Report and Recommendation of the President to the Board of Directors

Transcription

1 Report and Recommendation of the President to the Board of Directors Sri Lanka Project Number: September 2013 Proposed Multitranche Financing Facility India: Accelerating Infrastructure Investment Facility in India

2 CURRENCY EQUIVALENTS (as of 1 August 2013) Currency unit Indian rupee/s (Re/Rs) Re1.00 = $ $1.00 = Rs60.66 ABBREVIATIONS ADB Asian Development Bank DFI development finance institution EIRR economic internal rate of return ESMU environment and social safeguards management unit ESSF environmental and social safeguards framework FFA framework financing agreement FIRR financial internal rate of return GDP gross domestic product IIFCL India Infrastructure Finance Company Limited IIPFF India Infrastructure Project Financing Facility MFF multitranche financing facility NBFC nonbank finance company PFR periodic financing request PPP public private partnership RBI Reserve Bank of India SIFTI scheme for financing viable infrastructure projects through a special purpose vehicle called the IIFCL (i) (ii) NOTES The fiscal year (FY) of the India Infrastructure Financing Company Limited (IIFCL) and the Government of India ends on 31 March of the following year. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2014 ends on 31 March In this report, "$" refers to US dollars. Vice-President X. Zhao, Operations 1 Director General J. Miranda, South Asia Department (SARD) Director B. Carrasco, Public Management, Financial Sector and Trade Division, SARD Team leaders C. Kim, Lead Finance Specialist, SARD V. Rao, Principal Financial Sector Specialist, SARD Team members D. Lambert, Senior Finance Specialist, SARD G. Mahajan, Senior Environment Officer, India Resident Mission (INRM), SARD R. Sabur, Senior Safeguards Specialist, SARD S. Singh, Senior Project Officer (Finance), INRM, SARD V.S. Rekha, Principal Counsel, Office of the General Counsel Peer reviewers R. Poddar, Principal Treasury Specialist (Institutional Coordination), Treasury Department S. Sampath, Principal Urban Development Specialist, Regional and Sustainable Development Department In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

3 PROJECT AT A GLANCE CONTENTS Page I. THE PROPOSAL 1 II. THE INVESTMENT PROGRAM 1 A. Rationale 1 B. Impact and Outcome 5 C. Outputs 5 D. Investment and Financing Plans 5 E. Implementation Arrangements 7 III. DUE DILIGENCE 8 A. Economic and Financial 8 B. Governance 8 C. Poverty and Social 9 D. Safeguards 9 E. Risks and Mitigating Measures 9 IV. ASSURANCES AND CONDITIONS 10 V. RECOMMENDATION 10 APPENDIXES 1. Design and Monitoring Framework for the Investment Program List of Linked Documents 13

4 PROJECT AT A GLANCE 1. Project Name: Accelerating Infrastructure Investment Facility in India 2. Project Number: Country: India 4. South Asia Department/Public Management, Financial Sector, Department/Division: & Trade Division 5. Sector Classification: Sectors Primary Subsectors Multisector Road transport Air transport 6. Thematic Classification: 6a. Climate Change Impact No Climate Change Indicator available. 7. Targeting Classification: General Intervention Geographic dimensions of inclusive growth 9. Project Risk Categorization: Complex Targeted Intervention Millennium development goals Electricity transmission and distribution Rail transport Renewable energy Water supply and sanitation Themes Primary Subthemes Private sector development Public sector goods and services essential for private sector development Promotion of private sector investment Income poverty at household level 6b. Gender Mainstreaming Gender equity theme (GEN) Effective gender mainstreaming (EGM) Some gender elements (SGE) No gender elements (NGE) 8. Location Impact: National High 10. Safeguards Categorization: Environment Involuntary resettlement Indigenous peoples 11. ADB Financing: 12. Cofinancing: Sovereign/Nonsovereign Modality 1 Source Amount ($ Million) Sovereign MFF-Facility (Loan) Ordinary capital resources Total No Cofinancing available. FI FI FI 13. Counterpart Financing: Amount Source ($ Million) Local Market Borrowing 6,536.0 Foreign Borrowing 1,000.0 Equity and Reserve 1,202.0 Total 8, Aid Effectiveness: Parallel project implementation unit No Program-based approach No 1 The proposed multitranche financing facility is also a financial intermediation loan.

