1  

Hydro Power Project Financing Scenario in India –

A Case Study on Hydro Power Projects in India

Dr.Hiren Maniar1

Abstract Although India has 1,50,000 MW Hydro Potential, but hardly 30,000 MW has been developed so far.

Initially Government of India has been funding the development of Hydro Project from their budgetary

support only. In 90s Government of India offered the various hydro sites for development for Private

Sector. Although 20 years have been passed but there is a not significant addition in Hydro

development took place in India. Over the years hydro power projects have proven that it is the most

cost-effective power projects for commercial scale hydro power generation in country like India.

However, the question must be asked why such a slow growth has taken place in the development of

hydro power projects inspite of enormous potential available in India. So far Hydro Power Projects of

37367 Mw as on December 2010 have been installed with an investment of Rs.1500 billion in debt

and equity financing. Investors and bankers who make these investments are the real clients for

hydro power projects. They are not interested in hydro power project efficiencies, but in risk, return on

investments and coverage ratios. This paper will take a look at hydro power projects from the project

financier’s perspective. The challenge in moving forward is to attract private investors, commercial

lenders, and international development agencies and to find innovative solutions to the difficult issues

that investment in Indian power market poses for hydro power projects.

Keywords: Hydro Projects, Project Financing, Private Investors, Commercial lenders

JEL Classification Codes: G2, H54

Publication Details:

Paper Published & presented at GTU (Gujarat Technical Univresity) sponsored International Conference on “Dynamics of Global Recession: Economics and Corporate Strategies for Survival and Growth” conducted between 6th to 8th January 2012 at Vadodara. Volume-1 2012, Paper no-30, Page no-225, ISBN: 978-93-812361-78-8

                                                            1 Dr.Hiren Maniar is working as a faculty in finance with L&T Institute of Project Management. He may be contacted on mail hm_maniar@rediffmail.com 

2  

Introduction

For any growing economy, power is a vital input needed to fuel the engine of economic growth and to

fulfill the basic needs of the entire population of a country. Energy differentiates a least developed or

developing economy from a developed economy. Empirical evidence suggests that lack of energy

can whittle down the pace of economic development while its abundance can stimulate the

development. As per some research data, an average an American consumes approximately 40

percent more energy than an Indian does. This stark gap in consumption levels may safely be

attributed to the government’s failure to maintain an appropriate ratio of Hydel and Thermal power

and not properly harnessing hydro power which is possible only through the construction of large river

valley projects. Apart from storing water, river valley projects not only produce electricity but also

ensure cleanliness of the air in the process.

Hydropower currently accounts for nearly one-quarter of the world's electricity production, with a total

some 777,000 megawatts (MW)2 installed as on 2010. It is not only a significant contributor in terms

of the overall global energy balance, but is arguably the only renewable energy resource that is

commercially exploitable on a large scale at present levels of technology.

Despite the obvious advantages that hydropower offers to a world that is becoming increasingly

conscious of the problems of sustainability, and global warming in particular, there are serious

challenges facing the industry. These arise primarily from the worldwide trend toward deregulation of

the power sector, which means that the development and ownership of new power stations has

passed into the hands of the private investors whose commercial priorities tend to favor other forms

of generation. A secondary, but still important, factor is the environmental concerns that are tending

to cast a negative image over hydro as a whole, although these are primarily triggered by projects

with large storage reservoirs.

Prior to 19913 the provision of electric power in India was the responsibility of the public sector, and

where this was not the case the task was undertaken by closely regulated private utilities. In either

situation the funding of new projects was based on the financial strength of the utility or the

creditworthiness of the government that lay behind it. With the deregulation of the power industry

                                                            2 Energy Information Administration international statistics database 3  Introduction of Economic Reforms in India 

3  

there has been a fundamental shift in the way projects are financed. The devolution of the industry

into smaller competing units meant that it was no longer possible to rely upon traditional utility-based

financing. The trend has been toward the funding of individual projects on a limited-recourse basis

where the lender relies for debt servicing on the revenue stream of the project in question, with little

or no security being provided by the sponsoring organizations. Under such conditions it is inevitable

that financiers become much more closely concerned about the viability of the project itself, rather

than the strength of the sponsors to whom they would have little recourse if things go wrong.

As a consequence of these trends the hydro industry finds itself at a crossroads. The past has been

dominated by projects financed in the public sector, usually under concessional arrangements. The

future will be driven by private finance, and projects will have to stand on their individual merits in a

world that is geared toward quick commercial returns. Under this scenario the record to date shows

that hydro is finding it difficult to hold its position.

This deterioration in the apparent attractiveness of hydropower is not as a result of any change in its

underlying economics. Hydro still remains a sound long-term investment whose shelf life is almost

indefinite compared with the 15- to 20-year life cycle of a typical thermal power station. But what have

changed are the criteria by which projects are selected for development, with the emphasis now

being on the ability to finance a project from private sources. In consequence the bias has been

toward low-cost thermal projects, particularly gas-fired plants, which are relatively easy and risk-free

to construct, and whose limited life span comfortably matches the short tenor of most commercial

lending.

Indian Power Sector Scenario

The Indian Power Sector is undergoing a rapid growth phase with a vision to provide reliable,

affordable and quality power for all by 2012. The demand for power is growing exponentially in

accordance with the high level of developments on both infrastructure and social fronts. In the

infrastructure sector the focus is on the progress in telecommunication, roads, airports and ports. On

the social front the aim of providing reliable power has emerged as the main reason for

increased focus on the power sector.

4  

India is the 5th largest power producer in the world with an achievement of increasing installed power

capacity from 1362 MW at the time of independence to 1,81,558.12 MW4 as on July 2011. In spite of

this growth, the power sector is plagued by a large gap in the demand and supply.The electricity

sector in India supplies the world's 6th largest energy consumer, accounting for 3.4% of global energy

consumption by more than 17% of global population. the Energy policy of India is predominantly

controlled by the Government of India's, Ministry of Power, Ministry of Coal and Ministry of New

Renewable Energy and administered locally by Public Sector Undertakings (PSUs).

