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Stiff competition among the financial institutions (FIs) and banks may force some of them to reduce the fees for providing guarantees to infrastructure projects.

Though the banks and FIs dominate this fee-based segment, the last credit policy paved the way for foreign banks to provide guarantees for raising rupee resources.

Foreign banks charge a fee of about 4.5 per cent. This includes a 2.5 per cent fee on the principal, 1.6 per cent on the interest, and the remaining as management fee.

Indian banks and FIs charge between 3.15 per cent and 4 per cent. In some cases, this consists of a 2.5 per cent fee on the principal and 1.5 per cent on the interest.

However, institutions like Power Finance Corporation (PFC) have queered the market. PFC's portfolio consists mostly of state electricity boards' debt, though it has now started providing guarantees to independent power producers.

At present, PFC charges a flat guarantee fee of 2.5 per cent on both principal and interest. PFC sources said this was being reduced and would be bifurcated into fees on principal and interest.

Hudco is also preparing to enter the market and officials indicated it would charge around 2.5 per cent.

Guarantees are provided to facilitate debt financing of infrastructure projects.

They bring down the debt costs of projects. Debt service payments are treated as fixed costs in most infrastructure projects.

Borrowing costs reduce proportionately to the creditworthiness of the guarantor. Since such costs are passed on, low financing costs have a positive impact on tariffs.

Currently, such guarantees are provided by state governments for projects promoted by state-sponsored entities. However, most states have eroded their ability to provide guarantees and have built up contingent liabilities well over their tax revenues.

Therefore, state guarantees have not contributed substantially to reduction in costs. For instance, borrowing costs on a state government guarantee will be about 15.5 per cent, depending on the rating. However, guarantees provided by FIs are more creditworthy and the borrowing costs are close to the r