5 I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on a proposed multitranche financing facility (MFF) to India Infrastructure Finance Company Limited (IIFCL), to be guaranteed by India, for the Accelerating Infrastructure Investment Facility in India. The design and monitoring framework is in Appendix The MFF involves a sovereign loan of $700 million to IIFCL to support renewed government efforts to accelerate infrastructure growth through increased private sector investment given competing pressures for fiscal resources. II. THE INVESTMENT PROGRAM A. Rationale 3. Importance of infrastructure financing for development. India s infrastructure deficit is arguably the critical development challenge facing the country. The weak state of infrastructure represents a drag on higher, sustainable gross domestic product (GDP) growth reflecting supply-side constraints. It impedes economic development and poverty reduction efforts. 1 To meet the growing aspirations of its citizens including for better service delivery, India will have to identify new means to expand infrastructure financing given limits on fiscal space, external commercial borrowing, and bank balance sheets. The solution to overcoming these limits lies in part on increasingly leveraging private capital. To achieve the targeted real GDP growth rate of 8.4% in the Twelfth Five-Year Plan ( ), the government estimates infrastructure investment of about $1 trillion will be required. Of this, about 47% is targeted to come from private capital as compared with about 38% under the Eleventh Plan and 22% under the Tenth Plan Infrastructure financing gap. The infrastructure investment funding gap during the Twelfth Five-Year Plan is estimated to be about $113 billion. The government projects sourcing the shortfall from the private sector Infrastructure challenges across sectors. According to the 2012 report of the Reserve Bank of India (RBI), the total fixed investment by large firms in new projects, led mainly by infrastructure and metals, which were sanctioned financial support during FY2011, dropped by 46% compared with the previous year. Investments in infrastructure during FY2012 declined by 52%. 4 The unfavorable investment climate includes increasing losses of public sector utilities, delays in legal and environmental clearances for roads, and constraints in availability of finance to project companies that are already leveraged and unable to raise more debt in the absence of fresh equity capital including quasi equity. All these factors contribute to the recent slowdown in infrastructure investment. 5 1 According to the World Economic Forum s Global Competitiveness Report, India ranked 82nd of 142 countries during According to the interim report of the high-level committee on financing of infrastructure of August 2012, GDP is assumed to grow at 7% in FY2012, 8% in FY2013, and 9% for the remainder of the Twelfth Five-Year Plan. 3 A detailed estimate on the infrastructure financing gap is provided in the Framework Financing Agreement (accessible from the list of linked documents in Appendix 2). 4 Reserve Bank of India Reserve Bank of India Annual Report Mumbai. 5 Sector Assessment (Summary): Infrastructure Financing (accessible from the list of linked documents in Appendix 2).

6 2 6. Financing challenges. To date, the banking sector has been the main driver of infrastructure financing in India. However, it is facing increasing challenges in addressing the infrastructure financing gap. First, high credit expansion for infrastructure in recent years has resulted in an increasing asset liability mismatch for banks. Second, banks are approaching exposure limits to borrowers and infrastructure sectors. Third, the asset quality of banks deteriorated considerably during the half year ending September 2012 with the gross (net) nonperforming advances ratio for all banks rising sharply to 3.6% (1.7%) from 2.9% (1.2%) as of end March Should the slowdown in GDP growth persist and interest rates remain at current levels, estimates suggest the risk of further increases in nonperforming loans. 7. Equity availability. Based on a 70:30 debt equity mix, $500 billion funding in private capital implies mobilizing $150 billion of equity over the Twelfth Five-Year Plan. While the sector has a market capitalization of $55 billion (50% promoter share), generating $95 billion of additional equity will be a challenge. A periodic dilution of promoters share may not be possible due to contract restrictions; excessive dilution will suppress the market. As most infrastructure companies do not generate significant free cash flow, new equity will have to come from new fund raising. However, markets can be unfavorable due to limitations on exit options hindering the raising of equity. 8. Other nonbank financing. Historically, development finance institutions (DFIs) 6 provided infrastructure finance, raising low-cost, long-term funds from multilateral and bilateral agencies and government-guaranteed bonds. As DFIs were exposed to high-risk sectors like infrastructure, they were dependent on government equity. Thus, the government decided which DFIs to support and which to convert into a bank or nonbank finance company (NBFC). 7 Consequently, several former DFIs such as Industrial Credit and Investment Corporation of India and Industrial Development Bank of India became universal banks. In 2003, RBI set up a working group to address the regulatory and supervisory issues of DFIs, within the broader NBFC framework. 8 The working group suggested that the exclusive role of DFIs as providers of development finance is unnecessary and that banks may extend project finance and develop required skills. More recently, RBI indicated that NBFCs and banks will be subject to similar asset classification, income recognition and provisioning norms, and prudential measures for systemic risk. 9 Thus, the flexibility of NBFC operations may be reduced in the future In this context, IIFCL is the only DFI that receives both periodic government equity infusion and guarantees for its borrowings. 11 Thus, to justify government support and to respond to evolving market needs, IIFCL operations are increasingly geared to leveraging market 6 Other NBFCs, such as Rural Electrification Corporation and Power Finance Corporation, have a limited subsector focus and do not have a specific public private partnership mandate. 7 Reserve Bank of India Narasimham Committee on Banking Sector Reforms. Mumbai. 8 In 2003, RBI set up a working group to examine, within the broader framework of NBFCs, regulatory and supervisory aspects including access to short-term resources for the DFIs as a separate category. 9 The time for classifying a loan as a nonperforming asset for an NBFC will be reduced from the existing 180 days to 120 days from 1 April 2014 to 31 March 2015, and ultimately to 90 days (bank standard). 10 Reserve Bank of India Working Group on the Issues and Concerns in the NBFC Sector Report and Recommendations. Mumbai. 11 IIFCL was established on 5 January 2006 as a wholly owned government company with the mandate to (i) play a catalytic role by leveraging resources and specialized skills, and (ii) be a nodal public-private partnership (PPP) financing agency as an integral element of the overall PPP development strategy. IIFCL provides commercial longterm debt financing for stand-alone nonrecourse infrastructure projects, such as project-specific special purpose vehicles established for PPP.

