The working group report

Introduction

The present Indian tonnage as on 1.7.2006 is 8.75 million (756 ships) as per details below:

Nature of ships	Number of Ships	Tonnage (GRT)
Overseas	246	77,48,725
Coastal	298	6,14,016
Offshore Supplies/ Specialised Vessels	120	1,67,829
Port Trust and Maritime Bodies	89	44,127
Barges	3	1,220
Total	756	85,75,917

(Source INSA)
The strength of Indian fleet is hardly 1.5% of the World Fleet.
The Indian ships carry about 15% of the country’s Liner cargo and 30% of its bulk cargo and the balance are carried by foreign vessels. The average Indian cargo carried by Indian fleet is about 13%. The country’s dependence on foreign ships to carry overseas trade has been increasing and there is an urgent need to increase Indian fleet strength. Further as per the current age profile of the Indian fleet, vessels over 20 years old account for 50% in the dry bulk sector and 44% in the oil tanker segment. This calls for early replacement of the ageing fleet. As projected, about 374 vessels of 3.79 million are likely to be scrapped over the next 5 years due to crossing over the 25 year age limit.
Investment during the 10^th Plan Period:
There was no target of investment set for the 10^th plan period.
During the first four years of the 10^th Five Year Plan (2002-03 to 2006-07), the investments made in the acquisition of ships (both newbuilding and secondhand) was to the tune of Rs. 10,656 crores as under :- (Source DG Shipping office)

Year	Tonnage (GRT)	Value (Rs./Crore)
2002-03	90503	339
2003-04	1151270	1910
2004-05	1824467	4200
2005-06	1131115	4207
	Total	10656

Investment requirement during 11^th Plan Period
The investment in the shipping sector during the 11^th Plan period will consist of

1. 
   investment in replacement of ageing vessels;
   
2. 
   fresh investment in acquisition of additional ships;
   
3. 
   investment in shipbuilding activities;
   
4. 
   investment in Inland Water Transport
   

In the shipping sector, where both public and private sector investments take place, it is generally difficult to fix the overall Plan target for investments. Accordingly, there was no target set for the X Plan period. However, based on the discussions, the Group could arrive at a tentative investment figure for XI Plan of the order of 72,000 crores –

Rs.
1. Addition of ships .. 55,000 crores

2. Port/shipbuilding .. 15,000 crores

3. IWT .. 2,000 crores

______

72,000 crores

Analysis of Financing Arrangement (Equity and Debt)

Considering debt equity ratio of 70: 30 for financing of the above investments, the requirement of equity comes to Rs. 21,600 crores and the requirement of borrowings comes to Rs. 50,400 crores.

The equity component in case of already established companies are expected to be deployed primarily from the internal resources which is supplemented by Tonnage Tax reserve in case of companies who have opted for tonnage tax. Estimated tonnage tax reserve per annum is Rs.625 crore. As the tonnage tax regime started in 2004-05, the amount of estimated tonnage tax reserve over 8 years culminating in the financial year of 11^th Plan i.e. 2011-12 is of the order of Rs.5000 crore which will be available as equity for investment.
The availability of funds from lenders for a particular sector depends on the revenue flow as well as the consistency of the revenue flow vis-à-vis the other sectors competing for finance. Shipping is known for its cyclical nature. Therefore, the lenders emphasize quite a lot on good revenue margins which will be able to stand against the worst of the cycles and provide enough cash flows to the lenders for recovery of their debt. Shipping is a global activity. Indian shipping sector has to compete globally with the others for securing business. The business environment and operating conditions of the shipping companies in our country vis-à-vis the other global shipping companies become an important factor while Indian shipping companies approach the lenders for financing.
Shipping Industry : Banker’s Perspective regarding Debt Financing
1. Growth and Fund Requirement
1.1 Shipping is a cyclical industry. It’s revenue model depends a lot on the quantum of traffic handled and the freight rates as may be realized. In so far as the traffic handled at major ports in India is concerned, over the last five decades commencing 1950-51, the average compounded annual growth rate (CAGR) was 5.5%. During the post reforms period reckoned from 1991-92 the CAGR marginally rose to 6.7%. However, in the last 4 year period commencing 2002-03, the average annual rate of growth clocked a double digit figure ranging between 10-11%. Given the expectation that the economy might grow at 8-9% per annum, the potential for import export trade through major as well as minor exports in the country could be truly phenomenal. In this context, there is a great need to increase the Indian fleet strength by adding new vessels. Further, as per the current age profile of Indian vessels, around 50% in the dry bulk sector and 44% in the oil tanker segment are more than 20 years old. The situation calls for an early replacement of this ageing fleet.
1.2 The fund requirement of the shipping industry for acquisition of new tonnage and maintenance of existing tonnage has been estimated, as indicated in the earlier para at Rs.72,000 crore during the 11th Five-year Plan Period ending 2012. Considering a debt equity ratio of 70:30 usually prescribed for funding capital intensive projects, the above requirement could be met by way of equity including internal generation (Rs.21,600 crore) and debt (Rs.50,400 crore), by way of rupee or foreign currency resources provided by Financial Institutions, Commercial Banks and Overseas Sources.
2. Exposure Norms for Commercial banks
The policy of funding borrowers by Commercial Banks is typically governed by the prudential guidelines prescribed by Reserve Bank of India (RBI) further limited by the internal credit policy of each bank. As per RBI guidelines for funding normal and infrastructure projects, maximum exposure to a single borrower is limited to 15% and 20% respectively of the bank’s net worth. The ceiling for a single group, the limits are 40% and 50% respectively of the bank’s net worth. However, with the approval of the Board of Directors, an additional 5% could be considered for sanction in both the categories. Some banks also have an internal cap on exposure to term loans and also to a particular sector. The policy issues relating to exposure norms are not likely to have a bearing on the flow of funds to the shipping industry from the banking system.
3. Shipping Industry Outlook and Bankers’ Perspective
The banking sector typically monitors the performance of any sector at the time of proposing to take additional exposures therein. As per current indications, the shipping industry is buoyant with reasonable EBITDA margins. Further, the exim trade from India expected to continue to grow at a healthy rate. The funding requirement of the industry, as indicated, is spread over a period of 5 years over the 11th five-year plan period. In the circumstances, funding by way of debt for viable projects will not be a constraint to the banking system. However, it may be mentioned that within the sector, preference might be given to companies that have,

