4.1. Sources of project finance

Sources of finance. Project finance may come from a variety of sources. The main sources include equity, debt and government grants. Financing from these alternative sources have important implications on project's overall cost, cash flow, ultimate liability and claims to project incomes and assets.

IDevice Icon What are equity and debt?

Equity refers to capital invested by sponsor(s) of the PPP project and others.

Debt refers to borrowed capital from banks and other financial institutions. It has fixed maturity and a fixed rate of interest is paid on the principal.

Equity is provided by project sponsors, government, third party private investors, and internally generated cash. Equity providers require a rate of return target, which is higher than the interest rate of debt financing. This is to compensate the higher risks taken by equity investors as they have junior claim to income and assets of the project.

Lenders of debt capital have senior claim on income and assets of the project. Generally, debt finance makes up the major share of investment needs (usually about 70 to 90 per cent) in PPP projects. The common forms of debt are:

  • Commercial loan
  • Bridge finance
  • Bonds and other debt instruments (for borrowing from the capital market)
  • Subordinate loans

Commercial loans are funds lent by commercial banks and other financial institutions and are usually the main source of debt financing. Bridge financing is a short-term financing arrangement (e.g., for the construction period or for an initial period) which is generally used until a long-term financing arrangement can be implemented. Bonds are long-term interest bearing debt instruments purchased either through the capital markets or through private placement (which means direct sale to the purchaser, generally an institutional investor - see below). Subordinate loans are similar to commercial loans but they are secondary or subordinate to commercial loans in their claim on income and assets of the project.

The other sources of project finance include grants from various sources, supplier's credit, etc. Government grants can be made available to make PPP projects commercially viable, to reduce the financial risks of private investors, and to achieve socially desirable objectives such as to induce economic growth in lagging or disadvantaged areas. Many governments have established formal mechanisms for the award of grants to PPP projects. Where grants are available, depending on government policy they may cover 10 to 40 per cent of the total project investment. 


IDevice Icon Example: Viability gap funding in India

The viability gap funding scheme of the Government of India is an example of an institutional mechanism for providing financial support to public-private partnerships in infrastructure. A grant, one-time or deferred, is provided under this scheme with the objective of making projects commercially viable.

The viability gap funding can take various forms including capital grants, subordinated loans, operation and maintenance support grants, and interest subsidies. A mix of capital and revenue support may also be considered.

A special cell within the Ministry of Finance manages the special fund, which receives annual budget allocations from the Government. Implementing agencies can request funding support from the fund according to some established criteria. In case of projects being implemented at the state level, matching grants are expected from the state government

Copyright © 2008 by Transport Policy and Development Section, United Nations Economic and Social Commission for Asia and the Pacific (ESCAP).