| The project finance may come from a variety of sources. The main sources include equity, debt and government grants. Financing from these alternative sources have important implications on project’s overall cost, cash flow, ultimate liability and claims to project incomes and assets. | Sources of finance |
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| Equity refers to capital invested by sponsor(s) of the PPP project and others. The main providers of equity are project sponsors, government, third party private investors, and internally generated cash. The commitment of equity for project finance comes with a designated rate of return target, which is higher than the rate of borrowed capital as debt. This is to compensate the higher risks taken by equity investors as they have junior claim to income and assets of the project. | Equity |
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| Debt refers to borrowed capital from banks and other financial institutions. It has fixed maturity and a fixed rate of interest is paid on the principal. Lenders of debt capital have senior claim on income and assets of the project. Generally, debt finance makes up the major share of investment needs (usually about 70 to 90 per cent) in PPP projects. The common forms of debt are: | Debt |
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| • Commercial loan • Bridge finance • Bonds and other debt instruments (for borrowing from the capital market) • Subordinate loans | Form of debt |
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| Commercial loans are funds lent by commercial banks and other financial institutions. Bridge financing is a short-term financing arrangement (say for the construction period or for an initial period) which is generally used until a long-term (re)financing arrangement can be implemented. Refinancing after a project is implemented may allow more favourable lending conditions which can reduce overall borrowing costs. Bonds are long-term interest bearing 29 debt instruments purchased either through the capital markets or through private placement (which means direct sale to the purchaser, generally an institutional investor - see below). Subordinate loans are similar to commercial loans but they are secondary or subordinate to commercial loans in their claim on income and assets of the project. To promote PPPs, governments often provide subordinate loans to reduce default risk and thereby reduce the debt burden and improve the financial viability of projects (see box 7). | Sources of debt |
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| Senior debt and subordinate debt | |
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| The other sources of project finance include grants from various sources, supplier’s credit, etc. Government grants can be made available to make PPP projects commercially viable, reduce the financial risks of private investors, and achieve some socially desirable objectives such as to induce growth in a backward area. Many Governments have established formal mechanisms for the award of grants to PPP projects.30 Where grants are available, depending on government policy they may cover 10 to 40 per cent of the total project investment. | Government grant |
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29 Not all types of bond however, pay interest. Zero coupon or discount bonds are bought at a price lower than their face values, with the face values paid back at the time of maturity. For such bonds, no additional interest is paid either on the face value or on purchase price.
30 The viability gap funding scheme of the Government of India is an example of an institutional mechanism for providing financial support to public-private partnerships in infrastructure. A grant, one-time or deferred, is provided under this scheme with the objective of making projects commercially viable. The viability gap funding can take various forms including capital grants, subordinated loans, operation and maintenance support grants, and interest subsidies. A mix of capital and revenue support may also be considered.
A special cell within the Ministry of Finance manages the special fund, which receives annual budget allocations from the Government. Implementing agencies can request funding support from the fund according to some established criteria. In case of projects being implemented at the state level, matching grants are expected from the state government.