#Agenda2014 - Development of Highways
India’s post-Independence government undertook the mammoth task of building infrastructure in the country. Road connectivity between centers of major economic activity and rural and urban areas was the main concern of this endeavour. Since, private players were unwilling to take up road infrastructure projects due to the low profitability and long gestation periods involved, it was the government alone which was involved in building of roads.
Direct budgetary outlays were used to finance the roads. But by the 1980s, it was becoming clear that the road infrastructure remained inadequate to attain the required socio-economic development. Also, the general argument was building up against a state directed economic strategy and in favour of de- regularisation and privatization.
The case was made for the reduction of government involvement in the economy especially in areas where private sector is willing to/potentially can enter. The government was expected to actively court the private investment in infrastructure projects. It was supposed to reduce the burdens on the government finances and improve plan implementation by freeing the sector from bureaucratic red-tapism and delays. But since, private sector had been unwilling to invest in the road projects, a new mechanism were conceived –Public Private Partnerships (PPPs). This was marketed as a win-win situation. The government will share risks of the road projects which will remove the hesitation of the private players and also reduce the burden on the public funds. It will also provide concessions to bolster the profitability of the projects. In short, government will make it a priority to attract private investments in the road sector.
PPPs have been adopted as the main route for implementation of the road projects in the country especially in National Highways Development Programme (NHDP). Public-Private partnership is the cornerstone of the flow of the investment in the infrastructure in the 11th and 12th five-year plans. It is expected to finance the major share of NHDP which is the most ambitious project ever undertaken to modernize/upgrade the road network in India. In addition, over the last decade more and more state governments have moved towards PPP model to execute multi-billion rupee road projects like Yamuna-Expressway etc.
But it has increasingly become clear that PPP has not been able to attract expected investment in the road sector and even the implementation of these projects have been slow and quality leaves much to be desired. The sector is marred with several problems which can be classified as under:-
Firstly, the problem of financing the projects. The Central sector financing for highways had predominantly been through the following five different sources: Central road: Through cess on sale of petrol and diesel, Budgetary allocation, Toll revenues on sections tolled by the government or NHAI, Negative grants or premium from certain projects awarded on BOT (Toll) mode, Multilateral funding.
External assistance (grants and loans) through GOI and additional budgetary support for specific purposes forms another important source in the budgetary sources. Internal and extra budgetary resources (I & EBR) resource mobilization includes capital gain tax exemption bonds, Line of credit from banks, direct loans from ADB and World Bank and surplus of toll revenue. Rest is private sector share under BOT (toll and annuity) and Special Purpose Vehicle (SPV) models. But despite all the efforts in attracting private investments and hype surrounding it, private sector has actually shied away from road sector. And where it has come it is due to massive concessions given by state. Government has been forced to revise its estimates to conform to the ground reality. Private sector is now expected to finance around 20-25% of NHDP rather than the over-optimistic expectations of financing about 60% of the same.1 On the basis of the estimation that 56% of roads will be awarded under BOT(toll) and 35% and 9% under annuity and EPC basis respectively, borrowings of NHAI will be Rs 1,90,000 crore by 2030-31. Annual borrowings will be around Rs 13,000 crore with Rs 71,500 crore outstanding debts by 2019-20. The borrowings of NHAI mainly constitute 54EC bonds. However, the three-year tenure and limits of Rs 50 lakhs per individual is a constraint.
The only security NHAI has is cess revenue. But even the cess revenues are not adequate in the view of magnitude of investment required. Further, due to commitments of annuity payments, flexibility in using cess is limited. In addition, cess accrual is not available for securitization as its allocation is approved on the yearly basis. The option of vesting roads with NHAI as security is unviable and toll rights are already vested with private companies. It is difficult to think about NHAI becoming debt free in medium-run. In fact, according to Gajendra Haldea2, the annuity commitments of the NHAI are already greater than the cess revenue. It means that it will have to rely on debts to meet its commitments for annuity payments and undertaking further projects. Since NAHI is planning an investment of about Rs 3, 70, 000 crore till 2012-13, the debts can touch Rs 85, 000 crore.
