Talking Point. It’s time to build highways differently

The highway infrastructure sector is burdened with structural problems. NHAI has started awarding projects under the new hybrid annuity model (HAM) to overcome issues seen in the past. While this is a welcome step, it lacks a long-term view to solve the problems. It may be better to adopt methods such as least present value of revenue (LPVR), which was emphasised in the economic survey 2015-16 to boost confidence among all the stakeholders.

Hybrid annuity model The NHAI decision to adopt newer models has been spurred by the shortcomings of the older methods. Over a decade ago, NHAI started paying private players to lay roads. This is the EPC (engineering, procurement and construction) model.

Later, the government shifted to BOT (build, operate, transfer) mode where the private player built, operated and maintained the road for a period of time before transferring the asset to the government. The private player financed the project and collected revenue through tolling or from the government directly as an annuity fee. The advantage is the low capital requirement for the government.

This BOT model resulted in bad loans for the lenders, mainly due to inaccurate toll revenue projections, thus inability to service debt by the private player.

The problem multiplies further as the process of dispute resolution and making changes to MCA becomes a worrying and long-drawn process. These factors have led banks to hold progressively increasing value of stressed road infrastructure assets over the last decade.

The NHAI recently proposed the HAM model, a combination of EPC (40 per cent) and BOT-Annuity (60 per cent). In BOT-Annuity, the toll revenue risk is taken by the government while the private player is paid a pre-fixed annuity for construction and maintenance. The overall cost of debt and equity infusion for private player is also lowered as 40 per cent of the project construction is being done through EPC. This mechanism will lead to inefficient project level allocation of traffic risk.

This hampers the philosophy of PPP which intends to share the project risks among the players who can best manage it. The problem of cost escalation and contract renegotiation may not be handled efficiently.

LPVR and the way forward

To encourage a bigger role for private players, while mitigating short-term revenue risks, we can adopt methods tested elsewhere. One such is least present value of revenues, which was first conceptualised by Engel, Fischer and Galetovic in 1997, specifically for highway franchising. It was successfully executed for Route 68 Santiago-Valparaiso highway concession in Chile in the year 1998.

The government awards the project to the player who is willing to accept the lowest present value of returns from the toll collection. For example, a player willing to expect a return of ₹100 crore should be offered the project when compared to a player who wants a return of ₹110 crore when the cost incurred by both is ₹90 crore. This is considered in tandem with other technical and financial parameters.

This helps the government to understand the normal market return expected.

The project is granted with the expectation that once the quoted LPVR is reached, the concessionaire term comes to an end and the project asset gets transferred back to the government. This method converts the demand risk into time period risk.

This allows a flexible time period for the concessionaire as well as allows short-term demand fluctuations to be managed efficiently while framing the contract. This helps the traffic risk to be transferred to the private player in the most efficient manner possible, at the same time capping the renegotiation terms return requirement to the initially accepted lowest present value. A lower and decreasing present value of return that is still required to be paid as the project progresses will help government to cap the payment to the difference between LPV and the return already received by the private player in case of severe operational or contractual issues. This creates greater confidence among the project financiers, including pension and insurance funds.

A combination of EPC and LPVR similar to the HAM model can help transfer the traffic risk away from NHAI while reducing the equity and debt burden for the private players. This will be an encouraging move in the current context of macro-economic uncertainty and a depressed investment cycle.

COMMENT NOW