Enforcing contracts: Upholding the sanctity of contracts

Mitigating regulatory risk in infrastructure, the airport regulator shows the way by rejecting DIAL’s petition for a viability gap funding of Rs 3,538 crore till 2023-24; flexible contracts and easy renegotiations only uphold the jugaad principle in Indian infrastructure, which entails winning the contract by aggressive bidding, and then renegotiating later

Enforcing contracts: Upholding the sanctity of contracts
We do not want to go the Latin America way where renegotiations (implying, no sanctity of contract) have become the rule rather than the exception.

By Kumar V Pratap

The most important regulatory risk faced by investors in infrastructure sectors is tariff risk, i.e. the regulator may not allow cost-recovering level of tariffs. This is apparent from the record of the power sector, where there is a loss of Rs 0.72 per unit of power sold in the country, resulting in bankrupt power distribution companies, stranded power plants, and the recurring need for bailout packages for the power sector—even the Aatma Nirbhar Bharat Package had a Rs 90,000 crore loan component for power distribution companies to be sourced from the Power Finance Corporation (PFC) and the Rural Electrification Corporation (REC). Regulatory risk is mitigated through cost-reflective tariffs and upholding the sanctity of contracts.

The Covid-19 pandemic has had a major impact on the finances of user fee-based infrastructure services such as toll roads, airports like Delhi International Airport Limited (DIAL), metro rail, etc, as the services were shut for many days and even now are running well below full capacity because of the requirements of social distancing and the continued impact of the pandemic.

Covid-19 is agreeably a black swan event and the relief provided in the concession agreements for this non-political force majeure occurrence is the extension of the concession period by the force majeure period. To take care of the immediate liquidity requirements, the Reserve Bank of India (RBI) had allowed a moratorium of six months on debt servicing.

The DIAL has represented that its traffic in 2020-21 would be about 30% of the traffic in 2019-20, and the traffic is expected to normalise only by 2023-24; it has requested the airport regulator, the Airports Economic Regulatory Authority (AERA), for a viability gap funding of Rs 3,538 crore till 2023-24, to be made good through higher user fees imposed on passengers and airlines.

However, the AERA has, in its order dated December 30, 2020, rejected the petition saying that “it is not inclined to consider the representation of the airport operator at present stage and therefore has not acceded to the request,” while keeping the window open for providing any additional tariff support in the event that the depressed traffic and non-aero revenue sustains beyond FY 2022. The AERA maintained that the DIAL had over-collected the revenues beyond its entitlement by Rs 5,721 crore earlier. This surplus collection needs to be considered for recovery from the airport operator, which will be done in a staggered manner. The AERA provided the following reasons for its stand:

—The proposal is unfair to the airport users as they have already overpaid in the previous years and rather than being benefited from adjustment on this account would have to bear additional burden.
—In the case of airlines whose sustainability and viability are already impacted by the Covid-19 pandemic, the proposed increase in tariff could further worsen their sustainability, which, in turn, would adversely affect the airport.
—The proposal by the DIAL to increase tariffs would adversely impact revival of demand in airport traffic at the present juncture, which would be detrimental to all the stakeholders.

By not allowing a demand, which is not part of the concession agreement (the Operation, Management and Development Agreement) between the Airports Authority of India and the DIAL, the AERA also upheld the sanctity of the contract. India is ranked 163rd out of 190 countries in Enforcing Contracts, the lowest rank amongst the ten parameters considered in the World Bank’s Ease of Doing Business (EoDB) index. With an overall rank of 63 and the ranking on Enforcing Contracts at 163, it is clear that the low rank on Enforcing Contracts is pulling down India’s overall EoDB rank. If we are to break into the top 50 in the EoDB rankings, we need to do better on Enforcing Contracts, and AERA’s December 2020 order helps the process.

The Comptroller and Auditor General (CAG) of India was extremely critical of the move to impose a Development Fee by the DIAL in its 2012 report, which was not provided in the Concession Agreement between the AAI and the DIAL. It was maintained that the Development Fee enriched the DIAL by Rs 3,415 crore (27% of the capital costs of the DIAL) at the expense of passengers. In the current instance, the disallowing of the viability gap funding request by the AERA makes amends for the earlier aberration and also, therefore, upholds the sanctity of contract.

Flexible contracts and easy renegotiations, as advocated by some, will only uphold the jugaad principle in Indian infrastructure, which entails winning the contract by aggressive bidding, and then renegotiating later, saying that tariffs are too low (as in the instant case) or investment obligations too high, and an adjustment on tariffs or investment obligations is required for the project to be financially viable.

We do not want to go the Latin America way where renegotiations (implying, no sanctity of contract) have become the rule rather than the exception with Guasch (2004) finding that over 30% of the concession contracts having been renegotiated in that continent. He updated those numbers in 2010 to find that 68% of the contracts are renegotiated in Latin America.

According to the Private Participation in Infrastructure database of the World Bank, India is second in the developing world both by the number of public-private partnership (PPP) contracts as well as the associated investments. India had also released the first-ever National Infrastructure Pipeline in April 2020, with data on 6,847 projects at a cost of over Rs 111 lakh crore to be implemented up to FY 2024-25. India would do well to uphold the sanctity of contracts, which would strengthen the institutional mechanism so painstakingly developed in the country over several decades, for these ambitious targets to be attained.

(The author is former joint secretary (Infrastructure Policy & Finance), Ministry of Finance, and currently joint secretary (UT), Ministry of Home Affairs. Views are personal)

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First published on: 05-01-2021 at 04:47 IST