About 65.22% of the electricity consumed in India is generated by thermal power plants, 21.04% by

hydroelectric power plants, 11.10% by Renewable Energy Sources and 2.63% by nuclear power

plants. More than 50% of India's commercial energy demand is met through the country's vast coal

reserves. The country has also invested heavily in recent years in renewable energy utilization,

especially wind energy.

The power sector has registered significant progress since the process of planned development of

the economy began in 1950. Hydro -power and coal based thermal power have been the main

sources of generating electricity. Nuclear power development is at slower pace, which was

introduced, in late sixties. The concept of operating power systems on a regional basis crossing the

political boundaries of states was introduced in the early sixties. In spite of the overall development

that has taken place, the power supply industry has been under constant pressure to bridge the gap

between supply and demand. Indian Power sector has grown in terms of installed generation capacity

from 1713 MW in 1950 to 1,81,558.12 MW as on July 2011. The per capita electricity consumption

has also increased from 18.17 kWh in 1950 to 1032.25 kWh in 2011.

India is expected to add up to 113 GW of installed capacity by 2017. Further, renewable capacity

might increase from 15.5 GW to 36.0 GW. In the private sector, major capacity additions are planned

in Reliance Power (35 GW), Adani Power (20 GW), TATA Power (12 GW) and CESC (7 GW).

                                                            4 Source –Ministry of Power and Central Electricity Authority (CEA) 

5  

Table-1: Installed Power Generation Capacity in India as on July 2011

Source –Ministry of Power and Central Electricity Authority (CEA)

Indian Power Sector Funding Requirement

Considering Hugh demand supply gap and 12th Five year plan target, there is a wide gap between

demand and supply of power in the country. Serious efforts are required to finance projects to meet

this wide gap. There has also been difference between public generation targets and achievements,

which has seen many ups and downs. Only in the seventh plan there was a shortfall of 4 percent

which was also the lowest among all 11 five year plans so far. But in the very next plan i.e. eighth

plan the shortfall shot up dramatically.

Table I: Power generation Target capacity and Installed Capacity

Five Year Plan Target Capacity

(in KW)

Installed Capacity

(in KW)

Percentage

shortfall

1st Plan 1,300 1,100 15

2nd Plan 3,500 2,300 36

3rd Plan 7,000 4,500 36

4th Plan 9,300 4,600 50

5th Plan 13,200 8,600 35

6th Plan 19,670 14,230 28

7th Plan 22,250 21,500 4

Fuel MW % share

Thermal (Coal) 99,503.38 54.81%

Thermal (Gas) 17,706.35 9.75%

Thermal (Oil) 1,199.75 0.66%

Hydro 38,206.40 21.04%

Nuclear 4,780.00 2.63%

Renewable Energy

Sources

20,162.24 11.10%

Total 1,81,558.12 100.00%

6  

8th Plan 30,540 16,420 46

9th Plan 40,245 19,119 47.5

10th Plan 41,110 21,180 51.5

11th Plan 78,530 47,178* 60.0

12th Plan 82,200 **

* Projects under construction and likely to be commissioned

** Preliminary studies have been conducted on identified projects and work would be started on these projects for

adding capacity of 82,200 MW

Source – Indian Infrastructure Report, 2010

As per the estimates of Planning Commission, the total capacity addition in 10th plan was only around

21,180 Mw against 41,110 Mw. The main reason for shortfall was Government's withdrawal of

budgetary support for power projects in the anticipation that Independent Power Projects (IPP) would

come up with the required investment. In fact, a large number of projects were selected by the

Government and several "Memorandum of Understanding" (MOUs) were signed for power

generation. Ironically State governments have not done much besides showing interest in such

projects. A lot needs to be done on issues relating to environmental clearance, availability of land etc.

The working group report on power envisages a capacity addition of 78,530 Mw during the 11th Plan.

The Planning commission, on the other hand, estimated that the installed capacity requirement in the

year 2011 would be 1,82,660 Mw. The installed generation capacity (as on December 2010) was 1,

69,749 Mw. This way capacity addition required during in the remaining part of 11th Plan (Year 2011-

2012) would be 31,352 Mw. In addition the Planning Commission considered all sanctioned, ongoing

and pipeline projects and arrived at the conclusion that a capacity addition of the order of about

82,200 Mw would be possible during the 12th Plan Period. The envisaged composition is:

Central: 13,914 Mw (17 %), State: 17,350 Mw (21%), Private: 50,936 Mw (62%)

The whole exercise does not seem to be feasible on account of three reasons:

The state sector has neither the financial resources nor managerial capacity to add 17,350 Mw

in 12th five year plan.

The capacity addition of 50,936 Mw by private sector is too mammoth target considering

worsening economic situation and fiscal imbalance situation in India.

7  

Given the Government's expectations of a high investment from private players, the prospects

of capacity addition in the 12th Plan look bleak looking at the past record of private investment.

The private sector power policy was introduced in 1992 but it has failed to attract desirable

level of investment.

Therefore, one of the major issues in the power sector is, “raising of funds for carrying out the

operations” to meet the demand & supply gap. The companies in the power sector finance their

outlay through both the internal as well as external sources. They plough back own profits to finance

their outlay. They also enter into agreements with various multilateral agencies for financial support. A

look at the following table would give us the idea of the size and dimension of funds requirements in

Indian Economy.

