PPPs Revisited

India needs an investment of over $1 trillion in new infrastructure over the next five years. Such large-scale financing requirements cannot be funded by the government alone, given the budgetary situation and the fiscal deficit position. Given this, the public-private partnership (PPP) model for implementation of infrastructure projects assumes a crucial role.

India Infrastructure recently organised a conference on “Revitalising PPPs in Infrastructure” in which key stakeholders discussed their views on private participation in infrastructure sectors, the experience so far, recent government initiatives, key issues and challenges and the way forward…

In India, the PPP model has had mixed success. Projects such as Delhi airport, the Nagpur 24×7 water project, power distribution in Delhi and port connectivity projects are some of the success stories. These projects have delivered much higher levels of quality and service than the public projects they replaced. It may also be noted that many PPP projects that have not progressed or have been stalled would not necessarily have fared better even if they had been public projects.

The model, though, has had its own set of problems. Dispute resolution and renegotiation of contracts have been major problem areas in the past. Dispute resolution has been poor, which has left projects in a limbo, denting the PPP space. With respect to renegotiation, there have been problems especially when unforeseen events (beyond the control of the involved parties) have taken place. The model has not accommodated changes with respect to project dynamics.

Past experience indicates that many private sector players were not committed enough or had bid too aggressively for projects, in an attempt to earn a quick buck. This was compounded by the lack of proper project development and preparation, imbalanced risk allocation, poor financial appraisals and inadequate institutional capacity. Besides legal disputes, PPPs being an “off-balance-sheet item”, a lack of clear understanding among stakeholders and a difficult financing environment had an additional impact.

As PPPs are inevitable, the model needs to be revisited and perhaps modified. Thus far, most of the funding for projects has been met by banks. However, a new approach is required, looking beyond banks, given their current financial standing, which has been affected by stressed/non-performing assets (NPAs), sectoral limits and the adoption of Basel III norms. Further, it cannot be assumed that offshore funds will be brought in for the creation of fresh infrastructure, as such projects have high risks. Perhaps a good way to recycle capital is to offload completed projects. Another change that could be beneficial is an improvement in the procedure for achieving financial closures. At present, each bank carries out its own appraisal which causes delays. The central bank could consider authorising three-four institutions to carry out the appraisal and subsequently invite other lenders to participate in the project.

Moreover, sector-specific financing institutions need to be created. Institutions such as India Infrastructure Finance Company Limited (IIFCL) should also have a greater role to play. For this, tweaks in its management framework would be crucial. Alternative funding sources such as bonds as well as insurance and pension funds must be tapped into.

For PPPs to take off, changes are also required in model concession agreements. There has to be a fixed checklist across ministries to have a clear and uniform understanding of the model. Besides, there has to be discipline in bidding through the rules of governance.

The task of revisiting the PPP model was entrusted to the Kelkar Committee set up in May 2015 by the government. The slew of recommendations made by the committee have been well received by industry. These include the establishment of independent sector regulators, creation of a level playing field in terms of risk allocation (between public and private players), ex-ante provisioning of a renegotiation framework in the bid document, the establishment of a national facilitation committee to address the issue of “obsolescing bargaining”, setting up of bespoke concession agreements to suit the specific needs of each project, the need for setting up of an enforceable dispute resolution mechanism as well as the endorsement of concepts such as 3P India and the reverse build-operate-transfer (BOT) model. A key position of the committee was with regard to revisiting acts such as the Prevention of Corruption Act that allows scope for genuine commercial errors not to be treated as corruption.

Many of the committee’s recommendations have found place in the Public Utilities Dispute Resolution Bill. Meanwhile, the one-time dispensation of “date of commencement of commercial operations” and the need to deal with “actionable stress” have been appreciated across the industry. Further, the thrust of the committee on “service delivery” is a welcome move; however, it needs robust legislative support. Overall, implementing the committee’s recommendations calls for judicial reforms in a big way.

Meanwhile, there are reservations about the committee’s discouragement of the Swiss Challenge method. According to some industry players, the committee could have taken a more robust position on the creation of development finance institutions (DFIs). In addition, solutions to weed out irrational bids could have been better modelled for the government to act upon. It is also understood that projects will not be put up for bidding until 100 per cent of the sovereign clearances are in place (including the acquisition of the entire land required for the project).

