How to revive the PPP model in India

Manish Agarwal | Updated on January 23, 2018

The right connection Makes things work TRUEFFELPIX/XHUTTERSTOCK.COM

It’s possible, with balanced risk-sharing, robust dispute redressal mechanisms, and adequate exit norms

The moment the public-private partnership model is mentioned in India, the immediate reaction is that it has failed. There have been failures , such as in some power and metro rail projects, but that is not the complete truth. There have been significant successes too, in roads, ports and airports.

The PPP model is particularly important in infrastructure projects. In recent years, some of India’s — and the world’s — best airports have been built through the PPP model. But these are 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’s time to put these issues behind us and focus on reviving the infrastructure sector in India. This is imperative, given the ambitious infrastructure plans such as Housing for All, 100 Smart Cities and stiff goals in increasing the capacity of power projects in conventional as well as renewable energy.

Three steps

To revive India’s infrastructure sector, three steps will be required. The first is to kickstart 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 to revisit 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. User charges comprise part of the government’s financing strategy, and complement tax revenues. The 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 implications for 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 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.

Making a difference

The following key elements can lead to better alignment of PPP to areas where the private sector can genuinely make a difference.

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

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. Bringing predictability (lower risk) requires certain conditions.

(a) Identify and address controllable factors: ‘Plug and play readiness’ of projects is imperative, and issues such as land acquisition, 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).

(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. 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 to undertake adequate diligence in submitting a proposal. But for this to remain fair, 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: There may still be unanticipated developments that impact the project. These 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 make the implementation clear.

Towards greater efficiency

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 at the State level, is in operations and maintenance. Here, the scope for improving efficiency is significant. The 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.

Undoubtedly, while there are some lacunae in the PPP model, these can be resolved. The Centre has already tasked the Kelkar Committee to review the 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 projects.

The committee is expected to submit its report soon. 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 writer is a partner at PwC India

Published on October 23, 2015

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