Table 2: Estimated Phasing of Funding Requirement for Generation during 12th Plan

(All figures in Billion Rupees)

Type of

Power

Projects

2012-

2013

2013-

2014

2014-

2015

2015-

2016

2016-

2017

Total Fund

Requirement for

Generation

Hydro 218.57 236.94 250.58 271.36 289.04 1266.49

Thermal 763.67 669.05 627.01 618.67 628.28 3306.68

Nuclear 57.53 69.55 74.43 82.55 93.60 377.66

Total 1039.77 975.54 952.02 972.58 1010.92 4950.83

Note: The calculation assumes a US $ to Rupee conversion rate of Rs.45 and average price of $ 1 million per

MW of generation capacity added.

Source: Overview of Power Sector - 12th Plan and Beyond, Central Electricity Authority

Table 3: Estimated Total Fund Requirement for Generation & Transmission during 12th Plan

(All figures in Billion Rupees)

Generation 4950.83

Transmission 2400.00

Distribution 4000.00

Total Fund Requirement 11350.83

Note: The calculation assumes a US $ to Rupee conversion rate of Rs.45

Source: Overview of Power Sector - 12th Plan and Beyond, Central Electricity Authority

8  

Scenario of Hydro Power Project Financing in India

Background: India’s critical need for power

Severe power shortage is one of the greatest obstacles to India’s development. Over 40 percent of

the country’s people most living in the rural areas do not have access to electricity and one-third of

Indian businesses cite expensive and unreliable power as one of their main business constraints.

India’s energy shortfall of 10 percent (rising to 13.5 percent at peak demand) also works to keep the

poor entrenched in poverty. Power shortages and disruptions prevent farmers from improving their

agricultural incomes, deprive children of opportunities to study, and adversely affect the health of

families in India’s tropical climate.

Poor electricity supply thus stifles economic growth by increasing the costs of doing business in India,

reducing productivity, and hampering the development of industry and commerce which are the major

creators of employment in the country.

Hydropower Scenario in India

According to India’s Central Electricity Authority (CEA), India has a hypothetical hydropower potential

of 148,700 MW. Actual capacity stood at 508 MW at independence, and at 38,206.40 MW in July

2011. At times, hydro had a share of more than 50% both in generating capacity and actual

generation. This has since gone down to less than 21%. As India’s main problem is a lack in peaking

power, the authorities would like to increase the hydro share within the power mix to 40%.

India’s Northern region accounts for 36% of existing hydropower capacity, and the Southern region,

for 34%. Expansion is primarily planned in the North-Eastern region (the Brahmaputra-Barak basin,

with 48% of the country’s hypothetical hydropower potential), and the Northern region (the Ganga

basin, with 36% of the undeveloped potential). Of the 98 projects which CEA identified as the first

priority for further development in 2001, 52 are located in the Brahmaputra and 20 in the Ganga

basin.

Hydro Projects Proposal as per current 11th Five year Plan:

The status of Hydro projects totaling to 16,553 MW included in the 11th Five Year Plan is as under:

9  

14,431 MW (87%) are under construction;

1,537 MW (9.5%) have been accorded concurrence by CEA/State Government and are

awaiting investment decision/work award;

585 MW (3.5%) the DPR is ready and concurrence of CEA/State Government is awaited.

Besides capacity addition, a strong inter-state and inter-regional transmission system has also

been planned not only to evacuate the planned generation capacity but also to provide open

access for transfer of power from surplus to deficit areas.

Availability of Financial Market Instruments in Indian Hydro Project Financing

India Financial Market helps in promoting the savings of the economy - helping to adopt an effective

channel to transmit various financial policies. The Indian financial sector is well-developed,

competitive, efficient and integrated to face all shocks. In the India financial market there are various

types of financial products whose prices are determined by the numerous buyers and sellers in the

market. The other determinant factor of the prices of the financial products is the market forces of

demand and supply. The various other types of Indian markets help in the functioning of the wide

India financial sector.

Features of Indian Financial Markets

India Financial Indices - BSE 30 Index, various sector indexes, stock quotes, Sensex

charts, bond prices, foreign exchange, Rupee & Dollar Chart

Indian Financial market news

Stock News - Bombay Stock Exchange, BSE Sensex 30 index, S&P CNX-Nifty, company

information, issues on market capitalization, corporate earnings statements

Fixed Income - Corporate Bond Prices, Corporate Debt details, Debt trading activities,

Interest Rates, Money Market, Government Securities, Public Sector Debt, External Debt

Service

Foreign Investment - Foreign Debt Database composed by BIS, IMF, OECD,& World Bank,

Investments in India & Abroad

Global Equity Indexes - Dow Jones Global indexes, Morgan Stanley Equity Indexes

Currency Indexes - FX & Gold Chart Plotter, J. P. Morgan Currency Indexes

National and Global Market Relations

Mutual Funds

10  

Insurance

Loans

Forex and Bullion

Details of Indian Financial Market Instruments

Types of financial market instruments available in India

1. Money market instruments.

2. Capital market instruments.

3. Hybrid instruments

1. Money Market

The money market can be defined as a market for short-term money and financial

assets that are near substitutes for money. The term short-term means generally a

period up to one year and near substitutes to money is used to denote any financial

asset which can be quickly converted into money with minimum transaction cost.

Money market instruments

Call / notice-money market

Call/Notice money is the money borrowed or lent on demand for a very short

period. When money is borrowed or lent for a day, it is known as Call (Overnight)

Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus

money, borrowed on a day and repaid on the next working day, (irrespective of

the number of intervening holidays) is "Call Money". When money is borrowed or

lent for more than a day and up to 14 days, it is "Notice Money". No collateral

security is required to cover these transactions.

Inter-bank term money of maturity

Inter-bank market for deposits beyond 14 days is referred to as the term money

market. The entry restrictions are the same as those for Call/Notice Money

except that, as per existing regulations, the specified entities are not allowed to

lend beyond 14 days.

