The road ahead

Can In­dia bank on hy­brid an­nu­ity model?

Governance Now - - INFRASTRUCTURE - Radha Kr­ishna Tri­pa­thy

Af­ter mixed re­sponse from the EPC (en­gi­neer­ing, pro­cure­ment and con­struc­tion) and Bot-an­nu­ity (build, own, trans­fer) model, the road sec­tor in In­dia is ex­plor­ing the Hy­brid An­nu­ity Model (HAM) for road­ways con­struc­tion. In HAM, 40 per­cent of the project cost is pro­vided by the gov­ern­ment as ‘con­struc­tion sup­port’, while the pri­vate de­vel­op­ers in­vest 60 per­cent. De­vel­op­ers get their re­turns on their in­vested 60 per­cent in the form of an­nu­ity pay­ments from the gov­ern­ment over the con­ces­sion pe­riod. Toll col­lec­tion rests with the gov­ern­ment and there is sep­a­rate pro­vi­sion for op­er­a­tion and main­te­nance pay­ments. It is be­lieved that HAM cre­ated a con­ducive ground for the pri­vate play­ers to re­turn to the road sec­tor and pro­vided much needed op­por­tu­nity for the small and medium play­ers too. In this eu­pho­ria, the gov­ern­ment went on bid­ding a large num­ber of projects un­der HAM for road de­vel­op­ment. In 2017-18, the Na­tional High­ways Au­thor­ity of In­dia (NHAI) awarded 3,396 km of HAM projects val­ued at ₹76,500 crore as com­pared with 2,434 km and ₹36,300 crore in 2016-17.

This re­sulted in a back­ward pres­sure on the bank­ing sys­tem that is al­ready strug­gling with huge non-per­form­ing as­sets (NPAS). Com­mer­cial banks have al­ready hit their ceil­ing limit for the sec­tor and are not in a po­si­tion for fur­ther lend­ing. Fresh de­mands for debts are com­ing from the new play­ers who have nil or lim­ited ex­po­sure to the sec­tor. Though, they are en­thu­si­as­tic, they lack ex­pe­ri­ence and are not ac­quainted with sec­tor dy­nam­ics, which dent their chances of rais­ing funds. Most of the ex­ist­ing play­ers are over-lev­er­aged and do not have the band­width to take ad­di­tional loads.

This raises ques­tions on the gov­ern­ment’s abil­ity to com­plete projects on time. It also raises con­cerns whether the gov­ern­ment’s am­bi­tious tar­get of adding 20,000 km by 2018-19 will be ful­filled. The near-cri­sis sit­u­a­tion de­mands a proper strat­egy and de­mand re­sponse from the NHAI. The other ques­tions that are raised:

What should be a right mix of HAM projects in the NHAI’S port­fo­lio? Should there be a bet­ter laid out cri­te­ria and de­sign for the projects to be bided out on HAM model? As HAM model pro­vides an ad­di­tional se­cu­rity and com­fort to the pri­vate play­ers, should there be spe­cial guide­lines and pro­ce­dures to bid projects un­der this model? Can this model be repli­cated for other sec­tors like cre­ation of sus­tain­able in­fra­struc­ture in wa­ter and san­i­ta­tion, health and ed­u­ca­tion?

HAM and road sec­tor

By the end of 2014, there were 400 stalled road projects with a locked in­vest­ment of ₹3.85 lakh crore on the verge of be­com­ing NPAS. Rea­sons for the grow­ing NPAS in the sec­tor inl­cude right of way is­sues, long drawn lit­i­ga­tions pend­ing in courts, project com­ple­tion time es­ca­la­tion due to pend­ing clear­ances, etc. A huge cap­i­tal is locked in these projects and as­sets can­not be mon­e­tised. As a re­sult, pri­vate play­ers are re­luc­tant to fur­ther in­vest in the sec­tor and have de­vel­oped cold feet.

Sens­ing trou­ble, the road min­istry has come out with a pro­posal to bid out only those projects where 80 per­cent right of way is avail­able. This has al­le­vi­ated some con­cerns of the pri­vate play­ers and built con­fi­dence among the de­vel­op­ers and lenders. This cou­pled with the HAM model again at­tracted in­vestors and de­vel­op­ers. Slowly the road sec­tor has picked up growth.