In terms of financing PPP projects, there is a need to acknowledge that foreign funds will not assume the initial project risks. Thus, domestic financing must be strengthened. Be-sides, implementing two key recommendations of the committee, the first regarding the monetisation of projects (where viable projects with stable revenue flows are identified and monetised) and second, equity divestment by the government offering it to long-term investors (including overseas institutions), will be significant enablers for PPPs, going forward.

Also, the concept of DFIs to lower the cost of capital should be revisited. Innovative financing options such as an offshore special purpose vehicle (SPV) which can utilise the economies of scale by borrowing in toto from around the world and then on-lending to infrastructure projects may be considered.

Infrastructure financing lines from both new and existing multilateral agencies must be encouraged and facilitated, as these entities (such as the World Bank and the Asian Development Bank) have had a long and rich experience in funding infrastructure projects in the country, and thus have a robust understanding of the same.

Overall, there is a need to have a comprehensive and cohesive environment for infrastructure financing (and development). Private investments will be crucially determined by the government’s ability to “crowd-in” the same. Going forward, with respect to emerging sources, masala bonds, infrastructure investment trusts, the National Investment and Infrastructure Fund and infrastructure debt funds are promising. Besides, initiatives such as the credit enhancement scheme will also aid significantly. However, initial support (withholding tax, for instance) would need to be provided to these infant markets to help them take off. The outlook is fairly positive for PPPs, as hopes have been revived with the clear position of the Kelkar Committee in terms of the problem areas. However, it remains to be seen how many of its recommendations are finally passed in the Public Utilities Dispute Resolution Bill as well as implemented.

Sector-wise overview

Roads

PPP projects in the road sector offer good returns at much lower risks if they are well planned. The sector has seen a lot of bullishness on projects, well beyond potential revenue streams. A key learning that the National Highways Authority of India (NHAI) has drawn from its past experience is that projects should only be bid out when 100 per cent of the land has been acquired and all the requisite clearances are in place. Developers should be cautious and make realistic and viable bids.

Financing has been a problem, especially with regard to the availability of equity, and it has been difficult to achieve financial closure of projects. Asymmetric risk allocation and the absence of an independent regulator for the sector continue to be key challenges. Land acquisition, right of way and securing clearances have also been perennial issues in the sector, while those related to exemption of vehicles from paying toll, delayed annuity payments and litigation are some of the other challenges being faced by lenders.

Overall, PPP projects in roads will be looked at on the operational and technology levels (toll collection strategies, for instance). Subsequently, better business models should be carved out. While sharing of risk is a key aspect, deliberations are needed to mitigate risk and not merely transfer it from one party to another. Also, “renegotiation” must be worked out to implement long-term contracts efficiently.

A hybrid annuity model (HAM) has been introduced in the sector, which is a mix of the pure PPP and engineering, procurement and construction (EPC) models. In this model, bids are likely to be rational and reasonable, as the total cost of projects under the hybrid annuity model is already clearly defined.

The national highway segment will offer project opportunities worth Rs 1.5 trillion in the next year. The sector will see ample opportunities in next five years for all stakeholders including developers, contractors and lenders since NHAI plans to award projects in a robust mix of EPC, BOT and hybrid annuity models.

Power

Very few power sector projects are implemented as per the erstwhile Planning Commission’s definition of PPP wherein the infrastructure asset is handed over to the government by the concessionaire after a given period of time. However, a number of projects fall under the PPP category while considering its broader definition wherein a concession agreement signed between the government and the private player entails risk balancing, reward sharing, equity sharing, etc.

In the generation segment, ultra mega power projects (with land and fuel provided by the government) are the closest to the PPP mode of execution. While there has been significant capacity addition from the private sector in the past six-seven years, there have been issues pertaining to the duration of the concession agreement which currently stands at 25 or 40 years. The Ministry of Power is presently considering proposals to amend the duration of the concession agreement for generation projects.

In the transmission segment, the PPP mode of project implementation has been quite successful. However, private players in the segment have expressed resentment over the limited role of the bid process coordinator and have sought to widen its scope of work beyond the award of the transmission project, for obtaining tariff approvals, providing precise coordinates of transmission lines, etc.

PPPs in the distribution segment have been limited either to the award of franchisees or privatisation of distribution utilities (as in Delhi). The success of the franchisee model is contingent on the proper benchmarking of expected outcomes and the availability of adequate baseline data. While the franchisee model has been successful in places like Bhiwandi, it has failed to deliver the desired results in Agra and Kanpur.