Treasury bills

11  

Treasury Bills are short term (up to one year) borrowing instruments of the union

government. It is an IOU of the Government. It is a promise by the Government

to pay a stated sum after expiry of the stated period from the date of issue

(14/91/182/364 days i.e. less than one year). They are issued at a discount to the

face value, and on maturity the face value is paid to the holder. The rate of

discount and the corresponding issue price are determined at each auction.

Certificate of deposits

Certificates of Deposit (CDs) is a negotiable instrument and issued in de-

materialized form or as a Usance Promissory Note, for funds deposited at a bank

or other eligible financial institution for a specified time period. Guidelines for

issue of CDs are presently governed by various directives issued by the Reserve

Bank of India, as amended from time to time.

Commercial paper

CP is a note in evidence of the debt obligation of the issuer. On issuing

commercial paper the debt obligation is transformed into an instrument. CP is

thus an unsecured promissory note privately placed with investors at a discount

rate to face value determined by market forces. CP is freely negotiable by

endorsement and delivery.

2. Capital Market Instruments

The capital market consists of the long term period (>one year) financial instruments. In

the equity segment Equity shares, preference shares, convertible preference shares,

non-convertible preference shares etc and in the debt segment debentures, zero

coupon bonds, deep discount bonds etc.

3. Hybrid Instruments

Hybrid instruments have both the features of equity and debenture. This kind of

instruments is called as hybrid instruments. Examples are convertible debentures,

warrants etc.

In India money market is regulated by Reserve bank of India. Securities Exchange Board of

India (SEBI) regulates capital market. Capital market consists of primary market and

secondary market. Initial Public Offerings come under the primary market and all secondary

12  

market transactions deals in secondary market. Secondary market refers to a market where

securities are traded after being initially offered to the public in the primary market and/or listed

on the Stock Exchange. Secondary market comprises of equity markets and the debt markets.

In the secondary market transactions BSE and NSE plays a great role in exchange of capital

market instruments.

Details of International Financial Market Instruments

Due to limited domestic finance available for power projects, the need to tap

international markets becomes inevitable which is characterized by long tenure of

maturities and availability of various modes of finances.

1. Export Credit Agencies (ECA):

It is a private or quasi-governmental institution that acts as an intermediary between

national governments and exporters to issue export financing. The financing can take

the form of credits (financial support) or credit insurance and guarantees (pure cover) or

both, depending on the mandate the ECA has been given by its government. ECAs can

also offer credit or cover on their own account. ECAs currently finance or underwrite

about $430 billion of business activity abroad - about $55 billion of which goes towards

project finance in developing countries - and provide $14 billion of insurance for new

foreign direct investment, dwarfing all other official sources combined (such as the

World Bank and Regional Development Banks, bilateral and multilateral aid, etc.). There

are certain limitations in ECA financing like exposure limit, exchange risk transfer to

IPP, guarantee requirements and cost of insurance etc. Since the mid-eighties, NTPC,

and the NHPC have been pushed into purchases from foreign equipment suppliers, as

the Government on grounds of political expediency has been going in for the bilateral

credit option, which has hurt domestic producers of electrical power generating

equipment, since bilateral credit is inevitably tied.

2. Multilateral Development Banks (MDBs)

A multilateral development bank (MDB) is an institution, created by a group of countries,

that provides financing and professional advising for the purpose of development. MDBs

have large memberships including both developed donor countries

13  

and developing borrower countries. MDBs finance projects in the form of long-term

loans at market rates, very-long term loans (also known as credits) below market rates,

and through grants. Example like the World Bank (WB), IFC (International finance

Corporation, World Bank Group) and the Asian Development Bank (ADB). These

public institutions have played an important role in the provision of debt financing in

seven out of the ten projects reviewed by direct loans (such as IFC "A" Loans) and

through acting as the Lender of Record for syndicated loan facilities (such as IFC "B"

Loans). The other increasingly important aspect of MDB participation is guarantees and

insurance facilities (for example, the guarantee programs of the World Bank and

political risk insurance of MIGA). Loan tenors are broadly in line with those of the ECAs.

3. External Commercial Borrowing (ECB):

ECB (External Commercial Borrowings) is an instrument used in India to facilitate the

access to foreign money by Indian corporations and PSUs (Public

Sector Undertakings). ECBs include commercial bank loans, buyers' credit, suppliers'

credit, securitised instruments such as Floating Rate Notes and Fixed Rate Bonds etc.,

credit from official export credit agencies and commercial borrowings from the private

sector window of Multilateral Financial Institutions such as International Finance

Corporation (Washington), ADB, AFIC, CDC, etc. ECBs cannot be used for investment

in stock market or speculation in real estate. The DEA (Department of Economic

Affairs), Ministry of Finance, Government of India along with Reserve Bank of India,

monitors and regulates ECB guidelines and policies. For infrastructure and green-field

projects, funding up to 50% (through ECB) is allowed. In telecom sector too, up to 50%

funding through ECBs is allowed.

4. Syndicated Loans:

A syndicated loan is one that is provided by a group of lenders and is structured,

arranged, and administered by one or several commercial banks or investment

banks known as arrangers. The special features of syndicated loans are that they are

available for medium to longer period; specific to the requirements of the borrowers to

suit their projects, and availability of floating rate of interest. Most of the investors are

Asian/ European banks, FIs, Insurance Companies and pension funds.

14  

5. Private placement:

Private placement (or non-public offering) is a funding round of securities which are sold

without an initial public offering, usually to a small number of chosen private investors.

In India as per rule 144A it allows for private placement of bet to financial institutions

known as QIB, without the kind of stringent disclosure requirements needed for equity

issues. Long tenure of bonds and less restrictive covenants make this proposition

conducive for financing power projects.

6. Global Depository Receipts (GDRs):

A Global Depository Receipt or Global Depositary Receipt (GDR) is a certificate issued

by a depository bank, which purchases shares of foreign companies and deposits it on

the account. GDRs represent ownership of an underlying number of shares. Global

Depository Receipts facilitate trade of shares, and are commonly used to invest in

companies from developing or emerging markets. GDRs present an attractive avenue of

funds for the Indian Companies. Indian Companies can collect a large volume of funds

in foreign currency through Euro issues.

