rs Mn) Start Commissioning Panvel Bypass - National Highway project 2072 - Feasibility studies completed Q3 1996-97 Q4 1998-99 Maharash - 10.135-km, four-lane bypass - Executed final MoU to Panvel town on National - Detailed engineering studies completed Highway 4 (NH4); includes - Update traffic study to be completed by one flyover, three river February 1996 bridges, one ROB and seven - Concession agreement to be executed underpasses. between MoST, GoM and IL&FS by March 1996 o 2 Delhi-Noida Bridge - State project 2309 - Feasibility studies completed Q4 1996-97 Q4 1998-1999 UP/Delhi - 550-m eight-lane bridge - Detailed engineering completed across river Yamuna; with - PQ for turnkey contract issued approx. 3.50 km. approach - Shortlisting completed in November 1995 roads and grade-separated - Bid document finalisation and issue by interchanges February 1996 - Concession agreement between GoD, GoUP and IL&FS to be executed by April 1996 at INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT INDICATIVE PROJECT PIPELINE 1996-97 No Name Description Cost Status Implementation (Rs Mn) Start Commissioning 3 Tirupur Area - State project 7782 - Initial feasibility studies completed Q4 1996-97 QI 2000-2001 Develop. Programme - An integrated area develop- - SPV incorporated (NTADCL) Tamil Nadu ment scheme including water - GoTN order issued authorising NTADCL supply, drainage, effluent to draw water to implement scheme on a treatment, roads and telecom commercial basis - Detailed project studies, including engineering, financial, economic, contrac- tual agreements, bidding documents, etc., to be completed by July 1996 - Roads works to be awarded for cons- truction by December 1996 - Water supply and related infrastructure to be awarded by February 1997 4 Dewas Water Supply - State project 1579 - Feasibility studies completed Q4 1996-97 QI 2000-2001 Scheme - The project seeks to - Agreement on recommended com- Madhya Pradesh substantially augment the mercial framework for implementation water supply to Dewas reached in December 1995 industrial estate - Contractual agreements to be drafted by March 1996 - PQ notice to be issued by April 1996 5 Borivali-Virar - Indian Railway project 2800 - Engineering studies completed Q4 1996-97 Q4 1999-2000 Quadrupling Project - Project being implemented - Commercial space development plan to Maharashtra on a commercial format be completed by April 1996 - 60 km of additional track - Agreement with IR by April 1996 - 6 new stations - PPM to be completed by June 1996 - Commercial development - Financial and technical close by of space September 1996 xII INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT INDICATIVE PROJECT PIPELINE 1997-98 No Name Description Cost Status Implementation (Rs Mn) Start Commissioning Adityapur Bridge - State project 570 - Initial screening report completed Q3 1997-98 Q3 1999-2000 Bihar - 500-m, 2-lane high level bridge - TORs finalised - 5-km approach roads - Appointment of consultants to be completed by March 1996 - Project documentation to be completed by September 1996 - Financial and technical close by June 1997 2 Elevated Highway - National Highway project 1000 - Initial engineering studies completed Q3 1997-98 Q3 1999-2000 Panipat - 5-km elevated highway on - TORs for additional studies to be finalised Haryana National Highway I (NH I) by March 1996 - Project documentation to be completed by September 1996 - Financial and technical close by June 1997 3 Bubaneshwar-Cuttack - State project 1472 - Feasibility study completed in December 1995 Q4 1997-98 Q4 1999-2000 Bypass - Bypass to National Highway 5 - Additional project documentation to be Orissa (NH5) completed by June 1996 - Includes roads & bridges - Financial and technical close targeted for Q4 1997-98 4 Gujarat Roads Project - State project 1500 - Initial screening report completed Q4 1997-98 Q4 2000-2001 Gujarat - Widening and strengthening of - Preliminary Report to be completed by existing two-lane state high- February 1996 ways - Detailed project documentation to be completed by November 1996 - Financial and technical close by Q3 1997-98 0I INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT INDICATIVE PROJECT PIPELINE 1997-98 No Name Description Cost Status Implementation (Rs Mn) Start Commissioning 5 Moradabad Area - National Highway & Ministry - Projects promoted by local exporters' Q4 1997-98 Q4 2000-2001 Development Programme of Commerce project association Uttar Pradesh - The programe envisages two - Land has been acquired distinct schemes: - TORs completed