7 3 resources and complementing bank financing by expanding its products to include take-out financing, 12 subordinate debt, and credit enhancements. 10. Policy framework: developing an enabling environment. Against the backdrop of these challenges, the government identified the need for further reforms to enhance private sector participation in infrastructure. These include strengthening public private partnership (PPP) support; 13 promoting project finance schemes in infrastructure development; 14 and developing new sources of take-out project bond financing, including infrastructure debt funds. 15 With these reforms in place, the government plans to accelerate infrastructure investment to above 9% of GDP during the Twelfth Plan compared with 7% during the Eleventh Plan. The government has also targeted IIFCL, an apex organization established for promoting PPP projects, to play a larger role in infrastructure financing. As such, the government amended IIFCL s scheme for financing viable infrastructure (SIFTI) to accommodate the need of the market for subordinate debt and added a new scheme, Take-out Finance Scheme for Financing Viable Infrastructure Projects The proposed facility has two pillars: (i) positioning IIFCL to play a larger role in infrastructure financing with newly introduced financial products and modalities; and (ii) building on the strong relationship and successful performance of previous Asian Development Bank (ADB) facilities with IIFCL support for PPPs. 17 The facility will involve a sovereign loan to IIFCL 18 to support three main areas: (i) direct lending, including to renewable and clean energy; (ii) takeout financing; and (iii) subordinate debt, all in line with the scheme. IIFCL provides up to 20% of its business in direct lending, resulting in efficient capital allocation for lending consortium members. 12. The new initiative to include the take-out financing option in the facility would help address the exposure and asset liability mismatch constraints of banks and provide space for 12 Take-out financing is a method of providing long-term financing for projects by banks. Under this method, the loan will be taken out of books of the financing bank within the pre-fixed period, by another institution, thereby preventing any possible asset-liability mismatch. 13 ADB provided a total of eight technical assistance projects of $11.8 million during for mainstreaming PPPs at both the state and central governments of India as well as for capacity building for IIFCL. 14 As pilot demonstration project finance, ADB financed the Bangalore Metro Project under its nonsovereign window in ADB Report and Recommendation of the President to the Board of Directors: Proposed Loan for the Bangalore Metro Rail Transit System Project in India. Manila (Loan 7329-IND, approved on 31 March for $250 million). 15 ADB introduced for the first time pilot infrastructure bond financing initiatives through partial credit guarantee. ADB Report and Recommendation of the President to the Board of Directors: Proposed Guarantee Facility for Credit Enhancement of Project Bonds. Manila (approved on 20 September for $128 million). 16 Scheme for financing viable infrastructure projects through a special purpose vehicle called the India Infrastructure Finance Company Limited (SIFTI). Under the SIFTI, IIFCL lends to project special purpose vehicles of PPP projects up to a maximum of 20% of the total project cost as part of a lending consortium. Further, under the SIFTI, the project special purpose vehicle has its loan appraised by a lead bank or by a reputed institution. Mandate of India Infrastructure Finance Company Limited: SIFTI and Take-Out Finance Scheme (accessible from the list of linked documents in Appendix 2). 17 ADB Report and Recommendation of the President to the Board of Directors: Proposed Multitranche Financing Facility to India for the India Infrastructure Project Financing Facility. Manila (MFF 0017-IND, approved on 20 December, $500 million); ADB Report and Recommendation of the President to the Board of Directors: Proposed Multitranche Financing Facility to India for the Second India Infrastructure Project Financing Facility. Manila (MFF 0037-IND, approved on 17 November, $700 million). 18 IIFCL has $1 billion of authorized capital and $500 million paid-up capital. Apart from equity, IIFCL raises long-term debt from the domestic market and debt from bilateral and multilateral institutions. IIFCL s borrowings are backed by a sovereign guarantee.