Role of Multinationals in Indian Hydro Project Financing

It will be evident from the reading of the case studies that the role of the multilateral

development banks has, in most cases, been essential for the success of the projects.

Furthermore, that the assistance that such banks provide can come in a number of

forms. Their potential role in assisting the financing of private hydropower projects can

be through the use of loans, equity investments and/or guarantee instruments, which

are described below in the following ascending order of dependence on public sector

support:

1. Loans/equity investments to the private partner,

2. Partial Risk Guarantees (covering government undertakings),

3. Partial Credit Guarantees (to extend the maturity of debt financing), and

4. Loans to governments and other public entities.

15  

Government of India Initiative in Hydropower Development

To boost economic growth and human development, one of the Government of India’s top priorities is

to provide all its citizens with reliable access to electricity by 2012. To ensure that the uncovered 40

percent of Indian homes get electricity by 2012, and to serve rising demand from those already being

served by the power grid, the government estimates that the country will need to install an additional

100,000 Mega Watts (MW) of generating capacity by 2012, expanding grid-based generation to about

225,000 MW. Given that India added about 23,000 MW during the last 10th Five Year Plan of 2002-

2007, this will be quite a quantum jump.

The Government of India has decided to acquire an increasing portion of this additional power from

the country’s vast untapped hydropower resources, only 23 percent of which has been harnessed so

far. India’s energy portfolio today depends heavily on coal-based thermal energy, with hydropower

accounting for only 21 percent of total power generation. The Government of India has set the target

for India’s optimum power system mix at 40 percent from hydropower and 60 percent from other

sources.

The main features of the Government of India policy on hydro power development are as follows:

Additional budgetary financial support for ongoing and new hydro projects under Central

Public Sector Undertakings.

Basin-wise development of hydro potential – comprehensive Ranking studies for 399

schemes.

Advance action for capacity addition – 10 year ahead of execution

Emphasis on quality of survey & investigations

Resolution of inter-state issues on sharing of water and power.

Renovation, Modernization & Uprating of existing hydro stations

Promoting small and mini hydel projects – 25 MW and below now fall into category of

“non conventional” qualifying for benefits.

Simplified procedures for clearances by Central Electricity Authority; Electricity Act 2003

further liberalises this.

Rationalization of hydro tariff by allowing premium on sale rate during peak period

Realistic estimates of completion cost considering new development on geological front

during execution.

Promoting hydel projects in joint venture

16  

Selection of developer through MOU/Bidding route

Govt. support for land acquisition, resettlement and rehabilitation, catchment area

development, etc.

Some of the measures announced by; Govt. of India have already been introduced

which include simplified procedures for transfer of techno-economic clearances,

streamlining of clearance process and introduction of three-stage clearance approach

for development of hydro projects in Central Sector/Joint Ventures, etc.

The Central Electricity Regulatory Commission has approved 5% hydro development

surcharge on annual fixed charges for central hydro power generation

Funding Scenario of Hydro Power Projects in India

Hydro Project financing in India, as in many other countries of the Asian region, has not been an easy

task. However, following the new initiative taken by the Indian Government to help create an

additional 50,000MW installed hydro capacity by the year 2012, things have started to look up. At

present, power projects (including hydropower schemes) in India are supposed to be funded from the

following sources:

Through NHPC and other central utilities, the government provides the equity capital of central

sector power projects. The government also offers a range of other incentives to promote the

development of power projects

State governments and utilities contribute the equity capital of state sector projects. They

conclude power purchase agreements with IPPs, and offer escrow accounts and other

guarantees as securities.

Investors from India and abroad are supposed to provide the equity of private sector projects.

In central, state sector or private projects, equity usually needs to cover 30% of project costs.

Once the equity has been secured, PFC and Indian development finance institutions extend

rupee loans for the debt-financing of central, state sector and private power projects.

Increasingly, Indian commercial banks and other financial institutions also provide debt funding

to power utilities and individual projects. Domestic lenders usually cover about 40% of the

project cost. In some cases, they also extend foreign currency loans.

17  

Export credit agencies, some bilateral institutions and numerous international commercial

banks extend loans (or guarantees) to cover the foreign currency debt of power projects, which

usually amounts to about 30% of project cost.

Apart from direct funding, the central government has started to offer a series of incentives to

encourage the development of power projects:

The government exempts bonds for the infrastructure sector, particularly PFC bonds, from

taxes.

In 1995, the government granted tax holidays of ten years and an exemption from import tariffs

for so-called mega-projects of more than 1,000 MW (in the thermal sector) or 500 MW (in the

hydro sector). It also extended guarantees to seven private hydropower projects.

In 1997, the government started to provide an interest subsidy of 4% for PFC loans for priority

projects (including the completion of power projects, missing transmission links etc.) under the

Accelerated Generation & Supply Programme. The Power Ministry believes that this

programme has been effective in helping states to complete projects, and would like it to be

funded also under the Tenth Plan.

Under the Accelerated Power Development Programme, the government contributes grants

and loans for the renovation and modernization of existing power plants and distribution

networks.

Host state governments receive a free share of 12% of the power produced by central

hydropower projects in their territory.

Project financing Issues in Indian Hydro Power Projects

The key issues in the financing of private hydropower projects are bankability and affordability.

