The long-term Project Finance for infrastructure and industrial sectors essentially involves a limited recourse to financial structure, since project debt and equity utilized for constructing the project are paid back from the cash flows generated by the project itself. This implies financial engineering of lending, solely against the cash flows of the project, not relying upon any other securities. A detailed evaluation and thorough analysis of the various risks involved are undertaken and the mitigation steps are identified for the perspective lenders, promoters, and other parties involved. The term loans for large projects are generally repayable in up to 20-25 years depending upon the economic life of the project, after the initial moratorium during the gestation period. The current unprecedented situation arising out of covid-19 disruptions and responses from the regulators has provided us with a lot of learning inputs, necessitating a relook at the funding mechanism, particularly for the Long Term Project Finance.
The importance of the requisite relaxations and flexibility in long-term project Finance is now being realized on the lines of the mechanism that was popularly called the 5 by 25 scheme. Drawing inferences from the line of action and approach adopted by the RBI, to deal with the covid-19 situations, now there seems to be a need to have a RELOOK at the Long term Project Finance mechanism.
The covid-19 pandemic has forced the governments and Central Banks across all the economies to provide economic stimuli and regulatory forbearance to deal with the unprecedented situation. In India too, besides the massive government economic stimulus of over 20lac crores, the Reserve Bank of India took several proactive steps with agility to cope with the adverse economic scenario.
Besides injection of substantial liquidity, the Reserve Bank of India announced a moratorium on repayment of Debt and a comprehensive covid-19 Regulatory Package. The need was duly recognized for relaxing the payment pressure and to mitigate the burden of debt by preventing the transmission of financial stress to the real sector. The relief package inter alia permitted a one-time resolution process for Covid-19 impacted cases. The committee headed by Mr. K.V. Kamath set up by the RBI undertook an in-depth analysis of the adverse impact of covid-19 and sector-specific threshold financial parameters for 26 sectors were prescribed. Substantially relaxed financial parameters were stipulated with respect to the Average Debt Service Coverage Ratio (DSCR) which was fixed at 1.20 against a much higher benchmark in normal circumstances.
This indicated the recognition of the realities in respect to the generation of fresh cash flows over a long period of time in the given circumstances. This is over and above the blanket moratorium on repayment of debt already permitted and extended up to August 2020.
The above two measures are nothing but essentially the changed spirit behind the scheme for 'Flexible Mechanism of Long Term Project FINANCE' popularly known as the '5 by 25 scheme', as we would see by discussing its broad features below.
It was a well-thought-out, path-breaking scheme for financing infrastructure and the core Industries, announced by the RBI way back on 15th July 2014 with a very justifiable rationale and realistic approach. As per the RBI notification, the scheme allowed the Bankers to fix longer repayment periods for loans to infrastructure and core industries say 25 years, based on the economic life or concession Period of the project, with periodic financing, say every 5 years. This was to ensure the long-term viability of infrastructure/core Industries sector projects by smoothening the cash flow stress in the initial years. The lenders would be able to extend finance to such projects without getting adversely impacted by Asset liability management issues. In such cases, the need for restructuring of loans due to initial cash flow stress or unforeseen circumstances would be minimized, allowing banks to once again take up refinancing of these loans. All this will lead to a reduction of project risk and improvement in the rating of such projects, leading to lower capital requirements for banks because of a possibility for the promoters to access the bond market.
The repayment of bank loans in an unduly compressed, the shorter period tends, in general, to strain the viability of the project and adversely affects the internal rate of return to the promoters. This in turn reduces the ability of the promoters to generate fresh equity/surplus from internal sources, for financing further investments. For example, for a sector like a hotel industry, because of the traditional tight schedule of normally 10 to 12, after meeting the EMI from the Earnings (EBIDTA), the promoter may not be left with adequate surplus to expand and invest in the normal course. By the time the previous loan is paid, the promoter may lose all his zeal and enthusiasm to invest further. This can prove to be a big deterrent for entrepreneurial development and job creation which is the biggest need of the hour. Further, with undue pressure of higher loan installments, the owner tends to levy heavy user tariffs to make the project viable leading to the burdening of the users too much - a losing proposition.
The above mechanism/scheme thus contained all the essential features of creating a robust platform for long-term financing for ensuring the sustainable success of the large projects with benefits to all stakeholders viz promoters, lenders, and the users/public at large. The scheme would have also enabled, to seamlessly face, unforeseen adverse circumstances like the present one and pre-empt the need for frequent restructuring.
With all the positive features, the above mechanism would have solved most of the difficult issues relating to long-term Project Finance. However, unfortunately, instead of treating it as a logical and realistic mechanism of long-term finance, it was, somehow, given a color of a 'restructuring scheme'/ever greening. We are certainly not advocating evergreening in any manner. Let the scheme be implemented for only standard assets which are not weak and for all new long-term projects being funded. The intention is to deal with the uncertainty and volatility (like the present one) in a pragmatic and realistic manner by enabling a review of the mechanism every 3 to 5 years. This will primarily depend on the actual economic, financial, and other relevant considerations/parameters and situations at each stage of the review over the economic life cycle of the project.
The current stipulation of the moratorium, relaxation in financial parameters, and elongation of repayment schedules are something akin to the features as envisaged in the above 5 by 25 mechanism of periodically taking stock of the situation and re-fixing the terms and conditions of the loan.
At present, the resolution process of the eligible covid-19 impacted borrower accounts is in progress. But it is felt that some of the most adversely affected sectors like tourism and hotels, aviation, etc. need a still better deal.
It may now be the proper time to have a relook, re-examine and reintroduce the 5 by 25 mechanism particularly for sectors that have been affected very adversely. This dispensation can make a success story of our efforts with a win-win situation for all stakeholders by re-adopting the 5 by 25 scheme now, which was perhaps ahead of its times when it was introduced earlier. This will bring in the requisite flexibility while at the same time enabling us to deal with uncertainties like the current one.