Enabling Growth in Indian Infrastructure: A Global Perspective

Submitted By: Namit Chugh Roll No 28 Crisil Certified Analyst Program Batch - 5

Contents
List of figures: .......................................................................................................................................... 4 List of tables: ........................................................................................................................................... 4 1. Sector Overview .............................................................................................................................. 5 Growth of the Indian Infrastructure after independence .................................................................. 6 Nehru Era ........................................................................................................................................ 6 Indira Gandhi Era ............................................................................................................................ 6 Rajiv Gandhi Era .............................................................................................................................. 7 Era of Decentralized Politics ........................................................................................................... 7 Inference ............................................................................................................................................. 8 2. Policies pertaining to FDI in Infrastructure ......................................................................................... 8 3. FDI in Asia: Trends and Prospects ..................................................................................................... 10 Leveraging TNC (Transnational Corporations) participation in Infrastructure development........... 12 4. FDI and Infrastructure ....................................................................................................................... 12 Opportunities for Foreign Investors ................................................................................................. 14 Tax considerations for foreign players.............................................................................................. 16 Entry and exit strategy .................................................................................................................. 17 Holding the investment................................................................................................................. 17 Cash and profits ............................................................................................................................ 17 Engineering, Procurement and Construction (EPC) Contracts...................................................... 18 Depreciation.................................................................................................................................. 18 Indirect Taxes ................................................................................................................................ 19 Contrast between Infrastructure FDI in Asia and Latin America ...................................................... 19 5. Highways and Roads Role of Private Foreign players and multilateral agencies........................... 19 Existing scenario................................................................................................................................ 19 Targets for highways during the 11th Plan ........................................................................................ 20 National Highways ........................................................................................................................ 20 Rural Roads ................................................................................................................................... 20 Types of Public Private Partnership in National Highways Developments ....................................... 21 Mainstreaming of PPP in Roads and Highways sector:..................................................................... 22 Constraints faced by foreign players ................................................................................................ 22 Determinants of FDI in Infrastructure .............................................................................................. 23 CASE ANALYSIS: India and Japan ....................................................................................................... 24 6. Role of Multilateral agencies ........................................................................................................ 24 Page 2

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7. 8. 9.

Challenges for foreign players looking to enter the Indian Infrastructure ................................... 25 Conclusion ..................................................................................................................................... 27 Web References ............................................................................................................................ 28 Other References .............................................................................................................................. 28

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List of figures:
1. 2. 3. 4. 5. Built up of Minor Irrigation Projects in Indira Gandhi era Global FDI Inflows FDI Routes in Infrastructure Projected Investment in the Road & Highways Sector in the Eleventh Plan Elements of a typical EPC Contract

List of tables:
1. Comparative table on definition of Infrastructure sector and Decision of the Empowered Sub-Committee of Committee on Infrastructure (CoI) 2. Economic growth and Infrastructure spending post independence 3. Distribution of FDI Inflows among economies by range, 2010 4. FDI Ceiling under automatic route 5. Road Infrastructure, Detailed Projections (USD Million) 6. Type of taxes which may be applicable for Infrastructure companies operating in India 7. Overview of Tax Holiday terms for various Infrastructure segments 8. Indias Road Network 9. Projected Public and Private Investment in Roads and Bridges during the Eleventh Plan

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1. Sector Overview
Even though infrastructure is critical for any economys development, there is no clear definition of infrastructure according to the current usage of the term in India. The National Statistical Commission Head Dr. C Rangarajan indicated characteristics of infrastructure sectors based on which the following have been included in infrastructure: Railways, Highways, Telecom, Power, Ports and Airports. Reserve Bank of India in its infrastructure lending guidelines has added projects involving construction related to agro processing & storage and construction of social infrastructure (educational institutes and hospitals) as infrastructure facilities. Due to the strategic importance of infrastructure facilities and the overall benefit to the society and the nature of investments, the state has always been a key player in the development of infrastructure. However, private players have been encouraged since the 1990s to invest in the sector.

Sector

Rangarajan Commission

RBI

Electricity Water Supply Sewerage Telecommunications Roads and Bridges Ports Airports Railways Wind Energy Irrigation Storage Housing Urban services Oil production and pipelines Mining Gas Distribution Aircrafts Road Transport System Industrial Parks Educational Institutions Hospitals Posts Table 1: Comparative table on definition of Infrastructure sector and Decision of the Empowered SubCommittee of Committee on Infrastructure (CoI) Source: Planning Commission, Secretariat for Infrastructure

Ministry Of Finance Economic Survey

World Bank

Decision of the empowered Subcommittee of CoI

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Growth of the Indian Infrastructure after independence

India has seen several cycles of Infrastructure development since independence each defined by a political era, distinct policy focus and interrupted by a crisis. A brief overview of the same is as under: Period Economic conditions Growth of GDP Avg. spending on Infrastructure(as percent of GDP) 4.4

1950-67 (Nehru Era)

1967-84 4.2 4.1 (Indira Gandhi Era) 1984-91 De-regulation of the industrial 5.9 5.2 (Rajiv Gandhi sector, technological Era) advancements Post 1991-2004 Economic reforms and 6.0 4.5 (Decentralized globalization politics) Table 2: Economic growth and Infrastructure spending post independence Source: RBI handbook on Indian Economy; Lall and Rastogi, The political economy of Infrastructure development in post-independence India Nehru Era The first three plans were focused on (a) increasing food production, (b) developing basic and heavy industries; and (c) repairing the damage from Partition. The first required irrigation to be developed, the second needed electric power and facilitating infrastructure such as roads, and the third required certain strategic assets to be rehabilitated. This, then, defined the governments priorities in the infrastructure space. Hence, massive resources were allocated for the development of multi-purpose irrigation schemes. The construction of large river valley projects like Bhakra-Nangal, Hirakud, Chambal, Tungabhadra, Nagarjunasagar and the D.V.C., which provided both irrigation and power, was commissioned. During the First Plan, as much as 23 per cent of plan expenditures or about 0.8 percent of GDP was poured into large surface water irrigation schemes. Over the second and third plans, the share of expenditure on power rose sharply. There was also some investment into railways and maritime transport, the primary objective being to rehabilitate assets which had been ignored for a long time due to the Second World War and separation of Pakistan from India. For instance, Kandla port was developed to compensate for the loss of Karachi port. Indira Gandhi Era Infrastructure during this era was village-oriented and projects with long gestation were substituted with shorter gestation initiatives. The droughts of 196566 and 196667 highlighted the need for adequate irrigation facilities to ensure food security. The possibilities offered by the new seed varieties, both, for increasing yields of cereal crops and for intensifying cultivation, were contingent
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Increasing industrialization and focus on public sector development Anti private sector(MRTP Act passed), High unemployment