Although the operating costs of hydro are minimal and the project life almost infinite, there are

multiple cost-related factors that make hydro difficult to finance on a private basis, particularly when

compared to equivalent thermal projects. These include the following:

High Capital Costs. The specific cost of a hydro power station (Rs. In Billion /MW) is typically

0.06 to 0.07 compared to 0.04 to 0.05 for a thermal power station, depending upon the site

characteristics and the type of thermal plant. This gap widens when private financiers require

18  

fixed price EPC contracts, because the contingency that has to be priced in for hydro is much

higher than for thermal power projects. Furthermore private development invariably implies

higher equity returns and higher interest costs so that the capital-intensive nature of hydro is

magnified relative to its thermal competitor. For thermal projects capital charges may constitute

less than half of the tariff. Therefore the consequences of using private capital are diluted; but

for hydropower, where capital charges dominate annual costs, the impact of higher capital

charges is much more pronounced.

High Front-End Costs. All private projects have to internalize their front-end costs. These

include transaction expenses for legal, financial and due diligence services; they also include

engineering costs, technical and environmental consulting fees, environmental mitigation and

the developer's own expenses. These "soft costs" are generally much higher for hydro than for

thermal plants (it is generally 45 percent compared with 25 to 30 percent for a typical thermal

project) because of the longer time that hydro takes to prepare for private financing and its

greater complexity.

Long Construction Period. Most hydro projects of any size will take four to five years to

construct. This is to be compared to less than two years for a gas-fired power station, or three

to four years for other types of thermal power station. The longer construction period increases

the interest and equity returns during construction (considered above as a component of "soft"

costs). However, the late start to the revenue stream also adds to the perception of project

risk, and in turn increases the risk premium in the financing charges.

Limited Availability of Export Credit Financing. The high civil work content of most hydro

schemes severely limits the availability of export credits. Generally the ECA (Export Credit

Agency) element will be no more than one-third of the direct project costs, which may be only

20 percent of the total funding requirement. In contrast the majority of the finance for thermal

power stations is in the form of ECA credits. The low proportion of ECA funding for hydro not

only increases the financing gap, but it also makes it more difficult to raise commercial funds,

which are usually piggybacked onto ECA loans. Where commercial loans are available they

are often expensive and of short tenor-unless extended by Partial Guarantees.

Mismatch of Loan Tenor and Asset Life. For both thermal and hydropower projects the

tenor of available ECA credits and commercial loans is considerably less than the asset life.

For thermal projects, loans may extend for up to 12 years from the commissioning date,

compared to an asset life of perhaps 20 years. The accelerated repayment required is

reflected in higher initial tariffs than would be the case if the project were publicly financed. For

19  

hydropower projects, the effect is exacerbated, since loan tenors are the same while asset life

is conventionally assumed to be 50 years or longer.

Peak and Base-load Plant. Most hydro plants are intended to operate in the medium to upper

range of the load curve, while many thermal IPPs are operated at high capacity factor near

base-load. In practice this makes it misleading to compare energy costs without recognizing

that the value of mid-range and peak energy is usually significantly higher than baseload

generation. Tariff comparisons should always be on the basis of the quality of the energy

supplied, which is reflected by the position it occupies in the load-duration curve and the

ancillary support services it provides.

Risk and Funding Opportunities in Indian Hydro Power Projects

Local financing of infrastructure projects has been very limited in many developing countries because

of the immature state of the domestic financial markets. Where such financing is available, interest

rates are usually too high to make projects affordable. For these reasons it is likely that for the

foreseeable future most private hydropower projects will continue to be financed using offshore funds,

as in the case studies.

While the international banks traditionally provide the major share of offshore project debt under an

ECA umbrella with maturities of up to 14 years, commercial bank loan maturities for developing

country projects can be very short (3-7 years) without multilateral cover. In addition, lending banks

normally expect loan principal amortization to start soon after completion of the project with equal

semiannual installments. Such repayment terms, aggravated by short maturity periods, result in high

debt service requirements in the initial years of operation.

The use of international capital markets to access long-term institutional funds has been explored by

private power companies, and project finance bonds have been used, principally in refinancing

situations. However, compared to commercial banks, familiarity with nonrecourse project finance debt

is still limited among bond investors, and their appetite has been seriously blunted by the recent

financial turmoil in parts of the developing world. In consequence capital markets remain wary of

infrastructure project financing in emerging economies. Official support mechanisms, such as export

credit insurance and multilateral guarantees, are available to reduce these problems. Their main

advantage is to reduce project risks and therefore lower the required interest rate, and to reschedule

20  

and extend the tenor of commercial debt beyond what would be available under purely commercial

arrangements. This can be particularly valuable in the case of hydropower projects where the terms

of the debt impact particularly heavily on tariff levels. The effect that improvement in the debt terms,

through longer maturities and lower interest rates, has on required tariff levels.

Required returns on equity are closely linked to the perception of risks. Where the project is

structured in a manner that passes most of risks outside the control of the sponsor to the utility or the

host government, and where the legal, regulatory and institutional environment ensure the contractual

rights of project financiers, the sponsor will accept lower equity returns, possibly as low as 15 percent

a year. In contrast, a high risk project would probably not attract equity investors at all, or the

investors will demand returns higher than 25 percent a year. Among the candidate projects, the actual

returns on equity lie between these two extremes, generally averaging around 20 percent a year.

There is no established pattern for risk allocation in private hydro projects and the accepted norms

are still emerging, driven largely by what is required to achieve financing. However Table 10 gives a

summary of the main risks and an indication of the way that they are tending to be allocated in a

number of countries as the market develops.

The arrangements shown reflect the level of risk assumption that generally needs to be assumed by

the public sector to make a project bankable. It will be seen that the public sector increasingly has to

bear many of the risks that they did under the traditional utility-led implementation arrangements, and

this is likely to remain a feature of most medium-to-large privately financed hydro developments for

the foreseeable future. This obviously raises some fundamental questions regarding the rationale

behind the practice of developing new hydropower stations in the private sector if the public sector

still carries much of the risk

Table 4: Normal Risk Sharing Arrangements for Hydro Projects in India

Type of Risk Risk Taker

Hydrology Risk

temporary deficits Usually PC, but sometimes access to GV

funds. Insurable

long-term deficits GVIUT increasingly assuming this risk. Not

insurable

21  

flood damage (construction) Generally CO risk unless force majeure, or

insurance

flood damage (permanent works) risk. Insurable

Construction Risk

changes in quantities/cost

overruns

Depends on reason. Either CO, PC or

shared

unforeseen g:round conditions Increasingly borne by the UT or shared.