8 4 new bank lending. 19 In addition, IIFCL offers take-out at financial close to take-out a portion of bank debt after project completion. The terms are based on subproject ratings and can result in long-term borrowing cost reduction. Thus, a key value addition of the facility is to provide longterm resources to IIFCL to sustain the long-term take-out finance option. The support for IIFCL's subordinate debt product through the proposed facility will enable overleveraged subproject developers in raising additional debt without having to raise additional equity and assist subprojects in achieving financial closure. In addition, the facility will include new areas such as green and renewable energy to support government efforts to meet the Millennium Development Goals and support PPP initiatives in lagging states for inclusive growth. 13. Multitranche financing facility. The MFF modality is well suited for PPPs as PPP subprojects are typically developed in a phased manner based on project implementation requirements. 20 The MFF modality provides IIFCL with flexibility to release financing in line with subproject readiness based on achievement of phased benchmarks including finalization of risksharing arrangements, readiness of engineering and procurement contracts, and phased release of equity by subproject promoters. In addition, disbursement of a subproject can take place through multiple tranches with the introduction of time-slicing in the MFF. This provides the much-needed flexibility for IIFCL to properly and cost-effectively plan the disbursements of subprojects allocated for financing under the facility. 14. ADB assistance to IIFCL and performance. 21 To support government initiatives to mainstream PPP in infrastructure development, ADB provided two MFFs totaling $1.2 billion to IIFCL under the India Infrastructure Project Financing Facility (IIPFF) (footnote 17). The IIPFF I (comprising two tranches) was fully disbursed for 30 PPP infrastructure subprojects, including major international airports such as the Delhi and Mumbai international airports. It achieved financial closure on 26 August 2011, ahead of the target closure date. The IIPFF II for $700 million comprises three tranches. To date, the first and second tranches, totaling $460 million, were fully disbursed well ahead of the target closing date (December 2014) for 14 subprojects. The third and final tranche, approved by ADB Management in December 2011, is also performing well with disbursement to date of $ million for 10 subprojects. ADB expects to disburse the entire third tranche of $240 million by November 2013, 1 year ahead of the target closing date. The average fund mobilization ratio of these two facilities is about 12 times, which means that every dollar drawn down from the facilities has mobilized $12 of additional funding. 15. Strategic context. The ADB country partnership strategy, for India emphasizes infrastructure development and is based on four pillars: (i) supporting inclusive and environmentally sustainable growth, (ii) catalyzing investment, (iii) increasing results orientation and knowledge solutions, and (iv) supporting regional cooperation. 22 The facility supports all pillars given the link between growth and infrastructure development and the need to mobilize financing. 23 The strategy also supports the role of financial intermediaries for providing long- 19 Infrastructure projects are initially funded by banks or a consortium of banks. Such projects require long-term funding of years, while traditional bank funding cannot be extended beyond years. 20 ADB Innovation and Efficiency Initiative: Pilot Financing Instruments and Modalities. Manila. 21 The evaluation of benefits and impacts of the two IIPFFs shows that they have generated significant benefits. They supported upgrading and expansion of more than 1,800 kilometers of the road network across India and added 3,200 megawatts of power generation capacity. Given that on average 20,000 person-days of employment are generated per kilometer of road construction, the IIPFFs have resulted in about 36 million person-days of employment. This employment opportunity has significantly benefited rural workers in the unorganized sector. 22 ADB Country Partnership Strategy: India, Manila. 23 Accordingly, the proposed facility will support PPP infrastructure projects under the SIFTI.

9 5 term infrastructure financing and supports the PPP modality, which is consistent with the draft country partnership strategy for Lessons. The facility incorporates lessons from earlier financial intermediation loans for infrastructure and, in particular, from implementing the IIPFFs. 24 First, building a strong partnership among stakeholders including subproject developers, executing agency, government, and ADB is essential to meaningfully pursue PPP development in India. Therefore, a holistic approach has been taken to support the government s infrastructure development priorities and assist executing agencies with capacity building, policy advice, and provision of financing to promote PPP. Second, the facility supports IIFCL s ability to leverage resources and expand the infrastructure investor base, and sustain a tested business model that has resulted in a robust pipeline of projects. Third, while IIFCL follows the lead bank in the lending consortium with respect to credit terms, its risk profile and appetite is different from the lead banks. Thus going forward, IIFCL could use its resources to price its loans differently from the lead bank. In addition, as the facility will also support take-out financing and subordinate debt, an additional innovation of offering take-out financing for a part of the loan after commercial operation commences, at the time of financial closure itself, may also be explored through the facility. 25 B. Impact and Outcome 17. The impact of the facility will be the increased availability of infrastructure. The outcome will be facilitated private sector investment in infrastructure PPPs. This will be achieved by supporting the evolution of the market for new financial products and modalities. C. Outputs 18. The outputs will be enhanced availability of long-term finance for PPP subprojects and improved project management. The indicative pipeline of subprojects will be subject to due diligence to ensure conformity with ADB requirements. 26 Subprojects will be financed for roads, railways, airports, energy (including renewable energy), and urban infrastructure. The pipeline comprises 31 subprojects for direct lending, including subordinate debt and take-out financing. Up to $300 million of bank capital is expected to be released for new greenfield projects by FY2018. For tranche 1, subprojects from the pipeline for the facility will be taken up for financing. Tranche 2 will include tranche 1 subprojects that are still in construction phase and new subprojects. Increased use of subordinate debt and take-out finance modalities may be envisaged based on market requirements. D. Investment and Financing Plans 19. By the end of March 2013, IIFCL had a pipeline of 300 sanctioned projects 27 with a total project cost of Rs4,631.8 billion ($89.1 billion), of which IIFCL financing is estimated at Rs537.6 billion ($10.3 billion). The IIFCL pipeline is expected to grow on average by The IIPFF I is rated highly successful. ADB Completion Report: India Infrastructure Project Financing Facility. Manila. 25 Lessons from the India Infrastructure Project Financing Facility (accessible from the list of linked documents in Appendix 2). 26 Indicative List of Subprojects Proposed by India Infrastructure Finance Company Limited (accessible from the list of linked documents in Appendix 2). 27 As of March 2013, IIFCL had a pipeline of 349 sanctioned projects. Of the 49 projects financed under the IIPFFs, the net pipeline is reduced to 300 projects.