3.6

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on availability of water at the right time. The large multi-purpose irrigation schemes launched during Nehrus time were complex due to the long gestation projects. Some of them took 2025 years to be built with numerous time over-runs aggravated by poor implementation capacity. The only immediate solution was to have ground water based irrigation using tube wells.

Figure1: Built up of Minor Irrigation Projects in Indira Gandhi era Tube well based irrigation required pump sets to be powered and hence, the delivery of electric power to the farming sector was critical to this strategy. Efforts were made for rural electrification and REC-Rural Electrification Corporation was setup. The other infrastructure that consumed substantial resources in this era was roads, especially rural roads. Rajiv Gandhi Era There are two noteworthy features with respect to the wave of infrastructure build-out under Rajiv Gandhi. First, given Rajiv Gandhis pre-occupation with modernization and technology, significant investment was made in the countrys telecommunications infrastructure. Second, the build-out of physical infrastructure for ground water irrigation and electricity supply that was needed to power the irrigation pumps continued during this wave. Era of Decentralized Politics In the era of Decentralized Politics while the financing constraint became the most severe in decades, shortages in the infrastructure sector intensified, and therefore, the sector began to attract unprecedented attention. The India Infrastructure Report (NCAER 1995) emerged as a seminal piece of work in the area with many of its recommendations finding their way into the several budgets spanning the Eighth Plan.21
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The Ninth Plan identified the management of the infrastructure deficit as a key objective which, given the binding nature of fiscal constraints, was to be achieved through organizational, management, structural, or in some cases, legislative reforms designed to improve operational efficiency, cost recovery and financial viability in key infrastructure sectors, and attract private capital into them. A Task Force on Infrastructure comprising both Government and industry representatives was constituted under the Chairmanship of Mr. Jaswant Singh, Dy. Chairman, Planning Commission, with the aim of attracting investment to specific projects of national and regional importance, and ensure their timely completion. Initially, the Task Force dealt with the following projects focusing on innovative methods for financing them: Six lane expressway of 7,000 km. length, having North-South and East-West corridors Four-laning of National Highways, and Five world-class international airports

Source: 9th Five Year Plan

Inference
We have seen how the dynamics on Indian politics has affected the Indian Infrastructure sector since Independence. The policies were aimed at the overall development of the sector but the functioning of the government was slow and flawed. Now the policies have moved towards attracting Foreign investments, opening up the sector by initiating Public Private Partnership, providing tax benefits and other measures leading to the development of the sector. We will look at the measures in details in the further sections.

2. Policies pertaining to FDI in Infrastructure

Foreign Investment through GDRs/ADRs, Foreign Currency Convertible Bonds (FCCBs) is treated as Foreign Direct Investment. Indian companies are allowed to raise equity capital in the international market through the issue of GDR/ADRs/FCCBs. These are not subject to any ceilings on investment. An applicant company seeking Governments approval in this regard should have a consistent track record for good performance (financial or otherwise) for a minimum period of 3 years. This condition can be relaxed for infrastructure projects such as power generation, telecommunication, petroleum exploration and refining, ports, airports and roads. In order to give further impetus to facilitation and monitoring of investment, as well as for better coordination of infrastructural requirements for industry, a new cell called the Investment Promotion and Infrastructure Development Cell has been created. The functions of the Cell include: a) Dissemination of information about investment climate in India; b) Investment facilitation; c) Developing and distributing multimedia presentation material and other publications; d) Organising Symposiums, Seminars, etc. on investment promotion; e) Liaison with State Governments regarding investment promotion; f) Documentation of single window systems followed by various States; g) Match-making service for investment promotion; Page 8

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h) Coordination of progress of infrastructure sectors approved for investment/technology transfer, power, telecom, ports, roads, etc.; i) Facilitating Industrial Model Town Projects, and Industrial Parks, etc.; j) Promotion of Private Investment including Foreign Investment in the infrastructure sector; k) Compilation of sectoral policies, strategies and guidelines of infrastructure sectors, both in India and abroad; and l) Facilitating preparation of a perspective plan on infrastructure requirements for industry.

Guidelines for the consideration of foreign direct Investment (FDI) proposals by the Foreign investment promotion board (FIPB) a) FDI up to 100% is allowed in telecom sector for Infrastructure providers providing dark fibre b) FDI is permitted up to 74% in infrastructure related to marketing of petroleum products c) No foreign investment is allowed in Housing and Real Estate sector except for development of integrated townships and settlements where FDI up to 100% is permitted with prior Government approval. d) FDI up to 100% is permitted in airports, with FDI above 74% requiring prior approval of the Government. e) FDI up to 100% is permitted for development of integrated townships, including housing, commercial premises, hotels, resorts, city and regional level urban infrastructure facilities such as roads and bridges, mass rapid transit systems; and manufacture of building materials. Development of land and providing allied infrastructure will form an integral part of townships development, for which necessary guidelines/norms relating to minimum capitalization, minimum land area, etc., will be notified separately by the Government. FDI in this sector would be permissible with prior Government approval. f) FDI up to 100% is permitted on the automatic route in hotel and tourism sector. g) FDI up to 100% is permitted on the automatic route for Mass Rapid Transport Systems in all h) Roads & Highways, Ports and Harbors: FDI up to 100% under automatic route is permitted in projects for construction and maintenance of roads, highways, vehicular bridges, toll roads, vehicular tunnels, ports and harbors.