Cur­rently there are 1,837 projects cov­er­ing 61,164 km of to­tal length and cu­mu­la­tive value of ₹6.5 lakh crore. The port­fo­lio of NHAI, which con­sti­tuted only 10 per­cent of HAM mod­els in 2015-16, has in­creased to 50 per­cent in 2017-18. There is an or­der value growth from ₹7,000 crore to ₹76,500 crore from 2014-15 to 2017-18.

The re­vival in the road sec­tor saw

an un­prece­dented growth in medi­um­sized de­vel­op­ers par­tic­i­pat­ing in the bids. Road sec­tor com­pet­i­tive bids wit­nessed on an av­er­age of 8 to 12 bids per project. The en­try of small and mid-level play­ers suc­ceeded to cre­ate the re­quired mo­men­tum in the sec­tor. Play­ers which tra­di­tion­ally fo­cused on BOT and EPC projects have mod­i­fied their strat­egy and started bid­ding for HAM projects too.

The road min­istry’s as­set mon­eti­sa­tion ini­tia­tive un­der toll op­er­ate trans­fer model has gar­nered a good amount for NHAI. It fetched ₹9,681 crore for the 700 km bided out in Andhra Pradesh and Gu­jarat in the first round. It is ex­pected to fetch ₹6,900 crore in the sec­ond round of auc­tion. NHAI has a bud­getary sup­port of ₹71,000 crore for 2018-19 and it is also poised to raise around ₹62,000 crore through long term bonds for 2018-19.

All these fac­tors at­tribute for NHAI’S ag­gres­sive­ness to bid out fresh projects un­der EPC and HAM. The healthy bal­ance sheet cre­ated con­fi­dence among de­vel­op­ers and lenders about timely pay­ment. But a large num­ber of projects un­der HAM im­posed a sig­nif­i­cant fi­nan­cial bur­den on NHAI also.

Emerg­ing chal­lenges

Though prima fa­cie the HAM sounds a lu­cra­tive op­tion for de­vel­op­ers as the fi­nanc­ing risk is re­duced, the vol­ume of projects and con­se­quent in­vest­ment re­quire­ment puts pres­sure on com­mer­cial banks and fi­nanc­ing in­sti­tu­tions as de­vel­op­ers ap­proach them for funds at the same time. Con­strained by liq­uid­ity con­cerns and over­ex­po­sure, banks are shut­ting their doors.

The ini­tial signs of de­pres­sion are clearly vis­i­ble as projects are get­ting stuck due to fi­nan­cial clo­sure not hap­pen­ing at right time. The av­er­age or be­low av­er­age credit rat­ing of small and medium de­vel­op­ers is also not help­ing them to raise funds from the cap­i­tal mar­ket. Most small and mid­size de­vel­op­ers were un­able to pro­vide bank guar­an­tees ow­ing to their weak fi­nan­cials and banks were un­will­ing to take ad­di­tional risk by fi­nanc­ing them. These chal­lenges cou­pled with other is­sues like poor de­sign of con­ces­sion agree­ments, non-flex­i­bil­ity in rene­go­ti­a­tion, and col­lec­tion risks are putting road projects on a stand­still. This cri­sis like sit­u­a­tion is now putting ad­di­tional pres­sure on the gov­ern­ment to go back to the EPC model for fresh awards.

Gov­ern­ment’s ef­forts

The gov­ern­ment is will­ing to help project de­vel­op­ers achieve fi­nan­cial clo­sure at the ear­li­est. In its ef­forts, the gov­ern­ment, along with NHAI, is ap­proach­ing sev­eral banks and other fi­nanc­ing in­sti­tu­tions to find a way for rais­ing funds. It is also ex­plor­ing ways to take over some se­lec­tive projects to be funded by NHAI, but tech­ni­cally it seems dif­fi­cult as it will amount to favouritism and bias to­wards some de­vel­op­ers. It may also look for in­creas­ing its share of con­struc­tion cap­i­tal but whether that would help the de­vel­op­ers to raise the bal­anced cap­i­tal re­mains a larger con­cern and in do­ing so, there is a dan­ger of projects mov­ing to­wards to the EPC model which might draw crit­i­cism.