10 6 projects per year during the investment period of FY2014 FY2019; 28 this will require an average $1.9 billion per year ($9.4 billion) in total. Table 1 summarizes the tentative financing plan during the investment period. Table 1: Tentative Financing Plan FY2014 FY2019 Amount ($ million) Share of Total (%) Source Asian Development Bank Local market borrowing a 6, Foreign borrowing b 1, Equity and reserve 1, Total 9, a Funds India Infrastructure Finance Company Limited will raise from the domestic market including insurance and pension funds and the national savings scheme. b Foreign borrowing includes bilateral and multilateral sources and funds that India Infrastructure Finance Company Limited will raise from international capital markets. Sources: Asian Development Bank estimates and India Infrastructure Finance Company Limited. 20. IIFCL has requested an MFF in an amount up to $700 million from ADB s ordinary capital resources to help finance a part of the IIFCL s investment program. Accordingly, the MFF is included in the India country operations business plan for FY2013. The proposed facility will capture approximately 7.4% of the IIFCL financing plan during the investment period. The MFF will comprise two tranches of $400 million and $300 million respectively, subject to IIFCL s submission of related periodic financing requests (PFRs), execution of the related loan and guarantee agreements for each tranche, and fulfillment of terms and conditions and undertakings set forth in the framework financing agreement. The first tranche of the MFF will have a 19.5-year term, including a grace period of 4 years, an annual interest rate determined in accordance with ADB s London interbank offered rate (LIBOR)-based lending facility, a commitment charge of 0.15% per year, and such other terms and conditions set forth in the loan and guarantee agreements. 21. Coordination with development partners. ADB coordinated with development partners during processing and implementation of its first two MFFs to IIFCL, as well as processing of the proposed facility. Coordination efforts with development partners are aimed at avoiding duplication of resources and exploring possible cofinancing, as well as providing continued capacity building support to IIFCL for institutional strengthening, particularly in the areas of safeguards and financial management. Development partners such as Agence Française de Développement, German development cooperation through KfW, Japan International Cooperation Agency, and the World Bank either have ongoing lines of credit with IIFCL or are in discussions for possible lending. Some development partners have indicated their interest in the possibility of providing cofinancing with ADB in a subsequent tranche of the facility Framework financing agreement. IIFCL and the government have entered into a framework financing agreement (FFA) with ADB. The FFA satisfies requirements established in ADB s Innovation and Efficiency Initiative. The FFA records the full set of assurances, warranties, and representations on cross-cutting themes covering safeguards, governance, anticorruption, financial management, procurement, disbursement, and subproject selection. 28 IIFCL sanctioned 37 (Rs74,020 million) new projects in FY2011, 47 (Rs69,140 million) in FY2012, and 66 (Rs69,140 million) in FY Development Coordination (accessible from the list of linked documents in Appendix 2).

11 7 The government and IIFCL have ensured full compliance with the terms and conditions of the FFA before submission of the PFR to ADB. 23. Periodic financing request. Subloans will be extended under the facility to a range of subprojects subject to submission of the related PFR by IIFCL and execution of related loan and guarantee agreements. Each PFR will be accompanied by a list of identified subprojects. IIFCL has submitted the first PFR in line with the FFA. E. Implementation Arrangements 24. The implementation arrangements are summarized in Table 2 and described in detail in the facility administration manual. 30 Table 2: Implementation Arrangements Aspects Arrangements Implementation period January 2014 March 2019 January 2014 December 2016 (tranche 1) Estimated completion date 31 March 2019 December 2016 (tranche 1) Management (i) Oversight body (ii) Executing agency (iii) Key implementing agency (iv) Implementation unit Source: India Infrastructure Finance Company Limited. Harsh Kumar Bhanwala Executive director, presently holding charge of chairman and managing director India Infrastructure Finance Company Limited India Infrastructure Finance Company Limited Chief general manager 25. Project management. IIFCL will be the executing and implementing agency. The IIFCL board will provide policy direction and strategic oversight. The IIFCL project management unit, established at the inception of the IIPFF I, will monitor day-to-day implementation of the facility. The environment and social safeguards management unit (ESMU), established in February 2010 at the inception of the IIPFF II, will be responsible for compliance with state and national policies and the environmental and social safeguards framework (ESSF) of IIFCL Maximum subloan size and free limit. As IIFCL can only finance up to 20% of subproject cost for direct lending and up to 30% for take-out financing, ADB will not stipulate any additional limitation on subloan size. Under each tranche, ADB may, subject to its policies and procedures, permit on request a free limit for the borrower for up to $30 million of the qualified subproject financed under the SIFTI. A suitable free limit for the subproject financed under the take-out finance scheme may be considered for the second tranche, based on ADB assessment of IIFCL s operating performance, appraisal standards, portfolio quality, and average loan size on take-out finance during facility implementation. 27. Retroactive financing. Under each tranche, ADB may, subject to its policies and procedures, permit on request retroactive financing of eligible expenditures for the facility up to 20% of the individual loan, incurred prior to loan effectiveness but not earlier than 12 months before the date of signing of the related legal agreement. IIFCL acknowledges that any approval 30 Facility Administration Manual (accessible from the list of linked documents in Appendix 2). 31 The ESSF was developed with ADB assistance in 2007, updated in 2010 to reflect the adoption of ADB s Safeguard Policy Statement (2009), and further revised in July 2013.