A new consolidated FDI policy, which facilitates the expansion of established foreign owned enterprises, allows the conversion of non-cash items into equity (with approval from the government). NRI's and OCB's are allowed the following special facilities: Direct investment in industry, trade, infrastructure etc. Up to 100% equity with full repatriation facility for capital and dividends in the following sectors: o o o o o o 34 High Priority Industry Groups Export Trading Companies Hotels and Tourism-related Projects Hospitals, Diagnostic Centers Shipping Oil Exploration Page 9

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o o o o o o

Power Housing and Real Estate Development Highways, Bridges and Ports Sick Industrial Units Industries Requiring Compulsory Licensing Industries Reserved for Small Scale Sector

3. FDI in Asia: Trends and Prospects

On the occasion of the 2011 Fourth United Nations Conference on the Least Developed Countries, UNCTAD proposed a plan of action for investment in developing countries. The emphasis is on an integrated policy approach to investment, technical capacity-building and enterprise development, with five areas of action: public-private infrastructure development; aid for productive capacity; building on LDC investment opportunities; local business development and access to finance; and regulatory and institutional reform. Global foreign direct investment (FDI) flows rose moderately to $1.24 trillion in 2010, but were still 15 per cent below their pre-crisis average. This is in contrast to global industrial output and trade, which were back to pre-crisis levels. UNCTAD estimates that global FDI will recover to its pre-crisis level in 2011, increasing to $1.41.6 trillion, approaching its 2007 peak in 2013. This positive scenario holds, barring any unexpected global economic shocks that may arise from a number of risk factors still in play. For the first time, developing and transition economies together attracted more than half of global FDI flows. Outward FDI from those economies also reached record highs, with most of their investment directed towards other countries in the South. Furthermore, interregional FDI between developing countries and transition economies has been growing rapidly. In contrast, FDI inflows to developed countries continued to decline. Major emerging regions, such as East and South-East Asia and Latin America, experienced strong growth in FDI inflows. State-owned TNCs (Transnational Corporations) are an important emerging source of FDI. There are some 650 State-owned TNCs, with 8,500 foreign affiliates across the globe. While they represent less than 1 per cent of TNCs worldwide, their outward investment accounted for 11 per cent of global FDI in 2010. The ownership and governance of State-owned TNCs have raised concerns in some host countries regarding, among others, the level playing field and national security, with regulatory implications for the international expansion of these companies. Global FDI inflows in 2010 reached an estimated $1,244 billion (figure I.1) a small increase from 2009s level of $1,185 billion. However, there was an uneven pattern between regions and also between sub-regions. FDI inflows to developed countries and transition economies contracted further in 2010. In contrast, those to developing economies recovered strongly, and together with transition economies for the first time surpassed the 50 per cent mark of global FDI flows.

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Figure 2: Global FDI Inflows Source: World Investment Report 2011, UNCTAD

In 2010, FDI inflows to South, East and South-East Asia rose 24 per cent, to $300 billion. However, the performance of major economies within the region varied significantly: inflows to the 10 ASEAN countries more than doubled; those to China and Hong Kong (China) enjoyed double-digit growth; while those to India, the Republic of Korea and Taiwan Province of China declined. FDI to South Asia declined to $32 billion, reflecting a 31 per cent slide in inflows to India and a 14 per cent drop in Pakistan, the two largest recipients of FDI in the subcontinent. In India, the setback in attracting FDI was partly due to macroeconomic concerns, such as a high current account deficit and inflation, as well as to delays in the approval of large FDI projects;10 these factors are hindering the Indian Governments efforts to boost investment, including the planned $1.5 trillion investment in infrastructure between 2007 and 2017. The table below indicates the range of FDI Inflows among Asian Economies. India is amongst the major nations receiving funds from other countries. Range Above $50 bn $10 to $49 billion $1.0 to $9.9 billion Inflows China and Hong Kong Singapore, India and Indonesia Malaysia, Viet Nam, Republic of Korea, Thailand, Islamic Republic of Iran, Macao (China), Taiwan Province of China, Pakistan, Philippines and Mongolia Bangladesh, Cambodia, Myanmar, Brunei Darussalam, Page 11

$0.1 to $0.9 billion

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Sri Lanka, Lao People's Democratic Republic, TimorLeste and Maldives Below $0.1 billion Afghanistan, Nepal, Democratic People's Republic of Korea and Bhutan Table 3: Distribution of FDI Inflows among economies by range, 2010 Source: World Investment Report 2011, UNCTAD

Leveraging TNC (Transnational Corporations) participation in Infrastructure development

Infrastructure development is crucial for Developing countries to reduce high transaction (communication and transportation) costs, overcome geographic disadvantages and move onto a path of sustainable development and poverty reduction. To realize the objective of rapid infrastructure build-up, governments need to introduce specific infrastructure development strategies, making use of the private sector and leveraging the potential contribution of TNCs. In a number of Developing countries, Greenfield investment and other forms of TNC participation have contributed to infrastructure development, in particular in electricity, transport and telecommunications. TNCs have been involved in infrastructure projects through different modalities, including various forms of PPPs, such as build-operate-transfer (BOT), build-own-operate (BOO), and concession. TNCs are often attracted by the growth potential in host developing countries and regions, as well as by business opportunities triggered by new liberalization and deregulation initiatives. Furthermore, PPP arrangements have helped infrastructure TNCs mitigate risks and overcome difficulties in their operations abroad. In some cases, TNCs from different home countries have set up joint ventures for a project. In other cases, TNCs form joint ventures with local Partners. TNC participation has helped mobilize significant amounts of capital for the development of infrastructure in Developing countries. In an enabling institutional environment (including a high-quality regulatory framework, an effective risk mitigation system and proper investment promotion activities), TNCs can be engaged in various types of infrastructure development projects, and their involvement can help mobilize financial resources and increase investment levels in infrastructure industries. In particular, the development of region-wide transport infrastructure is a vital way for those countries to access regional markets and sea ports. Governments need to develop the capacity to assess the feasibility and suitability of different forms of infrastructure provision whether public, private or through some forms of PPPs as well as to identify the potential role of TNCs and to design the framework of specific projects. Capacity-building needs to be strengthened in this regard and regional collaboration among developing countries should be encouraged.