in Nov. '95 (a) Implementation of a 2-lane 600 - Project documentation to be completed by bypass of 20 km on Q3 1996-97 National Highway 24 (NH24) - Financial & technical close by Q3 1997 (b) Provision of captive power 1000 w facility for Moradabad export units 6 Mangalore Area - State project 7225 - Scheme has been approved by Govt. of Q4 1997-98 Q4 2000-2001 Development Programme - Water supply scheme for Karnataka Karnataka Mangalore industry and town - Cabinet approval for commercial implementation of project expected by December 1995 - Project documentation to be completed byQ3 1996 - Financial and technical close by Q4 1997-98 ___ Standby Project for FY 1997-98: No Name Description Cost Status Implementation (Rs Mn) Start Commissioning Worli-Bandra Link Bridge - State project 6331 - Feasibility studies completed Q4 1997-98 Q4 2000-2001 Maharashtra - 1 2-km, 6-lane, partially cable- - Approval of MoEF for EIA awaited stayed bridge - Financial and technical close targeted for Q4 - 5.8-km approach roads 1997-98 INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT INDICATIVE PROJECT PIPELINE 1998-99 No Name Description Cost Status Implementation (Rs Mn) Start Commissioning I Vasai-Virar Area - State project 12000 -Initial concept has been proposed for Govt. Q4 1998-99 Q4 2003-04 Development Programme - Provision of water, transport of Maharashtra (GoM) approval Maharashtra and related infrastructure to -GoM approval expected Q1 1996-97 rapidly developing region -Preparation of project documentation to north of Bombay commence in Q2 1996-97 2 lndore-Bhopal Highway - State project 2000 -GoMP to tender for BOT operators Q1 1998-99 Q1 2003-04 Madhya Pradesh - 200-km state highway linking -Selection of BOT operators targeted for Q3 Indore, commercial capital of 1996-97 n Madhya Pradesh to Bhopal -IL&FS review to appraisal targeted for Q4 administrative capital of MP 1996-97 3 Tuticorin Port - National Port project 7000 -MOST tender selection to be completed Q1 1998-99 Q3 2001-02 Tamil Nadu - Upgrading, modernisation and by Q2 1996-97 expansion of existing port on a commercial format 4 Vizag Area Development - State project 5000 -Vizag municipality and industry would Q2 1998-99 Q3 2001-02 Andhra Pradesh - 50 MGD water supply scheme be the sponsors to industry to household -Preparation of project documentation to - Effluent treatment scheme commence in Q2 1996-97 5 Outer Ring Road - State project 3000 -Proposal for implementation of outer Ql 1998-99 Q3 2001-02 Tamil Nadu - 60-km 2-lane highway ring road on a commercial format has been accepted by GoTN -Initial screening report to be completed by December 1995 -TORs to be finalised by February 1996 -Preparation of project documentation to commence from April 1996 -3Z INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT INDICATIVE PROJECT PIPELINE Standby Project for FY 1998-99: No Name Description Cost Status Implementation (Rs Mn) Start Commissioning Gulf of Cambay - State project 50000 - Initial screening report completed Q4 1997-98 Q3 2002-03 Gujarat - Multi-facility bridge, includ- - MoU entered into between GIIC and IL&FS ing road, rail, water, gas and - Project documentation to be completed by oil pipelines Q2 1997-98 - Approach roads - Area development Qn 0J ac -56- -56- ~~~~ANNEX 3.3 Page 1 of 3 INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT IL&FS proposed training and technical assistance activities (summary) Training The development of infrastructure projects typically involves three distinct phases: (i) project identification and platning, (ii) detailed design and execution, and (iii) operation and maintenance. Given the range of activities, IL&FS needs to deliver from within its ranks a diverse range of skills across infrastructure development and project management, including inter alia, financial engineering, economic, legal and support functions. IL&FS has formulated a comprehensive staff development program, the details of which are contained in the project files. In order to provide the appropriate skills to its personnel, the company proposes to have a three-tier staff development program aimed at providing specialized training based on the functional responsibilities of the staff. The method of achieving skill upgradation at various levels are as elaborated below: * Junior level: IL&FS personnel would attend structured training courses, generally for a duration of 2-3 weeks, to familiarize themselves with techniques of project development and commercialization of infrastructure projects, mainly as a public/private