The major issue facing the financing of the PPP road projects is the shortage of the long-term funds due to underdeveloped financial market for long-term debt. The banks have been supporting the PPPs to fulfil the gap of such finds. But this means that they are over exposed to the road sector. Banks rely on the on the assest-liability balance to function smoothly. They are funding long-term projects based on short-term something, which means they are stretched beyond the limit. According to the RBI, the exposure of banks to seven of their top 20 borrowers exceeded 40% net worth of the bank. In another 37 cases, the amount of funding was in the range of 30% to 40%. This means that the availability of the funds for the PP projects may be difficult on the future as more and more banks hit their sectoral limits at the same time when the cost of the new projects is rising. Also, absence of a well-developed debt market in India means that the cost of borrowing from banks is higher. Banks issue short term loans whereas the loan requirement for the road projects is usually for the period of 15-20 years. This makes the bank loans costlier as the cost of projects increases.
Secondly, the problem of unavailability of most of the road projects when only assessed from commercial criteria and economic cost of concessions to private players. Since, capital expenditure on a highway project is indivisible and very large, fixed charges form the major component of the costs of providing the road services. When gains from a highway project are purely economic and accrue only to users with no externality present, the toll rate cannot exceed the marginal benefit from road services with the result that despite tolling consumer surplus may be substantial. Thus, though the net economic benefits from a road project are positive, it may not be commercially viable. Hence, there is a tendency for the private investment to be less than the optimal level. The inappropriateness of the private profitability criterion even when the benefits of highways are entirely economic and devoid of positive externalities is of special importance in India where easy transport facilities play a crucial role in stimulating local economies and creating job opportunities.3 Further, the long gestation period and uncertainty of the future traffic flow increases the risk to the private players.
But the adoption of the PPP route as the default method has meant that government has to give concessions to make the projects “profitable enough” for the private investments to flow in. Therefore, Government bears the cost of Project feasibility study, Land acquisition for road, Land for the right of way and wayside amenities, Environment clearance, cutting of trees etc. It launched various schemes like viability gap funding, tax exemptions period, duty free imports of equipment’s.
The rules for borrowing abroad are eased and tax exemptions are given to financial institutions financing such projects. And at many times government gives upfront grants for specific projects. These concessions negate the basic arguments in favour of PPP i.e. it will reduce burden on government funds. In fact, it is very difficult to deduce whether the total cost of project both overall and for government has increased or decreased due to recourse to PPP model. Also, since cost saving because of such concessions in duties etc would be minor in relation to total costs; the quantitative impact remains doubtful. However, they can have significant distortionary effects and strengthen bias against investment with high social but low private returns. Duty rebates on inputs and interest subsidies erodes allocative efficiency and give rise to deadweight loss for the economy.
Third, Lack of technical expertise, capacity building in government sector to implement PPPs and unfair practices & corruption. The lack of expertise and capacity in the government sector remains a major issue even though adaptation of model concession agreements, standardisation of the requests for qualification/ proposal and other procedures since 2005 has reduced then by significant extent. But a look at the PPP projects reveals that many of the concessions agreements have been poorly drafted. They handed over undue concessions and escape routes to the concessionaire. These concessions are aimed at reducing revenue risk arising from inadequate traffic. This negates the whole point of preferring PPP through BOT-Toll model, the main model used in India.
The concession period is often fixed for a longer time period than warranted by the costs and estimated returns involved. For this several manipulations of rules and procedures are done. Outdated traffic data are used either to over-project or under-project the traffic flow in such a way so as to provide maximum scope of windfall profits to the concessionaire.
Tolls are fixed at a higher level to ensure returns which have been calculated on inflated costs. This is also reason for private players preferring Toll based projects as it gives them maximum flexibility in recouping their costs and returns. PPPs have thus became an excuse for low cost-efficiency, maintenance etc as whatever be the cost, it can be recovered through user charges.
Then there is the crucial question of land use. The land is being handed over to the private players at no or little cost. The involvement of the private sector was to bring the much needed competition by diluting the government monopoly in the road sector. But PPP projects are more likely to have some kind of anti-competition clauses which limits the scope of the construction of any competing infrastructure facilities in the vicinity. This has reduced PPPs to a means of establishing monopolies by the private players.
The scope of the projects is decided in such a way that it includes only the bare minimum of what is actually required. When such deficiencies are revealed, it is left to the government, for which it again awards contracts to the private players.
Concessionaires are always sure of inserting a re-negotiation clause in case of lower than expected profits. It usually has provisions for right to construct more road links or development rights on surplus lands or extra land as may be granted by government. But there are no re-negotiation clauses in case where concessionaire fails to fulfil its commitments or faulty project reports result in omissions of crucial construction works. Such clauses hint not only at the incompetence of the government departments but also at the corruption and unfair practices on the part of both government bodies and private players.