• 
  relatively young fleet that meets with the requirements of safety and also command better freight rates;
  

• 
  an assured and steady income stream, namely, tie-ups with charterers /large industrial units, etc.
  

• 
  been promoted by established industrial groups.
  

4. Credit Products on offer
Typically, the credit products that are offered by the Domestic Commercial banks include assistance by way of Term Loan for construction of new vessels as well as acquisition of second hand vessels and improving structural liquidity needs. Working capital needs including funding of cash flow mismatch and day to day operational needs are normally met through sanction of cash credit or overdraft facilities. Both Term Loans and Working Capital facilities could be denominated either in rupees or any foreign currency. Depending on purpose and the cash flow stream, the tenor could go up to a maximum of 10-12 years. However, if the loan is sourced out of FCNB, the maximum tenor can be only 5 years as per extant policy guidelines of Reserve Bank of India.
5. ALM Issues and Associated Risks
Strictly speaking, long term loans are provided by the Banks mainly out of deposit funds whose tenures are normally shorter than those of the term of these loans leading to Asset Liability Mismatch. However, the deposit funds form the core of the resources of the Banks and hence while a significant percentage of existing deposits get renewed, new deposits are constantly added. Hence, ALM as an issue for the banking system could be viewed more from the angle of managing the liquidity and interest rate risks, the cost of which would need to be passed on to the borrowers appropriately through reset as well as put/call options as may be necessary. In respect of foreign currency lending, the additional risk is that of exchange fluctuations. However, fleet operators who have forex earnings have a natural hedge and hence avoid this risk.

6. External Commercial Borrowings

1. 
   As regards External Commercial Borrowing (ECB) is concerned, the fleet operators could either source these funds through international banks or through the offshore offices of the Domestic Commercial Banks. ECB for investment in real sector (including infrastructure sector) falls under the Automatic Route and will not require RBI/Government approval. However, the following are the limits in regards to the amount and duration of ECBs raised through automatic route:
   

• 
  ECB up to USD 20 million or equivalent with minimum average maturity of three years
  

• 
  ECB above USD 20 million and up to USD 500 million or equivalent with minimum average maturity of five years
  

• 
  The maximum amount of ECB which can be raised by an eligible borrower under the Automatic Route is USD 500 million during a financial year.
  

• 
  ECB up to USD 20 million can have call/put option provided the minimum average maturity of 3 years is complied before exercising call/put option.
  

6.2 The all-in-cost ceilings for ECB as indicated by Reserve Bank of India currently applicable are as under:

Minimum Average Maturity Period	All-in-cost Ceilings over six month LIBOR*
Three years and up to five years	200 basis points
More than five years	350 basis points

* For the respective currency of borrowing or applicable benchmark.
6.3 While the depth of ECB market is not perceived to be a problem, the issue remains that the tenure of ECB borrowings is usually short (typical exposures being limited to around 5 years) while the typical funding needs of the fleet operator is normally long. Further, the withholding tax @20% applicable on the interest paid on ECBs raises the cost of funds procured through this route. It may be noted that the Domestic Commercial banks are not normally permitted to issue guarantees, standby letters of credit or letters of comfort to secure ECBs. Of late international commercial banks have shown great interest in sanctioning term loans of longer duration say 10 to 12 years door to door particularly to Corporates having established credentials.
7. Assistance from Insurance Companies

1. 
   The other major category of institutions that could provide long term funding to the sector are insurance companies and among these, Life Insurance Corporation of India with a huge corpus is a very significant player in meeting with requirements of both debt and equity. However, it may be observed that the Insurance Regulatory and Development Authority of India (IRDA) has mandated the pattern of investments to be followed by the insurance companies as under:
   

