Skip to main content

Project Finance and CSOs

Disclaimer: There are many concerns that CSOs have in regard to finances and fundings of projects. The following has not covered them either due to my ignorance, or reasons thereof.
Here, I have laid stress on Project Finance, since for me this is where its differentiation with other vehicles of finance (a comparison is given towards the end of this note) could be outlined. Moreover, Project Finance is now looked upon as the most viable form of financing that there is with highly mitigated levels of risks, at least, according to the financial worldlings! What follows is a writeup, where potential points could be identified and the whole exercise could start with lines of difficulties and challenges/needs/necessities (in short applied/application) delineated. Additionally, a study on Project Finance leads inherently to a study on PPPs, another preferred mode in use in India at present. CSOs need to keep in mind that one of the fundamental trade-offs for PPP designing is to strike a right balance between risks allocations between the public and private sector, risk allocation within the private sector and cost of funding for the PPP company. This, for CSOs is a point of conflict with specially designed SPVs out there to bend inclinations due to lack of disclosure clauses that define Project Finance in the first place.
A project is characterized by major productive capital investment (mining, agriculture and forests, infrastructure, power generation and irrigation, telecommunication services). Now, there are some asymmetric downside risks associated with a project in addition to the usual symmetric and binary ones. These asymmetric risks are environmental risks and a possibility of creeping expropriation (due to the project). Demand, price; input/supply are symmetric risks in nature, while technological glitch and regulatory fluctuations are binary risks. All that a project is on the lookout for is a customized capital structure, and governance to minimize cash inflow/outflow volatility.
Project finance aims to precisely do that. It involves a corporate sponsor investing through a non-recourse debt. It is characterized by cash flows, high debt leading to a need for additional support, bank guarantees, and letters of credit to cover greater risks during construction, implementation (commissioning as the context maybe), and at times sustainability. Now funding is routed through various sources, viz. export credits, development funds, specialized assets financing, conventional debt and equity finance. This is archetypal of how the corporate financial structure operates as far as managing risks is concerned from the point of view of future inflow of funds.
It has a high concentration of equity and debt ownership, with up to three equity sponsors, syndicate of banks and financial institutions to provide for credit. Moreover, there is an extremely high level of debt with the balance of capital provided by the sponsors in the form of equity, while importantly, the debt is non-recourse to the sponsors.
A typical BOT in Project Finance is shown below,

The concession authority is the government, and grants a concession to the SPV, a license granting it exclusive ownership of a facility, which, once the term for the license is over is transferred back to the government, or any other public authority. The concession forms the contract between the government and SPV and goes under the name of project agreement.
The attractiveness of project finance is the ability to fund projects off balance sheet with limited or no recourse to equity investors i.e. if a project fails, the project lenders recourse is to ownership of actual project and they are unable to pursue the equity investors for debt. For this reason lenders focus on the project cash-flow as this the main sources for repaying project debt. The shareholders will invest in the SPV with a focus to minimize their equity contributions, since equity commands a higher rate of return, and thus is a more risky affair compared with a conventional commercial bank debt. Whereas, the bank lenders will always seek a comfortable level of equity from shareholders of SPV to ensure that the project sponsors are seriously committed to the project and have a vested interest in seeing the project succeed.
THIS COULD BE ACTED UPON, WITH A SPECIFIC CASE STUDY THAT UNDERLINES THE KNOWLEDGE-BASE REQUISITE FOR ANY UNDERSTANDING OF FINANCIALS INVOLVED IN THE PROJECT. KNOWLEDGE BASE COULD ENCOMPASS: issues for the host government/legislative provisions, public/private infrastructure partnerships, public/private financial structures, credit requirement of lenders, and analytical techniques to measure the feasibility of the project. In case of Project Finance, the financier principally looks to the assets and revenue of the project in order to secure and service the loan. In contrast to an ordinary borrowing situation, in a project financing the financier usually has little or no recourse to the non-project assets of the borrower or the sponsors of the project. In this situation, the credit risk associated with the borrower is not as important as in an ordinary loan transaction; what is most important is the identification, analysis, allocation and management of every risk associated with the project.

Thereafter a look at the disadvantages of Project Finance tells;
1. Project Finance mandates greater disclosure of information on deals and contracts, which happen to be proprietary in nature.
2. Extensive contracting restricts management decision-making, by looping it into complexities, where decisions making nodes are difficult to make.
3. Project debt is more expensive.
Originally posted here


Popular posts from this blog

Why Should Modinomics Be Bestowed With An Ignoble Prize In Economics? Demonetization’s Spectacular Failure.

This lesson from history is quite well known: Muhammad bin Tughlaq thought that may be if he could find an alternative currency, he could save some money. So he replaced the Gold and Silver coins with copper currency. Local goldsmiths started manufacturing these coins and which led to a loss of a huge sum of money to the court. He had to take his orders back and reissue Gold/Silver coins against those copper coins. This counter decision was far more devastating as people exchanged all their fake currency and emptied royal treasure. And nothing seems to have changed ideatically even after close to 800 years since, when another bold and bald move or rather a balderdash move by the Prime Minister of India Narendra Modi launched his version of the lunacy. Throw in Demonetization and flush out black money. Well, that was the reason promulgated along with a host of other nationalistic-sounding derivatives like curbing terror funding, expanding the tax net, open to embracing digital economy an…

GST – Impact on Small Industry and the Informal Sector

The Goods and Services Tax (GST), that came into effect on 1st July, 2017, has been lauded as the most comprehensive contemporary reform of Indian indirect taxation. Aimed at creating a common, unified and integrated domestic market, allowing the free flow of goods and services across state lines, GST is supposed to deliver Indian industry and thereby the economy the competitive edge apparently lacking till now.
Reality is however a far cry from the picture painted by government. GST by creating platform a conducive to economies of scale and nullifying regional tariffs, is both conceptually and practically advantageous to big business and detrimental to the informal sector and small businesses.
These groupings, informal and small, though quite different have some degree of overlap. Informal business is overwhelmingly small but not all small businesses are informal. GST’s impact on these groups is quite different both with regard to extent of impact or in terms of results sought.
Small Bu…

India diverts Rs 56,700 crore from the fight against climate change to Goods and Service Tax regime

This news has been causing quite a few ripples, with the most daring allegation being that of siphoning of funds, thus standing in contrast to India's commitment to Paris Accords. Well, the reality goes a bit deeper than merely reductionist. In what way, this happens is eloquently dissected by Anirudh Rajan

In an effort to redistribute indirect tax revenues to industrially backward states, a conceptual change in the mode of taxation proposed by the Goods and Services Tax reform was to shift accretion of taxes to the place of consumption from the place where goods are produced or services rendered. Manufacturing states, primarily those unencumbered with ties to the central government, fearing reduced tax revenues inevitably opposed such plans. To achieve consensus, a compensation was agreed upon which would make good any fall in revenues arising from GST levy, for a period of 5 years. To fund such, an increased tax rate for certain commodities (luxury and demerit goods) was initia…