Today's Editorial

30 April 2018

Hitting the highway construction target

Source: By Sudip Sural: Mint

Over the past three years, a substantial number of national highway projects have been awarded through the engineering, procurement and construction (EPC) and hybrid annuity model (HAM) routes rather than the build, operate, transfer (BOT) mode that was dominant earlier. Given that the EPC and HAM contract structures require significant—and upfront—“skin in the game” from the government, and given that about Rs5 trillion of funding is required over the next five years to build highways under the ambitious Bharatmala project, there could be incipient fiscal stress if the pace of project awards through these modes continues.

It would be prudent, therefore, to facilitate more private sector funding of greenfield BOT projects, and, thus, de-risk the fisc. BOT investments have been muted in recent times owing to the debt-laden balance sheets of sponsors and bloated stressed assets of public sector banks. Moreover, investors have been chary of infrastructure projects owing to perceived risks in the public-private partnership (PPP) framework.

Also, asset monetization programmes announced by the National Highways Authority of India (NHAI), such as toll, operate, transfer (TOT), have crowded out asset sales by private developers to private equity investors, and, along with a lukewarm investor response to new infrastructure investment trusts (InvITs), delayed the much anticipated deleveraging process in the private sector. Traditionally, cash-rich private equity investors have shied away from investing in under-construction infrastructure assets owing to the absence of optimal risk-return allocation in the contractual framework.

In order to improve participation by long-term investors and achieve the highway construction target of 45km per day, it is critical to revisit the nagging issues deterring investors/private developers within the overall framework of the concession agreements. The good part is, there exists potential for private sector participation in under-construction BOT (toll) projects with high traffic density, and the government can do its bit by facilitating some crucial enablers in concession agreements.

The first of these is easier land acquisition. The recent increase in compensation rates to farmers for their land and digitization of land records are expected to increase the project implementation rate. However, project timelines also get delayed in the absence, or partial availability, of right of way (RoW) and rail over-bridge (ROB) approvals, ultimately affecting project viability. To resolve this, the government should take a leaf out of the HAM book, where projects are awarded only when 80% of the required land, including in critical areas, has been acquired.

As a condition preceding the disbursement/pre-appointed date, all land that could prevent the construction of any critical element for toll projects—such as toll plazas, and structures with a revenue implication for the commercial operations date (say, tunnels/bridges where toll rates are linked to the structure cost)—and thus affect the issuance of provisional completion certificates, should be granted upfront. This condition should not be waived at all.

The second important facilitation is contract enforceability. In September 2016, in new guidelines for arbitration, the government said it would release 75% of the arbitral claim amounts against margin-free bank guarantees in situations where arbitral awards have been given but contested by the relevant authorities. However, this scheme has benefited only a few because most developers were unable to provide bank guarantees. Banks are wary of offering margin-free guarantees because many developers have weak financials. Although the NHAI has announced a conciliation and settlement mechanism through independent experts to resolve disputes with concessionaires, it needs to be closely monitored whether all claims are settled expeditiously in an unbiased, user-friendly and cost-effective manner.

At times, local users’ not paying toll leads to loss of revenue for concessionaires; this, in turn, affects investors and lenders. Despite concession agreements allowing discounted toll rates for local users, the concessionaire finds enforcement difficult owing to lack of administrative support, especially from the state governments. Offering such support is a contract covenant, but there is little forthcomingThird is renegotiation of contracts. Although the Union budget for fiscal 2017 announced that guidelines for the renegotiation of PPP concession agreements would be released, there’s no sign of that yet.

A pertinent example would be of what happened during demonetisation. Private road developers did not have the bargaining power to offset revenue loss when tolls were suspended in the absence of a renegotiation clause for unforeseen circumstances in concession agreements. Therefore, going forward, for force majeure events, such as demonetisation-driven toll exemption, the government should facilitate timely compensation by embedding it in the “change in law” clause of concession agreements.

Enhancing the enforceability of contracts and striving for predictability in execution are necessary to attract private capital in crucial infrastructure sectors such as roads. Going the whole hog on HAM— and EPC—and stretching the fiscal deficit would be folly.



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