The new government has a mammoth task on its hand with the target for around $1 trillion investment in the infrastructure in 12th plan period. A major chunk of it will flow to the roads and highways sector. The government must focus immediately on the funds availability for the road projects and debt liability of the NHAI. There is no reason for PPPs to be the default policy for every project. In cases where private investments are not coming or coming at too high a price (concessions), it should employ other methods like Engineering, Procurement and Construction (EPC) contracts. Here the private player/public agency is allocated a fixed budget and carries no risk other than that of completing the project on time. The self-imposed condition of attracting private investments in every project at any conditions must be dropped. The government must be ready to go ahead with the projects on its own.
In fact, this will send strong signal to market about the seriousness of the government in the sector which will boost investor sentiments. Government should rather concentrate on developing a long-term debt market and fixing the health of the financial sector of the country. The major impediment to the private investments is the lack of access to cheap and long term funds. Simplification & streamlining of the rules and procedures in the financial sector and adoption of coherent & transparent policies in the road sector should form the priority task of the government. It should speed up the proposal of creating India Infrastructure Debt Fund, which will have a capital outlay of Rs 50,000 cr for PPP projects. The Fund would re-finance upto 85% of the outstanding project debt from senior lenders. This would enable the project companies to substitute their existing debt by long-term bonds at comparatively lower interest rates. The restructuring of project debt would also release a large volume of the present lending capacity of the commercial banks, thus enabling them to lend more to new projects.
The investment by Non-Banking Financial Institutions should be smoothened to increase the fund availability. The existing re-financing and debt restructuring schemes should be streamlined and strengthened and if need new one should be launched.
Removal of the fund crunch and coherent and transparent policies along with government leading by example by undertaking projects on its own will do more to increase inflow of private funds than costly and often illogical concessions. When attracting private investment has been made the only way for building infrastructure, it is but natural that the government will have to dance on the tunes of the private players. It will have to make the road projects “attractive” by granting various concessions and guarantees.
The adoption of PPPs as a means of doing away with any scope for government to undertake road projects on its own is the major problem in the whole approach. The government always faces a trade-off between risk allocation and moral hazard in the case of PPPs. In the end, according to experiences, neither risks to government are reduced nor is problem of moral hazard resolved. The government ends up undertaking all the risks and also providing grants to the private sector players who are free to manipulate project costs & impose user charges as per their whims and reap super profits.45
Then there is an urgent need to review the concessions agreement and consequent liabilities of the government agency especially NHAI. The unfair concessions like guaranteed rate of return, no competition clauses, manipulative toll fixing must be rectified and proper mechanisms must be put in place to avoid the repetition of such agreements. It will call for a threefold approach: – capacity building in the government departments and technical training of the personnel, standardisation of the procedures for award of contract and concessions to reduce arbitrariness and lastly a clearly defined penalty for private players engaged in unfair practices.
The government must strengthen the system of audit and quality inspection. The quality of service delivery has often been found wanting especially at the toll plazas. Currently, government seems to be content by appointing (not so) Independent Consultants.
Also, an important issue has been the inter-regional disparity in the road infrastructure. Under the current system PPPs have become the default way of undertaking road projects. This has meant that bulk of the investment has gone to the richer and developed states which already had a better infrastructure. This is because they could afford to offer better concessions and incentives to the private investments.6 This has forced the poorer states to compete by offering even more explicit and implicit concessions which can only bode ill for their meagre resources. This is something the new government must take notice of and prevent state governments of backward states from granting concessions they cannot fulfil. This can be done by providing special assistance to bridge their infrastructure deficit thus dissuading them from blind rush to attract private investments.
In short, new government must make major policy decisions and also policy departure from the current regime. It must realise that the main objective is to build world class highway infrastructure at the lowest possible economic cost, rather than adopting any one method as a matter of faith, something which the current government has clearly lost sight of.
1 Report of B.K.Chaturvedi committee on NHDP
2 Gajendra Haldea, 2010, “Sub-Prime Highways”
3 Rakshit, Mihir (2009), ‘Issues in Infrastructure Investment: National Highways Development Programme’ in Macroeconomics of Post-reform India, Vol I, Oxford University Press, New Delhi.
4 “Toll-plazas-on-Gurgaon-expressway-shrouded-in-illegality”, Hindustan Times, August 09, 2013
5 “Noida DND flyway toll rates hiked from today”, TOI, April 01,2013
6 Anant, TCA and Singh, Ram, 2009 “Distribution of Highways Public Private Partnerships in India: Key Legal and Economic Determinants”