partnership. Courses would consist of classroom training and case study presentations; * Middle level: IL&FS personnel need to attend advanced courses on the formulation of infrastructure projects as well as develop expertise in designing innovative debt instruments and securitisation. The training program for such personnel would mainly be through providing avenues for interaction with experienced practitioners at workshops/seminars. Additionally, specially designed advanced courses would be delivered; * Senior level: IL&FS personnel would be provided with an opportunity to visit projects implemented on a commercial format and interact with major bankers, suppliers, contractors, consultants, operators and concessionaires. Such interactions would expose them to the latest thinking on the nature and form of agreements reached, for implementation and operation of such projects. Additionally, it is proposed that international experts be invited to work along with IL&FS personnel on a focused basis in areas like risk assessment and allocation, bid evaluation, contracts and performance monitoring. ANNEX3. Page 2 of 3 Technical assistance IL&FS has identified a number of areas where detailed studies or focussed advisory services would be required to facilitate the evaluation and implementation of commercial infrastructure projects. These are, for example, legal and regulatory framework applicable to BOT projects in sectors of IL&FS's interest, innovative financing for environmental infrastructure in medium-sized cities and townships, traffic forecasting, willingness to pay and fixation of user charges for water supply and road projects. A brief description of the proposed studies is provided below. The results of these studies would be used by IL&FS and would be available to others on a selective basis. Specific Studies: * Contractual and legal documents: The main objective would be to examine the legal and regulatory framework applicable to sectors of IL&FS interest. Additionally the assignment would include preparation of an outline bid document to invite BOT operators. As a part of this document, evaluation criteria for selection of BOT operator in the sectors where IL&FS is actively involved would also be included. * Financing environmental infrastructure in industrial townships: The main objective would be to examine innovative approaches to financing water supply, wastewater treatment and garbage disposal as an integrated package. IL&FS has initiated some work as part of the preparatory activities of the Tirupur integrated area development project, but this needs to be significantly enhanced. The resulting model could be replicated in other industrial townships. IL&FS will draw extensively from international experience, as there is none comparable locally. The scope of the assignment would include: (a) literature review and study of international experiences; (b) researching financial and regulatory instruments such as municipal bonds, water tariffs, effluent charges, tradable pollution permits and self- enforcement; (c) applying these in two suprojects -- Tirupur and Mangalore; (d) negotiateing with the Government to mainstream these instruments as an integral part of municipal financing; and (e) preparing the commercial documents for the two suprojects. * Traffic forecasting: The principal objective of this study is to establish an appropriate method for forecasting traffic on the road network by relating it to population and socio- economic characteristics in its catchment area. It should be based either on a travel demand model, or other suitable method, that allows the analysis of the relationship between traffic volume for each type of vehicles and specific economic variables. The study would include analysis of traffic and other information on two typical road stretches, where MOST has already undertaken traffic counts. The study should evolve a methodology using data bases as are generally available in the country, collection of specific primary information, and verify its consistency on the sample stretches. -58- ANNEX 3.3 Page 3 of 3 * User charge estimation - Willingness to Pay: The main objective is to determine viable user charges based on a willingness-to-pay assessment of users. The study would cover two sectors - water supply and roads. The consultant would be required to undertake user surveys and relate willingness to pay with service levels and income in the case of water supply and with respect to perceived congestion and trip purpose in the case of road users. The study