Project Financing Framework

News Excerpt:

RBI has proposed a “harmonized prudential framework for the financing of projects, considering the long gestation period of projects relating to infrastructure, non-infrastructure and commercial real estate sectors.

About the framework: 

  • The regulations endeavour to provide a “harmonized prudential framework” for financing projects. It also proposes to revise the criteria for changing the date of commencement of commercial operations (DCCO) of such projects.

  • The framework recommends that, at the construction stage, a general provision of 5% is to be maintained on all existing and fresh exposures. This is a revision from the erstwhile 0.4%. 
    • This 5% provisioning would be implemented in a phased manner, that is, 2% for FY25, 3.5% for the next financial year and eventually 5% in FY27. 
  • It can be reduced to 2.5% and 1% at the operational phase (that is, commencement of commercial operations). 

Purpose of the framework:

  • Infrastructure projects usually have a long gestation period, with a higher probability of not being financially viable, which may face multiple obstacles leading to delays or cost overruns.
  • As per the Ministry of Statistics and Programme Implementation’s March review of 1,837 projects observed that 779 of them were delayed and 449 faced cost overruns. 
    • Cost overruns were primarily due to under-estimation of the original cost, the high cost of environmental safeguards and rehabilitation measures for those displaced and spiralling land acquisition costs.  
  • The review attributed the delay to land acquisition, obtaining forest/environment clearances, changes in scope (and size), and delays in tendering, ordering and obtaining equipment, among other things.

Prerequisites in the framework for the financial projects:

The framework seeks that all mandatory prerequisites must be in place before the financial year’s closure. 

  • The indicative list must provide environmental, regulatory and legal clearances relevant to the project. It is only for PPP projects that the framework proposes to accept half of the stipulated land availability for financial closure.  
  • The Date of Commencement of Commercial Operations (DCCO) must be clearly spelt out.
  • For PPP projects, the disbursal should begin only after the de-facto handing over of a contract letter to the developer. 
    • The onus is on the bank to deploy an independent engineer or architect who would be responsible for certifying the project’s progress.  
  • RBI proposes to mandate that a positive Net Present Value (NPV) be a prerequisite to obtain project finance.

Net Present Value (NPV):

  • Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. 
  • NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project.
  • It is used to calculate the current value of a future stream of payments from a company, project, or investment.

Calculation of NPV:

  • Estimate the timing and amount of future cash flows and pick a discount rate equal to the minimum acceptable rate of return.
  • The discount rate may reflect your cost of capital or the returns available on alternative investments of comparable risk.
  • If the NPV of a project or investment is positive, it means its rate of return will be above the discount rate.

Revise repayment norms under the framework:

  • The framework proposes that the original or revised repayment tenure must not exceed 85% of the economic life of the project.
  • The revision will have to take place before the commencement of commercial operations, after lenders offer a satisfactory re-assessment of the viability of the project, and if the risk in project cost, excluding any cost overrun, is 25% or more of the original outlay.
    • Cost overruns happen when expenditures exceed the budgeted project outlay, whereas increase in costs refers to the difference between the original budget and the final cost at completion.  
  • The framework introduces guidelines to trigger a standby credit facility and stipulates an incremental funding of 10% of the original project cost.

Care Edge Rating: Care Edge Ratings discusses the potential impact on financing under-construction infrastructure projects following the implementation of the draft guidelines issued by the Reserve Bank of India (RBI). 

The key impacts of implementing the draft guidelines are:  

  • The sharp increase in provision for standard assets to 5% for all fresh and existing project loans under construction will have a direct impact on the cost of debt. Consequently, this will dampen the bidding appetite from infrastructure developers in the medium term. 
  • A mandatory tail period of 15% of the project’s economic life is estimated to reduce the leverage carrying capacity by 8-10% from the current level, especially for the projects having shorter concession, while it is estimated to increase equity requirements by 8-10% for realigning loan tenor to 85% of economic life. It also restricts top-up loan-raising abilities of all types of infrastructure projects.
  • Projects with a cost overrun (due to a change of scope) of less than 25% will face asset classification-related challenges and an increased financial burden on the project sponsor.
  • Restricting the permissible timeline for cumulative deferment of DCCO (infrastructure projects) to 3 years from the earlier limit of 4 years including reasons for litigation is viewed as stringent. Since the litigation cases require a longer time to resolve, this modification may result in the re-classification of such exposures (at the lender’s end) and a consequent step-up in borrowing costs during the implementation phase.
  • The debt raised at the Infrastructure Investment Trust (InvIT) level appears to be kept out of the ambit of this RBI circular. Thus there is an increased likelihood of operational assets being transferred to InvIT and raising debt at the InvIT level.

Way Forward:

  • Stakeholder Engagement: Engage with stakeholders including banks, financial institutions, project developers, and regulatory bodies to ensure smooth implementation of the revised framework.
  • Capacity Building: Invest in training and capacity-building programs for bank personnel and project developers to enhance understanding and compliance with the new framework.
  • Monitoring and Evaluation: Establish robust monitoring mechanisms to track the progress of projects funded under the revised framework and evaluate their performance against predefined metrics.
  • Continuous Review and Adaptation: Regularly review the framework based on feedback and evolving market dynamics to address any shortcomings and ensure its effectiveness in achieving its objectives.
  • Promotion of Best Practices: Encourage the adoption of best practices in project planning, execution, and financing to mitigate risks and enhance the overall success rate of projects in infrastructure, non-infrastructure, and commercial real estate sectors.

Book A Free Counseling Session

What's Today

Reviews

Programs

Centres

Social Platforms

Useful Links

Main Menu