Viability gap funding in key infrastructure sectors

By Akshay Jaitly, Amar Narula and Aniket Prasoon, Trilegal
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The Scheme and Guidelines for Financial Support to Public Private Partnerships in Infrastructure, 2008 issued by the Department of Economic Affairs of the Ministry of Finance provide an avenue for obtaining financial support from the government for infrastructure projects that are considered economically essential but commercially unviable.

Akshay Jaitly Partner Trilegal
Akshay Jaitly
Partner
Trilegal

The government can provide up to 20% of the project cost as viability gap funding (VGF) and the host state government can provide an additional 20% of the project cost. The VGF guidelines envisage that a project must be undertaken on a public-private partnership (PPP) basis. Under the VGF guidelines, a PPP project must fulfil the following criteria to be eligible for a VGF grant:

(a) Concession and contract for the project must be awarded to a private sector company;

(b)The private sector company must be selected by the relevant central government ministry, state government or statutory authority through a competitive bidding process;

(c) The project should be developed, financed, constructed, maintained and operated by the private sector company;

(d) The project must fall under the eligible sectors specified under the VGF guidelines;

(e) The project should provide a service against the payment of a pre-determined tariff or user charge; and

(f) The relevant ministry, state government or statutory authority requiring the VGF should certify, with reasons that the: (i) tariff or user charge cannot be increased to eliminate or reduce VGF; (ii) concession period cannot be increased to reduce the VGF; and (iii) capital costs are reasonable and based on the standards and specifications normally applicable to such projects and the capital costs cannot be further restricted for reducing the viability gap.

Sectors funded

From the time the VGF guidelines came into force, we have witnessed a trend where VGF has been granted primarily to highways and road sector projects. The roads sector stands out in contrast to others sectors in light of its higher economic necessity and commercial unviability. Other sectors where projects have received VGF grants are metro rail, tourism and power transmission.

Standard documents helpful

The Planning Commission is more inclined to approve VGF for projects that use its standard bid and project documents. Projects in the highways and road sector are usually approved for VGF as the Planning Commission has project documentation in place. Although, the Planning Commission has approved a tourism project without there being standard documents for this sector, such approvals have been rare.

Amar Narula Associate Trilegal
Amar Narula
Associate
Trilegal

Pre-determined tariff

In addition, the Planning Commission refuses VGF grants for projects where the tariff is determined by regulators assuming “commercial returns”. A pre-determined user charge or tariff is essential before VGF funds can be considered as the VGF guidelines mandate that the amount of funding sought by a bidder should be the sole bidding parameter for a project approved for the grant.

However, the regulators generally factor in a component of commercial return while determining a tariff under their respective legal frameworks. The approach of the Planning Commission has been to reject such projects as they are of the view that such commercial return built into the tariff makes projects commercially viable and therefore, there is no viability gap that merits funding.

Another reason for rejection of projects could be that there is no regulator prescribed by law to determine tariffs in certain sectors. Here, the reliability of the pre-determined tariff is the prime question of concern for the Planning Commission, since such tariffs cannot be the permissible bidding parameter under the VGF guidelines.

Wider ramifications

The implementation of VGF guidelines throw up various questions in terms of requiring standard documents, the acceptance of tariffs determined by regulators and reliability of tariff determination in non-regulated sectors which policy makers need to resolve.

However, the Planning Commission is attempting to fine-tune the implementation of the VGF guidelines and so recently developed standard documents for the transmission sector. Following this the Jhajjhar transmission project became the first project in the power sector to get a VGF grant.

Akshay Jaitly is a partner in the Delhi office of Trilegal where Amar Narula and Aniket Prasoon are associates. Trilegal is a full-service law firm with offices in Delhi, Mumbai, Bangalore and Hyderabad. The firm has over 120 lawyers, some of whom have experience with law firms in the US, the UK and Japan.

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