would take into account the past literature and studies conducted abroad, and suggest an appropriate methodology for the conduct of such studies in India. It would be desirable if the study results in the construction of willingness-to-pay curves similar to indifference curves. INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT IL&FS PROJECT CYCLE MILESTONES J GOAL PROCESS STEPS RESPONSIBILITY DECISION/PRODUCT Screening - Assessment of initial feasibility a. Desk review IL&FS - Initial screening report - Identification of critical issues b. Field investigations IL&FS/SPV/Sponsor Decision to proceed or otherwise - Examination of project eligibility with c. Interactions: IL&FS/SPV/Sponsor/ with the project respect to IL&FS project selection criteria - Project sponsor/SPV Government - Delineation of IL&FS Role - Government - Initial risk assessment - Users Scoping Consensus on: a. Interactions between IL&FS, IL&FS/SPV/ Sponsor/ - Memorandum of Understanding - Extent, scope and nature of project sponsors, SPV, government, Government (MOU) preparation public, users, etc. Finalisation of Channels of - Allocation of responsibility Consultation - Methodology of study - Time frame '. - Sharing of costs - Channels of Consultation Finalisation of terms of reference - TOR to be finalised with respect to all a. Preparation of TOR SPV/Sponsor/Consultant - Terms of reference (TOR) for (TOR) for project preparation tasks to be undertaken during project - findings from screening and appointment of consultants studies preparation phase scoping - technical components - execution arrangements b. Verification of TOR and IL&FS consistency check with IL&FS business practices Appointment of consultants - Selection of suitable consultants a. Selection of suitable consultants SPV/Sponsor - Consultants appointed b. Consistency checks with IL&FS business practices IL&FS iir MILESTONES GOAL PROCESS STEPS RESPONSIBILITY DECISION/PRODUCT Project preparation - Establish technical, economic, financial, a. Field SPV/Sponsor/Consultant - Detailed feasibility and environment and social viability - investigation investment banking report - Evolve a suitable procedure for the - surveys (DFIBR) commercial implementation of the project - interactions - Environmental and social - Establish the contractual framework for - sector studies assessment report (ESAR) the project including preparation of draft b. Technical and engineering SPV/Sponsor/Consultant - Contractual framework contractual agreements studies documentation (CFD) - Identify, assess and allocate risks c. Environmental and social studies SPV/Sponsor/Consultant - Detailed process of associated with the project during d. Market demand studies implementation, including construction, operation and maintenance e. Economic analysis SPV/Sponsor/Consultant request for proposal/bidding phases f. Financial analysis SPV/Sponsor/Consultant documents and evaluation g. Resource mobilisation plan Sl'V/Sponsor/Consultant criteria for selection of operator h. Institutional and legal SPV/Sponsor/Consultant (DPI) framework SPV/Sponsor/Consultant - Risk identification. assessment i. Development of contractual and management plan (RMP) framework Sl'V/Sponsor/Consultant j. Documentation for BOT operator selection SPV/Sponsor/Consultant T - Performance standards - Execution arrangements - Evaluation framework k. Risk analysis and allocation SPV/Sponsor/Consultant Initial project evaluation - Review of draft project documentation by a. IL&FS verification IL&FS/Consultants - Initial project evaluation report IL&FS b. Clearance/concurrence - Agreement on: - Clearances/approvals by government - State govemment clearance SPV/Sponsor - DFIBR - GO[ clearance SPV/Sponsor - EAR/SAMP - MA concurrence IL&FS - CFD -DPI - RMP Selection of Operator Selection of a suitable Operator a. Issue of PQ Notice SPV/Consultant - Award recommendation b. Shortlisting of Operators SPV/Consultant c. Bid document release SPV/Consultant d. Evaluation and selection of SPV/Consultant operator e. Consistency check with IL&FS IL&FS business practices MILESTONES | GOAL | PROCESS STEPS RESPONSIBILITY DECISIONIPRODUCT Project financial close -Translation of agreement into legally a. Negotiation of contractual IL&FS, SPV/Sponsor, - Final Project Evaluation Report binding instruments documentation between SPV, Govemment. Operator, - Signed: - Finalisation of financial consortia for the government and Operator SPV/Merchant Banker a. Concession agreement project b. Preparation of private b. Shareholders agreement placement memorandum. and