4. FDI and Infrastructure

Major infrastructure development requires a substantial influx of investment capital. The policies of the Indian Government seek to encourage investments in domestic infrastructure from both local and foreign private capital. The country is already a hot destination for foreign investors. As per the World Investment Report of the UNCTAD, India was rated the second most attractive location (after China) for global FDI in 2007.
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Currently, India has FDI of about US$21 billion per year, well below the targeted US$30 billion. In order to increase FDI inflows, particularly with a view to catalysing investment and enhancing infrastructure, the Indian Government has introduced significant policy reforms. For example, it now permits 100% FDI under the automatic route for a broad range of sectors only certain post investment intimation is required. For FDI in a few sectors, a prior approval is required, which takes around 6-8 weeks. As part of policy reforms, the Indian Government is constantly simplifying the approval route process, including setting up several agencies to expedite FDI approval. Further liberalisation is expected as the Government continues to emphasise infrastructure investment.

Figure 3: FDI Routes in Infrastructure Source: Manual on FDI in India, Department of Industrial Policy and Promotion, Ministry of Commerce and Industry Automatic clearance for foreign investment (not requiring the approval of the FIPB) was first introduced for infrastructure sectors like power and roads. The sectoral investment limits for the critical infrastructure sectors are presented in table below: Sectors Percent Telecom 49 Electricity generation, 100 transmission and distribution Roads and highways 100 Ports and Harbours 100 Civil Aviation (in Greenfield 100 airport ventures) Table 4: FDI Ceiling under automatic route Source: Manual on FDI in India, Department of Industrial Policy and Promotion, Ministry of Commerce and Industry

From an exchange control perspective, India is moving towards full current account convertibility. Most revenue transactions are freely permitted, except certain transactions like royalty, consultancy fees, etc., which are subject to certain limits. Capital account transactions need prior approval,
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except where specifically permitted. In order to promote the construction sector, the Indian Government has relaxed some of the exchange control restrictions and is now allowing foreign nationals/ citizens to acquire immovable property in India, subject to certain conditions and procedures. In August 2008, a press report stated that Morgan Stanley was looking to invest up to a quarter of its US$4 billion global infrastructure fund in emerging markets, notably India and China and that in India, Morgan Stanley would face competition from Australias Macquarie Group, JP Morgan, Goldman Sachs and Deutsche Bank, all looking to channel foreign investors money into Indian infrastructure. While some of this planned investment may be reduced or delayed given the current environment in the credit markets, India is still likely to garner substantial FDI, particularly if its economy is able to maintain a fairly strong rate of growth in the face of a global recession.

Cross border investments and technology transfers that broadly constitute Foreign Direct Investment have multiplied greatly over the past two decades. Several global economic changes have fuelled this growth. These include: Liberalisation and economic reforms across a large swathe of national economies The emergence of regional trading blocs particularly in Europe and North America Rapid technology absorption and industrialisation in East Asia The role of Foreign Direct Investment in an economy goes beyond simply easing financial constraints. FDI inflows are associated with multiple benefits such as technology transfer, market access and organisational skills. Consequently, there is an increasing and intense competition between countries to maximize the quantity of FDI inflows. Any successful policy for attracting FDI has to keep this competitive scenario in mind. The Benefits of FDI Inflows can be broadly identified as: Bridging the financial gap between the quantum of funds needed to sustain a level of growth and the domestic availability of funds Technology transfer coupled with knowledge diffusion that leads to improvement in productivity. It can, thus, fasten the rate of technological progress through a contagion effect that permeates domestic firms The transfer of better organisational and management practices through the linkages between the investing foreign company and local suppliers and customers

Opportunities for Foreign Investors

Indias roads are already congested, and getting more so. Annual growth is projected at over 12% for passenger traffic and over 15% for cargo traffic. The Indian Government estimates around US$90 billion plus investment is required over FY07-FY12 to improve the countrys road infrastructure. Plans announced by the Government to increase investments in road infrastructure would increase funds from around US$15 billion per year to over US$23 billion in 2011-12. The quantum of funds invested as part of these programmes will significantly exceed that invested in recent history. Such programmes would be funded via a mix of public and private initiatives.

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Table 5: Road Infrastructure, Detailed Projections (USD Million) Source: Crisil Research; Planning Commission

The Indian Government, via the National Highway Development Program (NHDP), is planning more than 200 projects in NHDP Phase III and V to be bid out, representing around 13,000km of roads. The average project size is expected to US$150 million-US$200 million. Larger projects are likely to reach the US$700 million- US$800 million range. About 53 projects with aggregate length of 3000km and an estimated cost of around US$8 billion are already at the pre-qualification stage. The procurement process favours players with good experience and sound financial strength.

Figure 4: Projected Investment in the Road & Highways Sector in the Eleventh Plan Source: 11th Five Year Plan, Planning Commission, Government of India

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Tax considerations for foreign players

Infrastructure companies looking to invest in India need to consider a variety of tax issues.