12 8 of advance contracting and/or retroactive financing will not constitute a commitment by ADB to finance the related project. 28. Subproject and subborrower selection criteria and approval procedures. The scheme provides the details of the definitions, eligibility criteria, appraisal, and monitoring and lending terms for subprojects. Thus, the eligibility requirements for subproject and subborrower selection criteria of the facility will adhere to the scheme, which includes appraisal of the subproject by the designated specialized appraisal agency for technical, economic, and commercial viability and review, and acceptance of the results of the appraisal by the lead bank. 32 In addition, subborrowers will be required to meet ADB requirements and follow the subproject approval procedure details stipulated in the loan agreement, FFA, and the facility administration manual. The assessment of compliance with undertakings under the FFA and loan agreements of the IIPFF II confirms that IIFCL is in full compliance Procurement and disbursement. All goods and services to be financed under the facility will be procured in accordance with ADB s Procurement Guidelines (2013, as amended from time to time). The individual loan proceeds will be disbursed in accordance with ADB s Loan Disbursement Handbook (2012, as amended from time to time) under chapter 11 for development finance institutions. III. DUE DILIGENCE A. Economic and Financial 30. The facility is expected to catalyze an investment estimated at more than $5 billion from the private sector to finance 30 subprojects. While the projects sanctioned by IIFCL are spread across all infrastructure subsectors, most subprojects identified for the facility are mainly for roads and energy. The economic efficiency of road projects is typically high with an economic internal rate of return (EIRR) of 25% 30% and financial internal rate of return (FIRR) of 10% 15%. The estimates are also robust from a sensitivity perspective with the EIRRs and FIRRs not declining significantly even in worst-case scenarios. Further, the EIRRs and FIRRs are significantly above the opportunity cost of capital. The facility is also expected to finance roads, power, and airport projects where EIRR estimates meet benchmark requirements. 34 B. Governance 31. Financial management. IIFCL has the financial management capacity to administer the facility. IIFCL board members actively oversee operations and have suitable industry and policy backgrounds. IIFCL staffing has significantly increased since the inception of the IIPFF I and it has meanwhile deepened its technical capacities. Accounting policies are well established and follow national statutes. IIFCL is currently upgrading its management information systems. The new system, which IIFCL has agreed to implement within 6 months of the facility s signing, will represent a significant enhancement and improve internal reporting. Given the government s 32 IIFCL's scheme requires IIFCL to only finance commercially viable projects and provide financing on commercial terms and price loans accordingly. Thus, all aspects of project economics and creditworthiness with regard to subprojects are subject to extensive due diligence prior to loan approval by IIFCL. 33 Compliance Review Matrix of Legal, Environmental, and Social Safeguards of the Second India Infrastructure Project Financing Facility (accessible from the list of linked documents in Appendix 2). 34 The EIRRs of ADB-funded energy projects in India were higher than 12% (ranging from 13% to 31.5%), implying economic efficiency in resource allocation and use. Independent Evaluation Department Sector Assistance Program Evaluation: Energy Sector in India. Manila: ADB. Research conducted by a local research firm in India in 2012 shows the EIRR of four road projects at 16% 21%.