c. Construction agreement negotiation with lenders and d. O&M contract agreement other shareholders Finalisation of project I consortium - I.enders' agreement Project Monitoring and Audit - Ensuring conformity to standards and a. Periodic progress report SPV/IL&FS - Compliance report agreements during construction. b. Field visits IL&FS/Lenders - Annual audit operation, and maintenance c. Interactions with IL&FS/SPV - Ensuring compliance with respect to Govemment, SPV. Operator, disbursement procedures lender. MA. local user groups, etc. H -62- ANNEX 3.5 Page 1 of 3 INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT Subproject evaluation report 1. The development and financing of commercial infrastructure projects are highly complex operations. IL&FS is expanding not only onto new grounds, but also into a demanding line of activities, where no experience is available in India. Because of its early involvement in the design of some projects, its extensive role in bringing them to financial close and their inherent complexity, IL&FS is compelled to set for itself high standards of project appraisal. 2. A project report will be the document that includes all necessary supporting data, analysis and recommendations for a proposed onlending operation to become a subproject of the proposed Bank loan. It will be the basic document that IL&FS submits to the Bank for review and. if applicable. for issuance of the Bank's no objection for the operation to become a subproject. To avoid duplications and possible misunderstandings, the project reports will resemble to a large extent what IL&FS will submit to its Board for project approval. 3. Attachment I shows, schematically, the agreed content of a typical project report. With respect to the section on "Sectoral Framework", IL&FS may have a problem in covering this area, in a comprehensive manner, in those cases where there is no official sectoral plan or strategy, as its staff is not mandated, nor has the capacity to undertake this type of background study. In such cases, IL&FS would strive to collect as much sectoral information as possible through meetings with government officials and lending agencies, and review of relevant documents, and would take the results as a framework to check the overall economic viability of the sub-projects. 4. IL&FS is adequately getting organized to prepare project reports for each case. Most of the contents of such reports are already being covered by the company, although not in a systematic way. As indicated elsewhere in this SAR, IL&FS currently has an advanced input in individual projects by providing advisory services to public agencies extending the concessions. These public agencies do not yet have the capabilities, nor the financial means to develop projects on their own in India. Thus, IL&FS is temporarily filling a vacuum, but at the same time is getting valuable experience in project appraisal. The project report, in most cases, will be the culmination of a lot of works that IL&FS will have been involved in through those advisory services. -63- ANNEX 3.5 Attachment 1 Page 2 of 3 CONTENT OF A PROJECT EVALUATION REPORT * ...IL&FS'9s Role inTProject Brief history of IL&FS's involvement in project Preparation preparation, other groups involved, coordination, details on who prepared the report. * Sectoral Framework Available plans in relevant and related sectors, consistency of proposed subproject with future sectoral plans, risk evaluation, proposal by promoter to improve some sectoral issues. * S*uproWect Technical Location, size, capacity, general configuration and layout, Description . . alternative designs, basis for selecting the design, technical data, construction procedure, timetable, proposed management. * Subproject Cost| Break-down of cost estimate, base data, physical and price Estimate contingencies, interest during construction, fees. . Resource Availability Availability and estimated cost of construction materials, water, power, human resources, social infrastructure, as needed. * Procurement Detailed description of procurement process, compliance with Bank guidelines, expected subcontracts, sample bidding documents. * Sponsor Members of consortium, previous experience, organization, management, staffing, legal constitution, technical/financial capabilities, assets/liabilities. ' Institutional & Details of all contractual agreements required for the Contractual Framework commnercial implementation of subprojects. * Implementation Timeframe. Framework * Market Assessment Willingness to