Table 6: Type of taxes which may be applicable for Infrastructure companies operating in India Source: Crisil Research

The Governments strong focus on promoting infrastructure development also extends to tax policy, with a number of policy measures and incentives now in place for the construction of infrastructure facilities, including a numbers of tax holidays, although Minimum Alternate Tax (MAT) of 11.33% may be payable on book profits during this period. Relevant tax holidays, their applicability, and the eligibility of each infrastructure sector are detailed in Table below.

Sector Power

Ports and Airports

Applicability Undertaking which generates power Undertaking which transmits or distributes power Undertaking which carries out substantial renovation and modernisation Companies developing and/or operating & maintaining ports and airports Applicable also to Inland waterway, Inland port, Navigational channel in the sea

Time-frame 10 consecutive years out of 15 years

Eligibility All the above should commence before March 31, 2010

10 consecutive years out of 15 years

New infrastructure facility Agreement with government/ statutory body

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Railways

Companies developing and/or operating & maintaining rail system Companies developing and/or operating & maintaining roads and highways

10 consecutive years out of 20 years

Roads and Highways

10 consecutive years out of 20 years

Water

Includes water supply 10 consecutive project, water years out of 20 treatment system, years irrigation project, sanitation and sewerage system or solid waste management system Table 7: Overview of Tax Holiday terms for various Infrastructure segments Source: Crisil Research

New infrastructure facility Agreement with government/ statutory body New infrastructure facility Agreement with government/ statutory body New infrastructure facility Agreement with government/ statutory body

Effective tax structuring into India is vital as this impacts on how attractive a project is to target investors and has a direct influence on the net internal rate of return. It is therefore particularly important that international investment opportunities are structured appropriately to take into consideration tax, accounting, regulatory and legal aspects. Some of the key issues are discussed below: Entry and exit strategy Holding company location Appropriate planning in respect of a holding company jurisdiction is necessary to minimise Indian withholding tax and Indian capital gains on the sale of shares in Indian companies. Financing In order to introduce debt into India, there are various issues that need to be considered such as the Indian External Commercial Borrowings rules, withholding tax issues on distributions out of India and the availability of a tax deduction for the distribution at the Indian level. Holding the investment Permanent Establishments One of the risks with managing investments in India is managing the Indian permanent establishment position, where if the Indian tax authorities successfully argue that there is an Indian permanent establishment of the foreign operations in India, then there may be significant adverse tax implications. It is therefore important to carefully manage the operations carried out at the Indian level. Cash and profits There are various options on repatriating profits from the structure, such as dividend distributions, share sale, capital reductions, etc, all with differing tax impacts. Page 17

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Engineering, Procurement and Construction (EPC) Contracts In an infrastructure project the execution of projects is undertaken substantially by way of an engineering, procurement and construction (EPC) contract. A typical EPC contract will have the following scope of work in a single project: Supply of equipment (offshore and onshore) Installation/commissioning Services (offshore and onshore) Software/technology transfer (offshore and onshore) Under a typical EPC contract, a non-resident contractor performs a multitude of activities. The scope of work under an EPC contract would include both onshore and offshore activities. Taxability of payments received by foreign companies under EPC contracts has become a matter of great debate and litigation. Onshore supplies and services are normally taxable in India. Offshore supply of goods and services under a composite contract are something of a grey area. The Indian revenue authorities often attempt to bring the entire EPC contract, including the offshore supplies and services, within the range of taxes in India. The tax authorities may cite a business connection in India, and also note the presumed indivisibility of EPC contracts.

Figure 5: Elements of a typical EPC Contract Source: Crisil Research

Depreciation In order to make infrastructure projects more attractive for companies and investors, the Indian Government is re-examining the existing depreciation policy for such entities. The infrastructure sector may be eligible for a higher rate of depreciation in book value for BOOT (build, own, operate, transfer) projects. The Government is still examining this proposal and also evaluating whether depreciation should be allowed or, alternatively, there could be a policy for amortisation of the entire expenditure for such companies. Private players are needed to invest in infrastructure projects on the BOOT basis, and in the future, infrastructure companies may benefit from the creation of a sinking fund by such companies for the concession period. Such a fund would depend on the life of the project and the concession period could vary widely, depending on the contractual conditions of the specific project.
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Indirect Taxes The majority of Infrastructure services rendered by a company in India are subject to either service tax, VAT, or both, depending on whether the services rendered are in the nature of a construction contract or service contract. Apart from the above, there are certain other indirect tax issues which need to be addressed appropriately, especially relating to contract structuring. Companies need to ensure that indirect taxes are taken into account as they make decisions around how to structure a particular project.

Contrast between Infrastructure FDI in Asia and Latin America

Internationally, countries have followed two routes to infrastructure development. Latin American economies generated the vast majority of their infrastructure FDI inflows through privatisation. This constituted about 88 per cent of total inflows during 1999-2000 with the rest coming from greenfield investments and concessions. In Asia, on the other hand, Governments relied exclusively on green field investments through the BOT route. India has followed the Asian route where the bulk of FDI in infrastructure has come in through the green-field route rather than through privatisation. The Government, for instance, has allowed strategic investment in major airports with a 74 per cent equity ceiling.

5. Highways and Roads Role of Private Foreign players and multilateral agencies
Existing scenario
Road network in India aggregates to about 3.3 million kilometre. This extensive road network, the second largest in the world, caters to about 65 per cent of the freight traffic and 87 per cent of the passenger traffic. National Highways constitute about 66,590 kilometres which is only 2 percent of the total network. However, it caters to nearly 40% of the total road traffic. Out of the total length of National Highways, 17 percent is four laned, 53 percent is two-laned and 30 percent single laned. Road type Length (In kms) Expressways 200 National Highways 70,934 State Highways 1,31,899 Major district roads 4,67,763 Rural and other roads 26,50,000 Total Length 3.3 Million Km (approx.) Table 8: Indias Road Network Source: www.nhai.org/roadnetwork The large network of Indian roads is still insufficient to meet the requirements of Indias huge population.