13 9 historical and expected support, IIFCL should have sufficient equity to absorb the $700 million facility without breaching its regulatory capital requirements Anticorruption policy. Consistent with its commitment to good governance, accountability, and transparency, ADB reserves the right to examine and review directly any alleged corrupt, fraudulent, collusive, or coercive practices relating to the subprojects under the MFF. To support these efforts, relevant provisions of ADB s Anticorruption Policy (1998, as amended from time to time) was explained to and discussed with IIFCL and the government. The specific policy requirements and supplementary measures are described in the facility administration manual (footnote 30). C. Poverty and Social 33. Infrastructure development strongly impacts poverty incidence by supporting inclusive growth. A recent ADB empirical study indicates that the higher the overall productivity growth, the faster is the pace of poverty reduction. 36 The anticipated key impact of the MFF will be through greater affordability of high-quality infrastructure facilities that stimulates productivity increases, which in turn increase employment and income opportunities leading to poverty reduction. The poor are acutely affected by inadequate infrastructure that impedes diversification and improvement of their livelihoods. Shocks to the national economy, such as the rationing of the supply of electricity will particularly impact many people who depend on small enterprises in the informal sector for their livelihood. D. Safeguards 34. In 2007, ADB assisted IIFCL in formulating its safeguard policy and framework in consultation with development partners. The environmental and social safeguards framework (ESSF) was updated during the processing of the IIPFF II in IIFCL again revised and updated the ESSF in July 2013 to reflect recent legislative and regulatory changes pertaining to environmental and social safeguards and changes in safeguard policies of development partners. IIFCL has uploaded the ESSF on its website. It will continue to ensure that all subproject proposals, to be financed under the facility, comply with ESSF safeguard requirements. Safeguard compliance performance during the IIPFF I and II was found to be satisfactory. 38 IIFCL is in the process of further strengthening its ESMU with an adequate number of qualified specialists in environmental and social safeguards to be headed by a senior safeguard professional. The ESMU will be supported by an external consulting organization and/or specialists to conduct field visits, safeguard assessments, monitoring, and review. E. Risks and Mitigating Measures 35. Potential key risks are mostly related to the impact of continued financial market volatility recently observed in India and in particular (i) significant increase in borrowing costs making 35 IIFCL s current capital adequacy ratio is 18.2%. Net nonperforming assets were nil in FY2009 FY2012 and 0.7% in FY2012 FY2013. Further details on IIFCL s financial management are provided in the Financial Management Assessment (accessible from the list of linked documents in Appendix 2). 36 R. Hasan et.al Working paper on Growth, Structural Change, and Poverty Reduction: Evidence from India. Manila: ADB. The paper finds that a 1 percentage point increase in the annual rate of productivity growth leads to a 0.64 percentage point increase in the annual rate of poverty reduction. 37 Financial Intermediary: Environmental and Social Management System Arrangement (accessible from the list of linked documents in Appendix 2). 38 Compliance Review Matrix of Legal, Environmental, and Social Safeguards of the Second India Infrastructure Project Financing Facility (accessible from the list of linked documents in Appendix 2).

14 10 financial closure difficult, and (ii) deterioration in IIFCL s portfolio from a weakening currency and other related factors. These risks are unlikely to have a significant impact on IIFCL operations and can be effectively mitigated. The integrated benefits and impacts of the facility are expected to outweigh the costs. Major risks and mitigating measures are described in detail in the risk assessment and risk management plan. 39 A short analysis of the impact of financial market volatility is provided as a supplementary document Climate change. A screening report for subprojects under the facility has been prepared for climate change risks on subprojects. Screening criteria to score subprojects used a score of 1 indicating low risk and 2 indicating higher risk for risks stemming from sea level rise, landslides due to precipitation, and others. Thus, the facility will prioritize supporting subprojects by declining level of risk. 41 IV. ASSURANCES AND CONDITIONS 37. IIFCL and the government have assured ADB that implementation of the facility shall conform to all applicable ADB policies including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement as described in detail in the facility administration manual and loan documents. 38. IIFCL and the government have given ADB certain undertakings for the MFF, which are set forth in the FFA. Specific covenants agreed by IIFCL and the government with respect to individual tranches under the MFF are set forth in the loan agreement and guarantee agreement for the respective tranches. 39. Conditions for loan effectiveness. As a condition precedent to the loan effectiveness of the first tranche, IIFCL will fully staff its ESMU. As conditions precedent to the loan effectiveness of the second tranche, IIFCL will have (i) instituted quarterly reporting to its board s risk management committee, (ii) installed an integrated risk management information system, and (iii) regularized the position of the ESMU head. V. RECOMMENDATION 40. I am satisfied that the proposed multitranche financing facility would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the provision of loans under the multitranche financing facility in an aggregate principal amount not exceeding $700,000,000 to India Infrastructure Finance Company Limited, to be guaranteed by India, for the Accelerating Infrastructure Investment Facility in India, from ADB's ordinary capital resources, with interest to be determined in accordance with ADB's London interbank offered rate (LIBOR)-based lending facility, and such other terms and conditions as are substantially in accordance with those set forth in the framework financing agreement presented to the Board. 5 September 2013 Takehiko Nakao President 39 Risk Assessment and Risk Management Plan (accessible from the list of linked documents in Appendix 2). 40 Recent Rupee Depreciation and Financial Risks Associated with India Infrastructure Finance Company Limited (accessible from the list of linked documents in Appendix 2). 41 Climate Change Preliminary Risk Assessment Matrix (accessible from the list of linked documents in Appendix 2).

