India’s PPP story: A glass half-full

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Published: October 17, 2015 2:22:37 AM

Balanced risk-sharing, robust dispute mechanisms and adequate exit norms needed to foster PPP success in India

Almost everyone has heard about the classic “glass is half-full or half-empty” parable, which shows how perceptions cloud human judgement. The story of PPP models seems to be similar. The moment the PPP model is mentioned in India, the immediate reaction is about how it has failed. No doubt, there have been a few failures in the PPP model during the past decade—such as in some power and metro rail projects—but that is not the complete truth about PPP projects.

There have been significant success stories where projects were well implemented—such as in roads, ports and airports. Unfortunately, the failures have been red-flagged, while success stories have not been prominently flagged. Besides other lacunae, the communications failure needs to be addressed when resolving PPP problems.

The PPP model is particularly important in infrastructure projects where noteworthy success stories have been overshadowed by a handful of failures. Unfortunately, failures sometimes have more traction in attracting attention than success stories. In recent years, some of India’s—and the world’s—best airports have been built through the PPP model. But these are conveniently overlooked, as the media focuses on some pain points that are inevitable in projects involving land acquisition, construction, environmental clearances and other contentious issues.

It is time to put these issues behind and focus on reviving the infrastructure sector. This is imperative, given the ambitious infrastructure plans the government has—such as Housing for All, 100 Smart Cities—and the stiff goals in increasing capacities of power projects, in conventional as well as renewable energy.

To revive the infrastructure sector, three steps are needed. The first is to kick-start the construction cycle by boosting public spending, which is already under way. The second is to address the financial stress in the banking system, largely caused due to infrastructure assets. This step is being discussed. The third is revisiting the PPP model in order to attract investors back to the sector. While some progress has been made here, particularly in national highways, it can serve as a good opportunity to learn from past experiences.

Busting the myth that user charges are necessary for PPPs would be a good starting point to avoid repeating past missteps. User charges comprise part of the government’s financing strategy and complement tax revenues. Pricing of public goods will remain a political issue, as will the need for subsidising the lower economic strata of users.

Therefore, deciding the user charges policy, and its implication on the extent of financing possible for capacity augmentation, needs to be independent of the role of PPPs in the sector.

Next comes busting the myth that PPP is a new source of capital, and can fill the gap between requirements and what the government can fund from other sources. Private sector capital is raised on the basis of future cash flows available to service the capital. Future cash flows—whether user charges or annuities—are enabled by the government, and can be leveraged for raising capital in the private or public sector. The private sector’s role in PPP is to actually commit to life-cycle costs and service levels, which can lead to better leveraging of future cash flows. For the PPP model to be viable, the efficiency differential needs to overcome the cost of capital differential.

With these two myths addressed, the following key elements can lead to better alignment of PPP to areas where the private sector can genuinely make a difference.

* Finance plan ahead of delivery plan: Each sector should prepare long-term investment and financing plans to identify revenue sources (user charges, tax revenues and others) as well as the extent of financing that can be enabled. This will highlight any gap between capacity increase needed and the capacity increase that can be afforded, through visible financing sources. Bridging the gap would require additional revenue sources or capital subsidy, which will need to be identified. Thus, the delivery plan should articulate the value expected to be delivered by PPP and thereby lead to a PPP concession structure (or risk-sharing) that is aligned to the expected role of the PPP (or areas of efficiency).

* De-risk concession structures: Focusing concession structures on areas of efficiency to be delivered by the private sector will require that risks the private sector has no control over are not transferred. In addition to turning a laser-sharp focus on performance, it will attract the right set of investors seeking long-term steady returns. But bringing predictability (lower risk) will require some steps.

(a) Identify and address controllable factors: “Plug and play readiness” of projects is imperative, and issues such as land acquisition and permits and clearances would need to be resolved ahead of the bidding process. Similarly, any other controllable parameter would need to be addressed, instead of being left unaddressed as an uncertainty (risk) in the future.

(b) Minimise speculation on uncontrollable factors: In “single-number” comparisons by the government, there is no distinction between diligent bidders and speculative ones. The argument that investors and their lenders are responsible for the risks they take is fallacious, as recent experiences show. In addition to eliminating speculative factors (such as future traffic) from being a source of competitiveness, the government should scrutinise uncontrollable factors (such as inflation). A detailed comparison of the assumptions underlying each bid will help identify whether competitiveness is arising from efficiency and innovation, or from ignoring reasonably predictable risks. Such comparative evaluation, and negotiations on technical proposals, will require bidders undertake adequate diligence in submitting a proposal, making information asymmetries visible to the authorities. But for this to remain fair, and not discourage innovation, the rules about where corrections will be permitted, and at what level it will trigger disqualification, need to be clear.

(c) Renegotiation for unpredictable factors: Finally, there may still be unanticipated developments that impact the project. The above steps, combined with a largely performance-based project structure, will minimise such an impact. Detailed scrutiny during evaluation will provide a baseline to compare the impact of unpredictable outcomes, fostering a relatively transparent framework for renegotiation. Several contracts contain the provision that the developer would be put back in the “same economic situation” in case of developments such as “Change in Law”. The baseline will help in making the implementation clear.

* Use PPPs beyond new-build: With PPPs being a tool to lock in efficiency commitments, its application becomes much wider than for new-build only. A fairly large part of government spend, particularly state level, is in operations and maintenance. Here, the scope for improving efficiency is significant. Use of long-term operations and/or maintenance contracts can bring in performance commitments and associated payments. Wherever this is expected to be visibly lower than government spends, it would make for a viable PPP. The cost savings can be channelled back into new-build. Further, in some sectors, if direct benefits transfer separates subsidy delivery from service delivery, it will become easier to design user-charge based projects (where revenue predictability is high).

Undoubtedly, while there are some lacunae in the PPP model, these can be resolved. Aware of these drawbacks, the government has already tasked the Kelkar Committee on reviewing the PPP policy in order to revitalise infrastructure development. The committee will analyse the risks involved for PPPs in different sectors and the existing framework for such risk-sharing, suggest an optimal risk-sharing mechanism between private investors and the government, and also suggest steps to improve capacity-building in government to effectively implement PPP projects.

The committee is expected to submit its report soon, with the suggestions likely to include showcasing success stories and better dispute mechanisms. Should a balanced PPP model come into force, with realistic risk-sharing and robust dispute mechanisms along with reasonable exit norms, private players may once again be able to enjoy sunny days while undertaking infrastructure projects across India.

The author is partner and leader, Infrastructure, PwC India

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