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Targets for highways during the 11th Plan

National Highways Six-laning 6,500 km of Golden Quadrilateral and selected National Highways Four-laning 6,736 km on North-South and East-West Corridors Four-laning 20,000 km of National Highways Widening 20,000 km of National Highways to two lanes Developing 1,000 km of Expressways Constructing 8,737 km of roads, including 3,846 km of National Highways in the North East Rural Roads Constructing 1, 29,707 km of new rural roads, and renewing and upgrading existing 1,77,726 km covering 60,638 rural habitations

Table 9: Projected Public and Private Investment in Roads and Bridges during the Eleventh Plan (Rs Crore) th Source: 11 Five Year Plan, Planning Commission, Government of India Currently, the private sector contribution in the development of roads is a mere 33% which has picked up soon. Historically, road infrastructure has been provided by the State. The enormous investment requirement, long gestation period and uncertainty of returns were mainly responsible for the lack of interest by the private sector including foreign players. The presence of significant externalities also warranted the dominant role of the State in providing basic road infrastructure. In the allocation of budgetary resources, therefore, the development of road infrastructure is still given priority. However, the resource requirements for maintenance and expansion have far exceeded the capacity of the budget, making a strong case for private sector participation. Resource constraints, however, are not the only reason for encouraging private sector participation in the development of road infrastructure. A number of benefits accrue as a result of private sector participation in the development of road infrastructure. The most palpable benefit is the expansion of road network. In addition, private sector participation is expected to help upgrade the technology, improve the quality and lower the costs. The central as well as a few state governments have successfully harnessed private sector partnership in road development. The government is now convinced of the merits of partnering with
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the private sector. Projects are offered on BOT basis to private agencies. After the concession period, which can range up to 30 years, road is to be transferred back to the Government/public sector by the concessionaire. Also, to attract the private sector to projects that are not commercially viable but considered essential, the government has established a Viability Gap Funding (VGF) mechanism to provide a grant of up to 40% of the project cost.

Types of Public Private Partnership in National Highways Developments

The three common forms of Public Private Partnership popular in India and which have been used for development of National Highways are - Build Operate and Transfer (BOT) Toll basis. - Build Operate and Transfer (BOT) Annuity basis. - Special Purpose Vehicle (SPV) basis. - In addition the recently introduced Operate Maintain and Transfer (OMT) Concession. (a) BOT (Toll) Model In a BOT (Toll) Model, the concessionaire (private sector) is required to meet the upfront/construction cost and the expenditure on annual maintenance. The Concessionaire recovers the entire upfront/construction cost along with the interest and a return on investment out of the future toll collection. The viability of the project greatly depends on the traffic (i.e., toll). However, with a view to bridge the gap between the investment required and the gains arising out of it, i.e., to increase the viability of the projects, capital grant is also provided (up to a maximum of 40% of the project cost has been provided under NHDP). BOT (Annuity) Model

(b)

In the BOT (Annuity) Model, the Concessionaire (private sector) is required to meet the entire upfront/construction cost (no grant is paid by the client NHAI / Government) and the expenditure on annual maintenance. The Concessionaire recovers the entire investment and a pre-determined cost of return out of the annuities payable by the client every year. The selection is made based on the least annuity quoted by the bidders (the concession period being fixed). The client (Government/NHAI) retains the risk with respect to traffic (toll), since the client collects the toll. Special Purpose Vehicle

(c)

The NHAI has also formed Special Purpose Vehicle (SPV) for funding port connectivity road projects. (d) Operate, Maintain and Transfer (OMT) Concession

NHAI has recently taken up award of select highway projects to private sector players under an OMT Concession. Till recently, the tasks of toll collection and highway maintenance were entrusted with
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tolling agents/ operators and subcontractors, respectively. These tasks have been integrated under the OMT concession. Under the concession private operators would be eligible to collect tolls on these stretches for maintaining highways and providing essential services (such as emergency/ safety services). Foreign Players are attracted by the increasing benefits provided by the government through the above routes.

Mainstreaming of PPP in Roads and Highways sector:

Mainstreaming has been significant in this sector. Requisite model documents, namely, Request for Qualification, Request for Proposal, Manuals for Specifications & Standards, Model Concession Agreements (for National Highways, State Highways and Operations and Maintenance of Highways), etc. have been standardized. Bidding procedures are systematic. Availability of certain financial schemes/guidelines Viability Gap Funding Scheme and India Infrastructure Finance Company Limited (IIFC) for funding/financing infrastructure development and India Infrastructure Project Development Fund (IIPDF) for project development - though not specific to only the roads sector. Institutional arrangements for operation of these schemes/guidelines have been put in place.

Constraints faced by foreign players

1. Absence of an independent body/regulator: There is need for a fair and independent body, more in the form of a road authority/user board rather than an exclusive economic regulator (similar to telecom, energy and insurance sectors) to act as a quasi regulator. In the absence of any independent oversight/control mechanism, the toll rates may be set without reference to the economic benefits and costs arising through externalities and social considerations. 2. Need for long term funds: Given the need for long term funds for BOT contracts, availability of funds might become an issue, particularly so with the prevailing global financial slowdown. Some other related constraints are: Delay in financial closures on account of banks/financial institutions not taking up the project on account of risks on revenues as projected by the concessionaires; High cost of debt service and inability of concessionaires to raise cheap long term debt; Poor domestic bond market for long term debt instruments; No scientific risk allocation methodology between the partied This is being done in other countries as part of their Value for Money (VFM) exercise. 3. Unified Construction Law: A unified construction law with the requisite legal framework governing all aspects of construction would strengthen the dispute resolution mechanism reducing the burden on the courts and the ensuing delays by satisfactory resolution of cases. In 2000, the Government of
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India notified construction as an approved activity under industrial concern but stopped short of declaring the sector as a fully fledged industry. This has limited the sectors opportunity to be brought under industrial regulations and better access to market finance. 4. Land acquisition: Land acquisition procedures and compensation demanded for transfer of Government land hinder the implementation of projects in Roads Sector. Example: Compensation demanded for transfer of Govt. land for NHDP projects Source: Ministry of Road Transport and Highways 5. Environment and Forest Clearances. Delay in getting the forest clearance/wildlife clearance is another constraint. Additional conditions and demands for compensatory afforestation, dedicated strip for plantation, staff quarters, etc. have resulted in delays in implementation of projects.