In this sce­nario, it is ex­plor­ing ways for tweak­ing the con­ces­sion agree­ments and al­low­ing the project de­vel­op­ers to sell some stake in the project to raise funds. It might at­tract wrath of other loos­ing com­peti­tors and end up in lit­i­ga­tion. So, over­all the gov­ern­ment is now in a Catch 22 sit­u­a­tion. The only way out is to go for EPC con­tracts for fu­ture projects and al­low the al­ready bided projects to lapse un­der the con­tract to go for fresh bid­ding un­der EPC route. This would re­sult in waste of time and ef­fort – a risk for gov­ern­ment in an elec­tion year.

The way ahead

Bid­ding out more projects on HAM ba­sis does not nec­es­sar­ily make sense un­til the fund­ing con­cerns are ad­dressed and ex­e­cu­tion ca­pac­ity catch­ing up in the In­dian mar­ket. The gov­ern­ment needs to draw a clear line on which projects it would want the HAM and should come for­ward with a ma­trix for se­lec­tion of such projects. As the risk is get­ting re­duced for such type of projects, ask­ing for strin­gent qual­i­fi­ca­tions (leav­ing out the over-lev­er­aged play­ers and new en­trants); fi­nan­cially and tech­ni­cally, would make sense as gov­ern­ment wants to com­plete some strate­gic im­por­tant road projects quickly. A stage-wise ap­proach for iden­ti­fi­ca­tion of projects, fil­ter­ing them un­der cer­tain cri­te­ria and rank­ing them would be a good in­di­ca­tor to start with.

Though the gov­ern­ment is run­ning out of time as the elec­tion ap­proaches in 2019, it can­not help much for the projects which are not clos­ing fi­nan­cially. So, it may de­vise a strat­egy to have a port­fo­lio ap­proach for fu­ture projects un­der HAM. It should di­vide all projects un­der three groups as ‘strate­gi­cally im­por­tant and must do’, ‘im­por­tant and medium term tar­get’ and ‘not so im­por­tant and can wait’ cat­e­gories. Top-most pri­or­ity should be given to strate­gi­cally im­por­tant projects and stricter time­line should be drawn to com­plete these projects quickly and it may be tar­geted un­der HAM, if not EPC.

In the wake of fund­ing con­cerns, it is time for NHAI and the min­istry to take a prag­matic view of award­ing projects un­der HAM model and de­cide on a suit­able port­fo­lio based on a mix of EPC, BOT an­nu­ity and HAM model. It should eval­u­ate the projects on case to case ba­sis and based on top-most pri­or­ity. NHAI should come for­ward with a pri­or­ity in­dex of iden­ti­fy­ing var­i­ous road projects based on sev­eral pa­ram­e­ters in­clud­ing sus­tain­abil­ity is­sues, com­mer­cial vi­a­bil­ity, load den­sity growth, eco­nomic em­pow­er­ment of the re­gion.

Along with this, there is a se­ri­ous need to es­tab­lish ‘in­fra­struc­ture-spe­cific fi­nance in­sti­tu­tions’ for long term in­fra­struc­ture projects which can cus­tomise their fi­nanc­ing to longer term projects with dif­fer­ent pay­ment struc­tures and risk based in­ter­est rates. Also, in­no­va­tive and al­ter­na­tive fi­nanc­ing op­tions such as pooled funds, pen­sion based funds and es­tab­lish­ment of in­fra­struc­ture in­vest­ment trusts (INVITS) may be ex­plored for long term fi­nanc­ing con­cerns. Tri­pa­thy is a se­nior fel­low at CUTS In­sti­tute for Reg­u­la­tion and Com­pe­ti­tion and a PHD scholar at Ra­jiv Gandhi In­sti­tute for Pe­tro­leum and Tech­nol­ogy.

Gn photo

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