Partly insurable

delayed completion Normally CO risk, but some exposure by

PC

Performance Risk

equipment Plant supplier or turnkey contractor

project performance CO, and possibly PC

transmission Usually the responsibility of the UT

Environmental Aspects Risk

permitting PC or, by preference, UT

land acquisition/resettlement GV/UT

Market Risk

market risk Usually UT through take-or-pay

dispatch Obligation and right of the UT

Force Majeure Risk

continued debt servicing Generally obligation on the UT to maintain

payments

rehabilitation costs Principal exposure on the UT (increased

tariff) and insurers

Political Risk

obligations of utility GV obligation often backed by political risk

insurance

changes in law GV obligation often backed by political risk

insurance

changes in tax GV obligation often backed by political risk

insurance

22  

Financial Risk

increase financing costs Generally passed to UT in the tariff, or

absorbed by PC

exchange rate Generally passed to UT, backed by GV

cost escalation Usually reflected in tariff during

construction and by limited

tariff escalation thereafter

Where - GV – Government, UT – Utility, PC - Project Company, CO - Contractor

Indian Government Initiatives in Funding Hydro Power Projects5

Indian Government has taken a number of measures in recent years to accelerate hydropower

development (of special relevance to private developers are the preparation of a shelf of well

investigated projects, which could substantially reduce risk perceptions), streamlining of the clearance

procedures, the provisions of open access and trading as per Electricity Act 2003, etc. Efforts are

also being made to make long-term debt available. As mentioned in Section V, PFC is now giving

loans to private sector hydropower projects for up to 70% of the project cost with a maximum

repayment period of 20 years with a moratorium for construction period plus 6 months.23 In January

2004, MOP constituted an inter-institutional group (IIG) of FIs with an objective to expedite the

financial closure of private sector power generation projects and to address last-minute issues

impeding project development and financing. The members of IIG are the State Bank of India (SBI),

Industrial Credit and Investment Corporation of India Limited (ICICI), Industrial Development Bank of

India (IDBI), Life Insurance Corporation (LIC), PFC and Infrastructure Development Finance

Company (IDFC). Since its formation, 11 projects with an aggregate capacity of 4,001.8 MW have

achieved financial closure. Currently, six projects with an aggregate capacity of about 7,532 MW are

under IIG’s consideration.

State-level Initiatives

The hydro-rich states like Uttaranchal, Himachal Pradesh and Sikkim have taken a number of

initiatives in recent years to promote a balanced growth of public and private sector projects These

are briefly discussed below.

                                                            5 Hydropower Development in India: A Sector Assessment, ADB website 

23  

Uttarakhand: The key features of the government of uttarakhand’s policy are (a) potential hydro

projects identified by the government of Uttaranchal are advertised for international competitive bids;

(b) bids are invited over a minimum premium, payable upfront to the government of uttarakhand, at

the rate of Rs.5 crores per project; (c) projects are allocated to bidders making the highest bid over

and above the upfront minimum premium; (d) projects are allocated for an initial period of 45 years on

a build-own-operate-and-transfer basis; (e) the developers of the project have the right to sell the

power outside the state; no agency of the state will guarantee purchase of power; and (f) 12% of

electricity generated is to be made available free of cost to the state during entire life of the project.

Himachal Pradesh: The key features of the policy of Himachal Pradesh are (a) selection of

developer on MOU route for projects up to 100 MW and based on international competitive bidding

route for projects above 100 MW; (b) no clearances from CEA for projects selected on competitive

bidding route for projects costing up to Rs2,500 crores; (c) secondary energy rate to be at par with

primary energy, (d) premium on peak power, and (e) 100% foreign equity permitted on the automatic

approval route provided it does exceed Rs1,500 crores. Also for projects above 100 MW installed

capacity, the government has reserved the right of equity participation up to 49% on a selective basis.

Sikkim: In order to expedite hydropower development through private sector participation in the

State, the government of Sikkim has formed the Sikkim Power Development Corporation Ltd

(SPDCL), to facilitate joint venture projects between a private power developer and the government.

For SPDCL-promoted projects and as per the MOU signed between the Sikkim government and a

private power developer, 12% free power would be made available to the State and the private power

developer would be permitted to sell its entire balance power directly to needy states or through

power trading agencies, whichever way they would like to sell. In all SPDCL-promoted joint venture

projects, the government’s equity participation ranges from a minimum of 10% to a maximum of 49%.

Investment Incentives for Investors in Hydro Power Projects

Below is a summary of the incentive package for both domestic and foreign investors:

All companies will be allowed a debt-equity ratio of 4-to-1.

The companies will be allowed to raise a 20 percent minimum of the outlay through public

issues.

24  

The promoter`s contribution should be at least 11 percent of the total outlay, with a ceiling of

40 percent from Indian public financial institutions. To ensure that the private entrepreneurs

bring in additional sector resources, they must obtain 60 percent of their contribution from

sources other than public financial institutions.

For both licensee and generating companies, up to 100 percent foreign equity participation will

be permitted for projects set up by foreign private investors.

The import of equipment for power projects by foreign investors will be permitted in cases

where foreign suppliers extend concessional credit.

To safeguard return on investment against a possible power demand shortage, private

generating companies will be allowed to sell power under a two-part tariff structure. This will be

based on operational norms and optimal plant load factor (PLF)--an important indicator of the

plants` operational efficiency. The PLF will be prescribed by the Central Electricity Authority

(CEA), the central government`s advisor to the Department of Power on technical and

economic matters.