Determinants of FDI in Infrastructure

While a liberal entry policy can go a long way in encouraging foreign investments in infrastructure, the willingness to invest in infrastructure projects has been restrained by a number of constraints across a number of economies. Thus, any successful strategy of attracting Foreign Direct Investment into these sectors will have to deal with these issues directly. These are: Subsidised prices: In most developing countries, infrastructure services are priced below the cost of supply. Subsidies may be hidden as increasing arrears to the banking system or outstanding payments to State agencies (like State Electricity Boards). This undermines the financial viability of projects. Mixed signals from different constituencies: Many diverse groups with varying levels of influence on Government policy have a stake in the policy that affects private infrastructure operations. Consumers benefitting from subsidised prices may resent price increases associated with privatisation. Managers and employees of public utilities are understandably concerned about their jobs. This often influences policy related to private infrastructure and affects the investment environment. Loss of authority: Governments are often reluctant to abdicate control over key sectors of the economy particularly where foreign ownership is involved. Most Governments do not have a strong record of regulating private industries because the public sector has been so dominant. This often results in rules prohibiting private entry into certain sectors, imposing limits on foreign ownership. Misunderstanding regarding what private involvement can offer and what investors require: Although private sector involvement does offer extra financing and the willingness to manage some risks (construction and operation risks), they are unwilling to bear risks that they cannot control (policy or regulatory risk).

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CASE ANALYSIS: India and Japan

Japanese Prime Minister Yoshihiko Noda arrives in New Delhi today to participate in the Sixth Annual Summit between the two countries on 28 December 2011. With the West reeling under severe financial crisis, Asia is being looked upon as the propeller of the global economy. It now accounts for 35% of the worlds GDP, up from less than 20% in 1980. Over the last 30 years, developing Asia has surpassed the rest of the world in recording a phenomenal GDP growth of 7.2 per cent. Japan perhaps may well be the fastest growing developed economy in 2012. India and Japan have strengthened bilateral relations in recent years through new initiatives in the spheres of economic and cultural linkages to defence and security co-operation. It is hence no surprise that Japan and Indias leaders will devote considerable attention to reviewing this Strategic and Global Partnership. On the economic front, under the India-Japan Strategic and Global Partnership, the two sides have launched a Special Economic Partnership Initiative, which has several high-visibility flagship projects like the Western Corridor of the Dedicated Freight Corridor to be partially funded by Japanese soft ODA loan and the Delhi-Mumbai Industrial Corridor (DMIC), whose project development is to be partially funded by Japan. The DMIC, projected to attract about $92 billion in foreign investment, will be built around the DFC. A consortium of Japanese private sector companies is collaborating with the DMIC Development Corporation as well as the governments of the concerned states, in developing eco-friendly townships in the DMIC zone using Japans best practices. http://www.indianexpress.com/news/japan-may-invest-4.5-bn-in-delhimumbai-corridor/892773/ The Japanese Prime Minister is also expected to sign a currency swap deal worth $10 billion to support the rupee when it fluctuates against the US dollar. This a classic example of an Infrastructure deal between two countries leading to greater diplomatic relations between them and also benefitting economy of both countries in not just the sector of deal but otherwise as well.

6. Role of Multilateral agencies

Given the various risks associated with infrastructure projects, the role of bilateral and multilateral agencies in funding these projects becomes critical. There can be three reasons for this: Given their structure, they are better able to absorb these risks than pure private participants Their participation often gives comfort to private investors who are more likely to participate in projects where there is some involvement of a multilateral agency The relatively long history of participation of the sector in development finance also equips them better to assess the viability and risk of projects in developing countries

Multilateral and bilateral agencies have played an important role in funding infrastructure in India. The box below lists some of the key projects funded by bilateral and multilateral agencies in India.

Multilateral agencies such as the World Bank, The Department for International Development (DFID), Japan Bank for International Cooperation (JBIC) and Asian Development Bank (ADB) etc. have Page 24

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financed projects in India across infrastructure sectors such as power, roads and highways, telecom, irrigation etc. Some of the key projects are: Road and Highways National Highway Loans, JBIC: A loan of Japanese Yen 11,360 million was signed in January 1994 for four-laning of Chilakaluripet-Vijaywada Section of NH-5 in Andhra Pradesh. The civil work on three contract packages commenced in March 1999,whereas civil work on the fourth contract for construction of 2.88 km long two-lane bridge over river Krishna commenced in May 1999. Tumkur-Haveri Project, ADB: Upgrading of Tumkur-Haveri section of NH-4 to a four-lane divided carriageway for a length of 259 km. ADB approved a loan amount of USD 240 million to incorporate a number of road safety measures such as partial access control, enlarged cross culverts etc.

Power Rajasthan Power Sector Restructuring Project, World Bank: Loan of US$ 266.8 million approved in 2001 to reduce Rajasthan State Electricity Boards (RSEB) technical and nontechnical losses; reinforce transmission/distribution systems; install system electronic (static) meters and provides technical assistance in the areas of reform project management etc. Orissa GRIDCO Restructuring Project, DFID: Loan of British Pound 6,000,000 granted to Government of Orissa for completion of the power sector reforms process in Orissa resulting in an efficient, self financing and accountable power sector which provides quality services to consumers at reasonable prices.