Limits for investments by Life Insurance Companies

Sino	Type of Investment	% of fund
i)	Government securities	25%
ii)	Government securities or other approved securities (including (i))	Not less than 50%
iii)	Approved Investments as specified in Schedule – 1
a)	Infrastructure and Social Sector	Not less than 15%
b)	Others to be governed by Exposure Norms. (Investments in `Other than in approved Investments' in no case exceed 15% of the Fund)	Not exceeding 35%

Limits of Insurance specified for General Insurance companies

S No.	Type of Investment	Percentage
i)	Central Government securities being not less than	20%
ii)	State Government Securities and other guaranteed securities including (i) above being not less than	30%
iii)	Housing and Loans to State Government for Housing and Fire Fighting equipment being not less than	5%
iv)	Investments in Approved Investments
	a) Infrastructure and Social Sector	Not less than 10%
	b) Others to be governed by Exposure Norms. However the investments in `Other than in Approved Investments' in no case exceed 25% of the Assets	Not exceeding 55%

7.2 Considering the corpus available with the insurance companies and the requirement of the shipping industry as also the variety of other sources available for funding, there is no likelihood of paucity of funds available from insurance companies for investment in the sector at macro level. However, in case of individual borrowers, insurance companies, by way of assistance, may not be able to give more than 20% of the net worth of the borrowing company. However, in participation with other players under the consortium approach the requirement of every single borrower could be met.

As far as tenure of the financing is concerned, insurance companies can provide very long term loan spanning upto say 15 to 20 years as they have availability of long term funds with them.

Analysis of Taxation and Other Fiscal Issues Impacting the Growth of the Indian Shipping Companies

Keeping in view the above background, the fiscal regime under which the Indian shipping companies work become very important.

World’s top 20 ship registries provide haven to 79.3% of the world’s total shipping tonnages and the main reason for this is the low taxation level prevalent as compared to that in the ownership nationality countries” (Rakesh Mohan Committee Report 2002).
Tonnage tax scheme was introduced by the Government of India in the year 2004-05, which has made the domestic shipping sector definitely more competitive to face competition from international shipping companies operating in other countries.
However, there are many other taxes, which are inhibiting the growth of Indian shipping companies and improvement of its competitiveness vis-à-vis the global shipping companies. The list of such taxes are as under :-

1. 
   Withholding Tax liability on charter hire charges
   

In India charter hire charges paid to foreign ship owners is considered as royalty and subjected to withholding tax at the rate of 10%. In a recent Order of June 2006 that may have serious bearing on all shipowners in India who charter ships, a Chennai bench of the Income Tax Tribunal has held that a ship is an “equipment” and hence payment for chartering foreign ship could be construed as royalty and therefore taxable in India. The Order by the division bench of Income Tax Appellate Tribunal (ITAT), Chennai was in the case of Poompuhar Shipping Corporation, a Tamil Nadu Government Undertaking. In other countries, such withholding taxes are not applicable or applicable only when the foreign shipowners have permanent establishment in the country.

2. 
   Withholding Tax on Interest paid to Foreign Lenders on External Commercial Borrowing (ECB)
   

In India withholding tax at the rate of 20% is applicable on the interest paid on external commercial borrowings to the non-resident. ECB loan agreements entered into by Corporates have conditions by which interest net of any taxes are to be paid to the lenders. Therefore, in effect, the burden of withholding tax falls on the borrower and that too on the grossed up basis by which the actual impact is increased from 20% to 25%. Further, when the surcharge and education cess is added, it comes to 26.1375%. This substantially increases the cost of borrowing. As per the Double Taxation Avoidance Agreements with certain countries, concessional withholding tax at 10% is applicable and borrowings from certain multi national institutions are exempted from withholding tax.

Under the domestic law of Singapore, interest paid to foreign lenders is exempted from withholding tax subject to the condition that the loan is utilized for purchase of vessels registered under the Singapore flag.

3. 
   Service Tax
   

In India, Service Tax at the rate of 12.24% is applicable on various services rendered to shipping companies. Domestically, various services received in India are subject to service tax. Over and above, service tax on services received in India from overseas such as P&I Insurance, brokerage and commission, consultancy, manpower recruitment shipmanagement services, etc. are also subjected to service tax on reverse charge basis.

In countries like UK, Ireland, Singapore and Australia, the services availed by shipping companies are either exempted from service tax or “zero” rated. Generally, it is found that most of the maritime countries are not subjecting the shipping industry to service tax.

4. 
   Minimum Alternate Tax (MAT) on profit/loss on sale of vessels
   

In India, profit resulting from the sale of vessels is outside the tonnage tax scheme and shipping companies have to pay MAT @ 10% which effectively comes to 11.22% with surcharge and education cess. In many other countries like UK, Singapore, Ireland, Netherlands, Spain, Brazil, profit on sale of vessels is covered within the scope of tonnage tax scheme. It may be recommended that profit from sale of vessels if reinvested in acquisition of ships be exempted from MAT.

5. 
   Tax on other income
   

Income such as interest income earned by tonnage tax companies on investments is outside the tonnage tax scheme and subject to tax at normal corporate tax rate. Since creation of tonnage tax reserve @ 20% on