15 Appendix 1 11 DESIGN AND MONITORING FRAMEWORK FOR THE INVESTMENT PROGRAM Design Summary Impact Increased availability of infrastructure Performance Targets and Indicators with Baselines Infrastructure investment to increase to reach 10% of GDP by FY2023 (baseline: average investment over Eleventh Five- Year Plan at 7.22% of GDP) Private investment accounts for 47% of total infrastructure investment by FY2023 (baseline: private sector investment at 38% of total infrastructure investment in Eleventh Five-Year Plan) Data Sources and Reporting Mechanisms For all indicators for impact: Planning Commission infrastructure reports, annual economic survey of India RBI banking survey and annual reports Assumptions and Risks Assumption Delivery mechanisms and enabling environment for infrastructure investment strengthened Outcome Facilitated private sector investment in infrastructure PPPs Catalyzing over $3.5 billion of private sector investment for financially closing subprojects by FY2019 IIFCL annual reports Infrastructure sector reports from research institutions Assumptions Sector-specific reforms continue Equity investors remain engaged in infrastructure Risk Borrowing costs increase significantly making financial closure difficult Output 1. Enhanced availability of long-term finance for PPP subprojects By FY2019, 30 PPP subprojects financed under the facility: (i) 25 subprojects through direct financing (greenfield subprojects) (ii) 5 subprojects through take-out finance (iii) maximum of $280 million of bank capital released for fresh greenfield subprojects through takeout finance IIFCL semiannual and annual reports and IIFCL PMU progress reports Assumption Pipeline of subprojects comply with both the scheme and ADB requirements a Risks IIFCL s portfolio quality deteriorates Key staff in the ESMU leave IIFCL 2. Improved project management Timely disbursement of tranches A free-limit of $30 million for direct financing introduced by April 2014 At least six PMU staff per year trained for risk assessment and credit appraisal beginning 2014 Quarterly risk management reporting to risk management committee of IIFCL by July 2014 For all indicators for output 2 IIFCL annual reports providing details of product offerings

16 12 Appendix 1 Design Summary Activities with Milestones Performance Targets and Indicators with Baselines Transition to an integrated management information system by July 2014 ESMU of IIFCL fully staffed by December 2014 Capacity upgraded periodically through training beginning April 2014 Data Sources and Reporting Mechanisms Assumptions and Risks Inputs 1. Enhanced availability of long-term finance for PPP subprojects 1.1 Identify and finalize subproject pipeline to be financed by ADB funds (March 2013 October 2013) 1.2 Commence due diligence of five sample subprojects by ADB (May 2013) 1.3 Finalize financial management assessment on IIFCL by ADB (October 2013) 1.4 Update and revise the ESSF of IIFCL (October 2013) 1.5 Commence due diligence of subprojects by IIFCL (ongoing from April 2014 until 2019) 2. Improved project management (continues to 2019) 2.1 Identify list of subprojects and submit PFR for first tranche of $400 million by September Negotiate and sign PFR for first tranche by FY Fully utilize the first tranche by end of December Identify list of subprojects for second tranche of $300 million by FY Submit PFR for second tranche for release by December Fully utilize second tranche of $300 million by 31 March Identify PMU staff for training on risk management and credit appraisal in the first quarter of each year (ongoing until 2018) 2.8 Conduct quarterly risk management assessment and prepare report to the IIFCL s risk management committee by July Implement transition to an integrated management information system by July Complete IIFCL s implementation plan for internal risk management by July Regularize the post of ESMU head by April Commence recruitment of remaining position in the ESMU by April 2014 ADB (ordinary capital resources): $ million Local market borrowing: $6.53 billion Foreign borrowing: $1.00 billion Equity and reserve: $1.20 billion ADB = Asian Development Bank, ESMU = environment and social safeguards management unit, GDP = gross domestic product, IIFCL = India Infrastructure Finance Company Limited, PFR = periodic financing request, PMU = project management unit, PPP = public private partnership, RBI = Reserve Bank of India. a Scheme refers to both the scheme for financing viable infrastructure projects through a special purpose vehicle called the IIFCL and the take-out scheme. Source: Asian Development Bank.

17 Appendix 2 13 LIST OF LINKED DOCUMENTS 1. Framework Financing Agreement 2. Periodic Financing Request for Project 1 3. Sector Assessment (Summary): Infrastructure Financing 4. Facility Administration Manual 5. Contribution to the ADB Results Framework 6. Development Coordination 7. Financial Analysis: India Infrastructure Finance Company Limited 8. Economic Analysis 9. Country Economic Indicators 10. Summary Poverty Reduction and Social Strategy 11. Financial Intermediary: Environmental and Social Management System Arrangement 12. Risk Assessment and Risk Management Plan Supplementary Documents 13. Indicative List of Subprojects Proposed by India Infrastructure Finance Company Limited 14. Mandate of India Infrastructure Finance Company Limited: Scheme for Financing Viable Infrastructure Projects through a Special Purpose Vehicle called the IIFCL and Take-out Finance Scheme 15. Compliance Review Matrix of Legal, Environmental, and Social Safeguards of the Second India Infrastructure Project Financing Facility 16. Lessons from India Infrastructure Project Financing Facility 17. Financial Management Assessment 18. Climate Change Preliminary Risk Assessment Matrix 19. Recent Rupee Depreciation and Financial Risks Associated with India Infrastructure Finance Company Limited