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Economy
Mahesh

21/05/24 06:24 AM IST

RBI’s proposed framework to administer project financing

In News
  • To strengthen the existing regulatory framework for long gestation period financing for projects,the Reserve Bank of India (RBI) issued draft regulations for consultation recently.
About Project
  • Infrastructure projects usually have a long gestation period, with a higher probability of not being financially viable.
  • It may not always be possible to meet investment requirements of the projects fully from the budgetary resources of the government.
  • This opens up two financing avenues: public private partnerships and project financing from domestic financial institutions.
  • The latter is particularly crucial for certain projects with longer payback periods. Depending on scale and technology, these projects may also require a loan with a longer tenure.
  • Such projects may face multiple obstacles leading to delays or cost-overruns. For perspective, 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 stood at ₹5.01 lakh crores when compared with their original cost.
  • 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.
  • Cost overruns were primarily due to under-estimation of original cost, high cost of environmental safeguards and rehabilitation measures for those displaced and spiralling land acquisition costs.
  • These factors are dampeners for banks, which would have priced the risks associated with the project in a certain way on their books.
  • The added uncertainty due to these factors (legal and procedural) affects the risk appetite of investors as well as banks to extend funds for the development of infrastructure.”
Major Provisions
  • RBI’s focus is on mitigating a ‘credit event,’ that is, a default or a need to extend the original DCCO or infuse additional debt, and/or diminution in the net present value (NPV) of the project.
  • One of the more important revisions concerns ‘provisioning,’ that is, setting aside some money ahead of time to compensate for a potential loss.
  • The proposed framework recommends that, at the construction stage (that is, when the financial assessment is finalised and before commencement), a general provision of 5% is to be maintained on all existing and fresh exposures.
  • This is a revision from the erstwhile 0.4%. Concerns have emerged about the impact on the cost of debt.
  • According to CareEdge Ratings, this would “dampen the bidding appetite from infrastructure developers in the medium term.”
  • 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.
  • The framework stipulates that the provisioning can be reduced to 2.5% and 1% at the operational phase (that is, commencement of commercial operations).
  • For the latter, the project must have a positive net operating cash flow to cover all repayment obligations and total long-term debt must have declined by at least 20% from the outstanding when the DCCO is achieved.
  • Projects with stable cash flows, like road annuities, transmission and commercial real estate, typically see an improvement in credit profile within one year of establishing a payment track record from the counterparty.
Significance
  • The framework seeks that all mandatory pre-requisites must be in place before the financial year’s closure (thus, before the finalising of a financial statement).
  • 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.
  • RBI proposes to mandate that a positive Net Present Value (NPV) be a prerequisite to obtain project finance.
  • It also seeks that lenders get the project NPV independently re-evaluated every year.
  • This is to help them avert the possibility of any build-up of stress and have an action plan in place.\
Other Provisions
  • RBI’s proposed framework also recommends certain criteria for evaluating a change in repayment schedule due to an increase in the project outlay if there’s an increase in scope and size of the project.
  • This revision will have to take place before commencement of commercial operations, after lenders offer a satisfactory re-assessment about 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.
  • Significantly, the framework also introduces guidelines to trigger a standby credit facility.
  • This is to be sanctioned at the time of financial closure to fund overruns arising due to delays.
  • The framework stipulates an incremental funding of 10% of the original project cost.
Source- The Hindu

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