The rate of depreciation will be periodically announced by the central government.

The specific incentives for the licensees are:

a license duration of 30 years in the first instance and subsequent renewal for 20 years,

instead of 20 and 10 years, respectively, prior to the amendment;

a 5 percent return rate in place of the previous 2 percent above the RBI (Reserve Bank of

India) rate;

capitalization of interest at actual cost during construction instead of the previous 1 percent

above RBI rate; and

Special grants to meet debt redemption obligations.

25  

Conclusion

Indian Power System has not been developed in a required manner and need hydropower potential

development on fast track basis. The exorbitant fund requirement to meet the gigantic challenge

cannot be met with the budgetary support of Centre/State Governments. A co-operation between

government and private sector is essentially required to develop projects in a time bound manner. To

facilitate smooth execution of the project it is necessary that government policy should be such that

the private sector finds easy approach in handling development of hydro sites since for individual

developers, tackling various agencies for seeking clearances/information would be difficult.

Need has been recognized for accelerated hydropower development in India. 80% of the existing

hydro potential is still unharnessed. Hydro Power Projects are still in a state of evolution, with the

process proving to be slow and expensive. Small projects will continue to be developed, but there is a

danger that interest will falter in the larger projects if prospective developers continue to be faced with

high upfront costs and long gestation periods, with only limited prospects of success.

Following points can be summersied as concluding comments on Scenario of Hydro Power Project

financing in India

India’s power generation capacity has expanded rapidly since independence. Even so, the

growth of generation could not keep up with demand. The country has a power shortage of 8%

on average, and of 11% at peak times. Power supply is unreliable and of poor quality, and

many rural communities have no access to electricity.

India’s per capita electricity consumption of 750 kWh per year is very low by international

standards. Even at this level, the lack of generating capacity is not the main problem. Power in

India is produced, transmitted, distributed and consumed inefficiently.

Encouragement of the further development and use of financing mechanisms that will facilitate

the flow of private capital into hydro.

A large amount of investment capital is created in India. Traditionally, it has been the role of

the country’s development finance institutions to make such capital available to industry and

infrastructure utilities in the form of long-term loans.

26  

Due to fundamental problems and environmental & regulatory hurdles financial institutions

seem to go through a certain cycle of hope and disillusionment regarding power, and

particularly hydropower, projects in India.

The multilateral development banks have completely withdrawn from directly funding

hydropower projects in India due to problem of fungibility.

Only Multilateral agencies like World Bank (WB), Asian Development Bank (ADB) and Pension

funds; which are called as a long term investors, are willing to finance Hydro projects having

GOI guarantees.

Encourage the availability of longer-term finance at low cost from international sources,

including ECAs, and through the use of credit enhancement mechanisms such as the World

Bank Partial Risk and Partial Credit Guarantees;

Foster a regulatory framework that is responsive to the needs of hydro, which includes a

willingness on the part of governments to assume certain project risks that cannot easily be

accommodated by the private sector;

Ensure that the deregulation process recognizes that most hydro can only be financed on the

basis of a long-term PPA signed with a credible offtaker and backed by a sovereign or similar

guarantee;

It will be necessary to develop Hydro Power Project structures that involve a risk-sharing

formula that is both bankable and cost-effective in terms of minimizing construction costs and

the resulting tariffs.

Coordination of financial support (loans/guarantees) by the various multilateral/bilateral

development banks and ECAs concerned with private hydro developments

In conclusion, Hydro Power Project sector is currently fragmented and without a clear sense of

direction needs a better-coordinated approach to what is inevitably a major exercise in public-private

partnership. The role of the multilateral and bilateral development banks is changing. It may have

diminished in the context of thermal power generation, but it remains as crucial as ever in the hydro

sector if the challenge of attracting required finance is to be adequately met.

27  

References

Research Articles

1. Asian Development Bank, Project Completion Report on the Power Efficiency (Sector) Project

(Loan 1161-IND) in India, August 2001

2. Balu, K. (2002), Infrastructure Financing by Indian Banks and Financial Institutions, Indian

Institute of Bankers, Mumbai

3. CIME, “India's Energy Sector”, CIME July 1995

4. Economic Survey, 2002-03, Government of India

5. Goel, R.S. and R N Srivastava, “Hydro Power & River Valley Development”, Oxford & IBH

Publishing, 1999.

6. Head, Chris, Financing of Private Hydropower Projects, World Bank Discussion Paper No.

420, July 2000

7. J.D. Agarwal & Aman Agarwal “Financing of Power Projects”

8. Mohan Rakesh (2009), The India Infrastructure Report

9. Mohile, A.D., River Valley Development — A Comprehensive Approach in Goel, R.S. & R.N.

Srivastava op. cit.

10. Paranjpe, Vijay, "High Dams on the Narmada: A Holistic Analysis of the River Valley projects",

Indian National Trust for Art and Cultural Heritage, 1990.

11. Prasad, Kanta, Analysis of Socio-Economic and Environmental Impacts of River Valley, in

Goel, R.S. & R.N. Srivastava op.cit.

12. Prayas/Public Sector International, India Power Sector Reform Update, Issue 1, October 2001

13. Raghuram G.; Rekha Jain; Sidharth Sinha; Prem Pangotra and Sebastian Morris,

"Infrastructure Development and Financing", MacMillian India Ltd

14. Reserve Bank of India, Financing Infrastructure Projects, Various Circulars and Press Releases.

Websites

1. Asian Development Bank: www.adb.org

2. Central Electricity Authority: www.cea.nic.in

3. Central Electricity Regulatory Commission: www.cercind.gov.in

4. Dams and Development Project: www.unepdams.org

5. NHPC: www.nhpcindia.com

6. Ministry of Power: www.powermin.nic.in

7. India Infrastructure: www.indiainfrastructure.com