Ports

Port contracts lack clearly defined risks and responsibilities for the two parties involved in the PPP, leading to a lot of room for ambiguity and dispute. The non-fulfilment of conditions by the concessioning authority has been one of the major reasons for delays in the commissioning of port projects. Even if a project is ready for commercial operations, the lack of adequate connectivity or draught can render operations unviable for the concessionaire.

Moreover, concession agreements are planned for 30 years for commodities for which there is no clear future scenario available. If the demand or supply for these commodities changes over the years, the entire revenue model for the private player comes under stress.

Another challenge faced by PPP operators in the port sector is aggressive bidding. A few years ago, private investors were offering a revenue share as high as 55 per cent in order to win bids. However, at a later stage these contracts either resulted in a legal tussle between the operator and the government or were handed back to the government.

Going forward, the Central Port Authorities Act, 2016, if implemented, will give greater autonomy and flexibility to major ports and will bring in a professional approach in their governance. The bill is expected to resolve some of the major issues currently faced by PPP operators with respect to port trusts.

Urban infrastructure

The traditional sources of funding for urban infrastructure projects are confined to government budgets, with allocations from the central, state and local governments. Financial assistance from the private sector has so far been limited due to the inherent complexities related to the lack of a stable income stream, regulatory uncertainties, the absence of cost-effective tariff structures and the poor financial health of urban local bodies (ULBs).

The government has been relying on the private sector mainly to bridge the skill gap and bring in professional and technical expertise. The majority of PPP projects in the urban infrastructure sector focus on design and construction combined with long-term operation and maintenance.

Overall, the experience of the private sector has been mixed, with both failures and successes. However, the success rate has varied widely across segments. The water supply and solid waste management segments have been partially successful in attracting private sector participation in the development and management of infrastructure facilities. On the other hand, the sewerage and urban transport segments have failed to attract large-scale private participation due to the absence of a widely applicable revenue model, high construction costs as well as long gestation and payback periods.

Factors such as limited resources and the lack of capacity of ULBs, the absence of a stable revenue stream, regulatory uncertainties and high capital costs combined with high revenue risks, all continue to discourage private investment. Going forward, there is a need to adopt appropriate revenue- and risk-sharing mechanisms, provide adequate political support and enhance collection efficiency to encourage private participation in the sector.

Railways

The PPP model in the railway sector is still evolving. Indian Railways (IR) has experimented with private participation in different areas – rail-port connectivity, container train operations, station redevelopment, freight terminal development, locomotive manufacturing, etc.

So far, IR has had a mixed experience with the PPP mode of project implementation. With regard to PPP projects, the rail-port connectivity segment has been quite successful so far. One of the successful PPP projects is Kutch Railway Company Limited, which started operations in 2007. The company operates 301 km of tracks from Gandhidham to Palanpur, mostly carrying freight traffic from Mundra and Kandla ports in Gujarat. The amount spent on the project was paid back within three years of operations. At present, a line doubling project is under way to meet the increasing demand.

In December 2012, the Ministry of Railways (MoR) brought out the Policy for Participative Models for Rail Connectivity and Capacity Augmentation Projects, which has five models for project implementation. These are the private line, joint venture, customer funded, BOT and annuity models.

PPPs in station redevelopment have not been quite successful because it was expected that stations will be self-sustainable based on real estate activity. However, this has not proved to be the case.

So far, the PPP model has been approached by the MoR on a case-by-case basis. This approach has led to time overruns due to the negotiation and finalisation of the concession agreement on an individual basis.

Going forward, IR requires huge amounts of funding. To meet this requirement, PPPs have to be encouraged. Concession agreements should be made flexible, with room for adaptation and learning. PPPs will be successful only if the private player is treated as a true partner and risk is properly allocated. The setting up of an independent regulator also needs to be considered more seriously.

Renewable energy

The government has scaled up capacity addition targets significantly in the renewable energy sector. To achieve these targets, it is essential that there is an alignment between the interests of private developers and the government (both central and state). While India is yet to see the PPP model in its true sense in the renewable energy segment, initiatives such as solar parks indicate that PPPs are possible in the sector. However, it is essential that risks associated with projects are adequately distributed between the two parties to ensure that the interests of all stakeholders are safeguarded.

Conclusion

Going forward, there is a need to create a well-designed contract with clearly defined risks and responsibilities for the parties involved in the project. The scope of projects offered to private operators should clearly spell out the role of each stakeholder, the share of the cost, methods for assessing performance, etc. To conclude, private investments are more of a necessity than a choice if we are to close the infrastructure deficit that is holding back economic growth.

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