The hybrid annuity model (HAM), one of the three variants of public-private partnership implementation modes, was introduced by the National Highways Authority of India (NHAI) five years ago, in January 2016. Although the engineering, procurement and construction (EPC) model has been one of the dominant modes of awarding projects by NHAI, HAM projects have recently witnessed a surge.
During 2020-21, NHAI awarded 141 projects for a length of 4,788 km. Of these, two were awarded on build-operate-transfer (BOT) (toll) mode for a length of 132 km, 69 projects for a length of 2,609 km were on HAM and the balance 70 projects for a length of 2,047 km were on EPC mode. However, over the years there has been a decline in the interest in HAM projects. The experiences so far have been mixed as HAM projects started facing implementation challenges such as issues in land acquisition and delays in achieving financial closure. The second wave of the pandemic further affected the progress of works. Concessionaires have been affected financially, while they are simultaneously providing basic facilities to labourers, staff and bearing all the expenses including on their treatment, etc.
Under Bharatmala Pariyojana, 60 per cent of projects have been envisaged on HAM while only 10 per cent and 30 per cent projects have been envisaged on BOT (toll) mode and on EPC mode, respectively. As of June 2021, an aggregate of 543 road projects with a total length of 19,062 km were approved and awarded at a cost of Rs 5.51 trillion, including 117 projects with a total length of balance work under the National Highways Development Programme (NHDP). Of the 543 projects, 358 projects, that is 58 per cent of the projects, spanning over an aggregate length of 10,972 km have been approved on EPC mode. Around 41 per cent of the projects, that is 181 projects, covering an aggregate length of 7,749 km were on HAM mode while only 4 projects (2 per cent) covering an aggregate length of 341 km were on BOT (toll) mode. Hence, EPC as a model remains more prevalent than HAM and BOT.
As per CRISIL Ratings, in July 2021, execution of HAM projects was mostly on schedule. Around 60 per cent of the projects covering 3,200 km of roads are either completed or being executed on time. However, weak sponsors remain a concern as their projects face multiple delays. Of the total number of delayed projects covering a length of 2,200 km, nearly two-thirds are being executed by a few weak sponsors with constrained liquidity, which has hampered project execution.
Some of the key challenges that continue to plague HAM projects have been elaborated below.
- Land acquisition: A large number of projects experience delays due to non-availability of required land. Project authorities often declare the appointed date even when 80 per cent of the land is not fully acquired. Therefore, it should be ensured that 80 per cent of the land is fully acquired with clear titles and free from any hindrances before declaring the appointed date. Furthermore, even though there is a provision that allows for descoping of the unavailable land from the overall project and issuing a partial completion date if the developer completes the project on the available land, disputes between the developer and the government often hinder a quick resolution.
- Weak financial strength of concessionaires: In HAM projects, 40 per cent of the project cost is funded by NHAI and rest has to be funded through debt and equity. Bid eligibility criteria have been revised – the minimum net worth limit has been reduced from the earlier 25 per cent of EPC cost to 15 per cent of EPC cost. The definition of the core sector has also been expanded to include stadiums, hotels, warehouses and hospitals. This is an opportunity for smaller players operating in non-road sectors. However, it could also cause further hindrances in the sector as a whole. Consequently, smaller companies can participate in the bidding who may not have the required technical or financial ability to complete the project. Banks may also not be inclined to fund, leading to overall delay in the process.
- Delay in achieving financial closure in HAM projects: With issues like low equity requirements on the part of the developer under HAM, financial closures have become difficult. Some bidders have won a disproportionate number of projects and as a result they now have orders that add up to over three times their annual revenue, creating difficulties in achieving financial closure.
- Increase in competition: According to ICRA, competition in the road sector is expected to remain at an elevated level with more contractors fulfilling the relaxed eligibility criteria. HAM has also witnessed heightened competition resulting in average premium to NHAI cost reducing to around 15 per cent from 25-30 per cent earlier and even negative O&M bid in some cases. The number of bidders has surpassed 40 for some of the EPC projects and 10-15 participants for HAM projects. Bidding discipline, therefore, remains a key for road contractors to maintain adequate profitability and avoid build-up of stress on the working capital cycle.
Key changes introduced in the revised MCA of HAM projects
The Ministry of Road Transport and Highways, in November 2020, issued a revised model concession agreement (MCA) for new HAM-based road projects in an attempt to mitigate the challenges faced by stakeholders under the previous concession agreement. The key changes introduced were:
- Interest annuities for upcoming HAM projects are now to be linked to the average of one-year marginal cost of funds-based lending rate of top five scheduled commercial banks as against bank rate linked interest annuities payable under the existing agreement.
- Release of construction annuity in ten tranches as against five tranches of the existing concession agreement.
- Increase in effective interest rate on mobilisation advances from authority.
- Allowing 100 per cent change of ownership post six months from commercial operations date (COD) as against the current lock-in period of two years from COD.
Linking both borrowing rate and interest annuities to a common benchmark is expected to lend greater stability to cash flows in the operational phase while offsetting the risk of non-linear transmission of bank rate over lending rate. Revision in the lock-in period is likely to deleverage the balance sheet and free up the equity quicker which will eventually lead to a surge in investments in the road sector. Under the revised model concession agreement, an improvement in the average debt service coverage ratio is expected. Phasing out of construction annuity is predicted to improve the working capital cycle for the road developers executing HAM projects.
The road ahead
With increased activity in the road sector, it becomes crucial for NHAI to address the above-mentioned challenges being faced by stakeholders. A parliamentary standing committee on transport, tourism and culture, in July 2021, suggested that the land for which compensation has been paid to the owners should be treated as available on the appointed date rather than treating the issuance of notification for “acquisition” of land as “availability of land”. An independent regulatory authority should also be established in the road sector to speed up the resolution of contractual disputes/ counter claims.
Increase in promoters’ contribution and corporate guarantees of sponsors need to be specified to improve the viability of HAM projects. It was also recommended that NHAI issue a clarification regarding the fate of annuities in cases where an extension of time (EOT) is issued in HAM projects facing delays. It is important for lenders to be sure that annuities do not lapse on account of granting EOT to a project. The current tender awarding methodologies should be reviewed. Safeguards should be included to ensure that the number and size of projects awarded to concessionaires are reasonable enough within their financial capabilities. Suitable amendments should also be made to the MCA for HAM projects to ensure financial closure.