Telecom and IT Telecommunication Sector Reform Technical Assistance Project, World Bank: Loan amount of US$ 72 million granted to the Department of Telecommunications to strengthen its policy making capacity; and, modernise the Wireless Planning and Coordination (WPC) wings radio frequency management. This included financing of software, and hardware equipment, in addition to capacity building, and strengthening the capacity of the Telecommunications Engineering Centre.

7. Challenges for foreign players looking to enter the Indian Infrastructure

There is huge opportunity in the Indian infrastructure space in the short- and medium-terms at least. The policies of the Indian Government, which have been evolving very rapidly in recent years, continue to encourage the private sector in taking on a larger and more diverse role from being an infrastructure builder (under a publicly financed arrangement) to an infrastructure developer (under PPP structures which include private finance). These developments have led to a large number of infrastructure projects open up as opportunities for the private sector. Considering the liberal FDI guidelines, these lucrative projects present both an opportunity and a threat to local players. In many cases, foreign players are believed to have greater technological expertise, deeper pockets and more extensive experience compared to domestic companies. These
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advantages could mean overseas companies winning work at the expense of local players, or partnering with them. Domestic Engineering and Construction companies may therefore look at foreign entrants in the market as tough competitors or as strong potential partners. Wharton Business Schools 2007 analysis of Indias construction boom pointed out that the proposed US$50 billion infrastructure spend per year in India is nearly two and half times the current turnover of the entire existing domestic construction industry (US$15 billion and growing fast), and that many of the major E&C companies have massive order backlogs. There are many factors that influence the role of the local players vis--vis foreign players for example, the criteria used for the selection of developers is an important influence on what role the foreign players will take. Risk-sharing on a PPP project also needs to be carefully considered. The revenues of most infrastructure projects in India will be denominated in the local currency. Foreign players will need to consider the currency and tax issues already mentioned in some detail, particularly on a PPP project where significant private investment is also sought. International EPC contractors, including Toyo Engineering, Jacobs H&G, Uhde, Tecnimont and Aker Kvaerner, are already leading players in India. At the same time, many Indian companies e.g. Larsen & Toubro (L&T), Gammon, Bharat Heavy Electrical Limited (BHEL), Engineers India Ltd and Thermax have either scaled up their skill sets or extended their operations to overseas projects. India has a very well established infrastructure developer market. Local firms have evolved in recent times into fully-fledged national players (and in some cases international players). In certain sectors, such as highways, power and water, the local firms also have significantly progressed on the technological front. Some of the India based companies such as L&T, Punj Lloyd, Reliance, GMR, Suzlon, Tata Power, etc. are very active in the international markets and thus, can no more be deemed local E&C companies. Indeed, they are global organisations based out of India. These and other large firms clearly look at foreign players as both partners and competitors. However, smaller and medium-sized infrastructure construction companies and developers (such as KMC, Nagarjuna, IVRCL, Gammon, etc.) are often happy to partner with foreign players without necessarily considering them as competitors. Foreign players looking to enter into the Indian marketplace and team with local players need to evaluate carefully the cost competitiveness of their prospective participation. India has witnessed huge interest from a number of foreign infrastructure companies in the past, but not many have really been able to offer a cost competitive proposal. Since India has evolved its own model of cost competitive delivery in many sectors (for example, in telecoms), local players have an incentive to work with foreign companies only if the partnering offers a competitive edge over other bidders. There have been few such success stories so far where the foreign player has offered a particularly cost-competitive product or service. In instances where we have seen the successful entry of foreign players (such as in the port sector), foreign companies have often been able to bring technology or management advantages, or expanded reach into international markets, to supplement the capabilities of local partners. Although India has a well-developed legal system, the current legal and regulatory environment sometimes acts as an obstacle to the necessary injections of foreign private capital into Indias infrastructure. Major infrastructure projects are governed by the concession agreements signed between public authorities and private entities. Tariff determination and the setting of performance standards vary somewhat by sector. In the roads and highways sector, the ministry generally sets tolls while in major ports projects, and many of those in electricity generation, an independent regulator will decide relevant tariffs. In the airport sector, a new independent regulator is planned
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for 2009 and is likely to play a major role in determining tariffs in concession agreements for the segment. In some instances, ministry or regulator control over potential proceeds can act as a disincentive to the private infrastructure developer. As is the case in many countries, there is no single regulator which formulates the policy for all infrastructure projects. There is also no standardisation in the concession agreements across the different infrastructure sectors. As a result, the development of certain sectors in India may be hampered due to lack of adequate and co-ordinated planning. Projects which are approved may face difficulties if related projects are substantially delayed.

8. Conclusion
A vast opportunity exists for foreign contracting companies looking to invest in Indian infrastructure. Already, a number of contractors from Europe, Australia, China, Malaysia and Korea have made their presence felt in India. Further, many E&C companies, particularly from Japan, Spain, France and the UK are also now aggressively looking out for opportunities to enter India for business. Overall, the opportunities to develop a significant business in India are extremely promising for E&C companies, if they have carefully selected strong local partners, structured contracts sensibly to maximise tax benefits where appropriate, and taken a longterm, sustainable perspective.

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9. Web References
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. http://www.mha.nic.in/ http://www.pppinindia.com/ http://www.indiainfrastructure.com/ http://indiajuris.com/ http://dipp.nic.in/English/default.aspx http://planningcommission.nic.in/ http://articles.economictimes.indiatimes.com/2011-0726/news/29816541_1_infrastructure-sector-foreign-investments-korean-companies http://www.projectsinfo.in/News.aspx?nId=s/qoPv/lnMEORW9IOfFj/A http://www.nhai.org/ http://www.unctad.org/ http://www.idfc.com/

Other References
1. World Investment Report, 2011; UNCTAD 2. International Economics, Carbaugh 3. 11th Five Year Plan, Planning Commission

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