pay surveys for relevant income groups, representative samples, rejection criteria for inconsistency, forecasted users' behavior; existing, diverted and generated demand, its mix, forecasted demand, scenarios on variations of relevant economic variables, including different toll rates and structure; optimum tariff/price to maximize revenues, recommended value, comparison with users' perceived benefits and willingness to pay. -64- ANNEX3. Attachment 1 (cont'd) Page 3 of 3 * Economic Analysis Underlying rationale for the choice of each subproject, expected beneficiary groups, economic benefits and costs, each increment of investment to be feasible (marginal analysis), staged construction, shadow prices, optimum timing, economic indexes (ERR, NPV, B/C) if relevant. + Environment & In accordance with IL&FS policy. Social Assessment f Financing Plan Identification of sources of funding, the nature of the financing instruments, their terms and conditions, the status of financing commitments already received or to be received, the proposed security package and associated interereditor arrangements. Details of IL&FS financial involvement: amount and description of securities to be acquired (senior/subordinated/deep discount), including coupon ondebt, any equity kickers, repayment schedule, security package, major lending terms or conditions for funding. * Financial Analysis Detailed cash flow analysis, calculation of FRR. Base case proformas of revenues and costs by major categories; major assumptions, including taxes, interest and operating costs (fuel and O&M, escalation rates, currency rates). Indication of the next actions involved for reaching financial closure, clearances/approvals to be received from DEAIRBI, etc. Audit arrangements for the project presentation of the financing plan for the project, with distinction between "during construction" and "after commissioning", if required. * Risk Analysis; Risk due to uncertainties on cost, financing shortage, Sensitivity demand, Government policies, tariff/price levels, users' behavior, actions to be taken by other parties, competing projects, and currency fluctuations. Sensitivities. * Required Clearances detailed list of official authorizations/clearances obtained and to be obtained, estimated required timing. -65- ANNEX 3.6 INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT Performance monitoring indicators INPUT INDICATORS 4 Overall loan disbursement (cumulative, computed annually) 4 Technical assistance to IL&FS (consultants' inputs in staff-weeks/ training of IL&FS staff in staff- days) 4 Technical assistance to public. authorities (consultants' inputs in staff-weeks) PROCESS INDICATORS 4 Financial closure of subprojects (# of projects closed per year) * Magnitude of private sector funds leveraged 4 Start of construction of subprojects (# of projects started per year) * Subproject commissioning of projects commissioned per year) OUTPUT INDICATORS 4* Kilometers of roads constructed/improved 4 Liters/day of water delivered * Cubic meters of waste water/effluentrteated * Kilometers of sewers built *: Number of houses built OUTCOME INDICATORS 4: Vehicle usage (traffic eounts on roads/bridgeail link built) D Daily water consumption (domestic, Industial) 4 Ratio of final cost vs. closure estimate by : subproject 4 Ratio of actual vs. projected construction period IMPACT INDICATORS 4 Growth in industrial output in subproject area 4 Reduced transportation costs * Improved water quality 4* User satisfaction (% of surveyed) INDIA PRIVATE INFRASTRUCTURE FINANCE (IL&FS) PROJECT Supervision Plan Total Estimated number of subprojects in the pipeline 18 of which: transport 10 integrated area development (IAD) 6 others 2 P = Preparation C = Construction 0 = Operations Y Subproject Development Lifeline Supervision Requirements (in staff weeks) Task Manager/ Environmental Social BOT Expert Economist Technical Annual _ Transport I TAD Others Financial Analyst Specialist Specialist Experts Total 95/96 P 5 3 7 7 6 6 4 4 10 C -- -- -- -- -- -- -- -- -- 3 96/97 P 7 4 2 12 6 6 8 8 10 C 3 2 --2 2 2 - 6 O - -- -- -- -- -- -- -- -- 62 97/98 p 3 2 2 8 4 4 6 4 C 7 4 -- 2 2 2 -- 10 mid term review 5 5 5 3 6 66 98/99 P I -- -. 3 1 1 4 2 C 7 6 2 4 3 3 -10 O 2 -- -- 3 1 1 2 38 9/2000 P 1 -- -- -- I I -- -- C 4 6 2 3 3 3 - 8 O 5 -- -- 5 2 2 4 4 36 000/01 P I -- -- -- 1 -- C 4 2 2 3 2 2 4 O 6 4 0 5 2 2 4 4 30 _ II] X "
Группа Всемирного банка · Staff Appraisal Report
India - Private Infrastructure Finance (IL&FS) Project
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