With shift from the erstwhile revenue-sharing model to fixed premium model under NVGF, NHAI has managed to reduce its own risk. Four of the best road sector experts explain how NVGF works and why it reflects increased competition.ParticipantsK Venkatesh, Chief Executive & MD, L&T Infrastructure Development Projects, which has bagged the 66 km Krishnagiri-Thopurghal stretch at a Rs 140.04 crore NVGF, and the Bharuch-Vadodara stretch under NHDP V at a Rs 470 crore NVGF.Lalit Jalan, CEO & Director, Reliance Infrastructure, which was the first to bag a NVGF contract in India (Pune-Satara National Highway stretch), and has also won the Hosur-Krishnagiri NH stretch.Sanjay Divakar Joshi, COO, Lanco Infratech, which has Rs 2,073 crore worth of NH contracts and is now keen to bid in NVGF road projects.Hemant Kanoria, Chairman, Srei Infrastructure Finance, which has recently decided to drop a part of its Rs 12,000 crore investment in 14 road projects.Who decides viability in Negative Viability Gap Funding (NVGF)? How do you arrive at the figures while calculating the revenues in your bid?KanoriaRoad projects typically have a single stream of revenue-user toll charges. We arrive at the revenue of user toll charges by analysing the likely traffic on the route and its projected growth over the years.The analysis includes several factors like seasonal variations, axle-road survey, alternative route survey, willingness to pay, origin-destination (OD) survey, analysis of traffic growth and traffic projections.The user toll rates are specified in the respective concession agreement.VenkateshLet us first address who decides the premium (as per today's bidding criteria) or the revenue share (as in the past). Negative grant (or premium, as it is more popularly called today) is an amount that can be shared with the authority in lieu of the concession. This amount is generally calculated from the toll revenues after all the obligatory expenses such for operation and maintenance (O&M) and debt service are met. Premium applies only to projects on dense traffic corridors with a significant potential for growth of traffic.The premium is decided by the bidders, and there is no outer limit to the premium that can be offered to a project. In the current form, this is quoted as a fixed sum to be paid to National Highways Authority of India (NHAI) irrespective of the revenues, and is escalated at five per cent per annum. The quantum of premium is a function of the construction and operating costs and revenue pitched against each other and weighed against the return expectations of individual bidder. In other words, the bidder is willing to share with NHAI any extra amount that he expects to generate after meeting debt servicing obligations of interest, repayment and his own return expectations.JalanBoth our NVGF projects (see box "Participants") have been collecting toll and have been paying monthly NVGF to NHAI. In recent bids, we have observed fierce competition among bidders resulting into exceptionally high premium sharing by L1.Typically, the occurrence of quoting VGF or NVGF by the concessionaire to win a project is driven by economics. In some of the feasibility reports, NHAI provides an indicative NVGF figure based on internal financial analysis which the potential concessionaire is expected to quote. However, R-Infra's decision to quote VGF or NVGF in a particular project is solely dependent on its own analysis and traffic / revenue projections, arrived after conducting detailed due diligence of the project at the pre-bid stage. Detailed traffic study is organised through a consultant of repute to understand the traffic volume, dynamics and travel pattern, and potential growth, and more importantly, to identify existence of alternative route and measuring the potential impact. Finally, based on the due diligence input estimation of revenue and cash flows are worked out and take decision to quote VGF or NVGF.The risk that the private bidder takes in this case is based on how optimistically he views several uncontrollables, including political decisions. How effectively can you factor them in?JoshiApart from land acquisition, delays on account of pre-construction activities such as forest clearance, shifting of utility infrastructure, clearance from railways, etc, needs to be factored in. Other financial risks such as interest rates and inflation are also a matter of concern for the developers. The delays in project implementation severally affects equity returns to the developers as increase in project cost due to inflation and interest during construction (IDC), in addition to the loss of toll revenue.VenkateshLand acquisition and the Right of Way (ROW) availability is a crucial factor. The Concession Agreement (CA) offers a few remedies and safeguards to protect the concessionaire against undue land acquisition delays. However, the CA in the current form does have certain loose ends where an imbalance in risk transfer exists. The delay penalties vide the CA are quite paltry when compared with the actual loss in revenue and escalation losses that may occur. As the concessionaire cannot negotiate the CA provisions, the concessionaire will conduct extensive field investigations and will factor suitable financial provisions in the bid.The MCA is standardised and tested, and political decisions seldom have any effect on concessions. The other risks which get factored in the bid are the risk of escalation of prices during the concession period. In case of hyperinflation, the risk still remains uncovered. In terms of the expectation of traffic growth in the corridor is a major determinant and for this extensive traffic studies by experts in the field is the only solution.There is no system to recognise the actual cost of the project of the concessionaire and Total Project Costs (TPCs) are governed by the 2-3 month old feasibility studies that NHAI undertakes. Many risk (political and non-political) mitigation measures in the CA links the same to TPC which in most cases does not cover the actual costs. With experience, bidders tend to provide for these risks adequately in bids, and perhaps this is one of the reasons for wide variations in perceptions at bid stage and consequently in bid numbers.JalanEarlier, NVGF was directly proportional to revenue collection by the concessionaire, but NHAI has changed that concept by implementing absolute NVGF with escalation. Because of this, the bidders are exposed to huge risk keeping in view the uncertainty of toll income and treatment of such NVGF as fixed cost.Initially, our Pune-Satara project had to face toll-noncompliance but it is addressed to a great extent so far due to effective liaisoning with the concerned.There have been relentless efforts from R-Infra towards continuous improvement of checks & balances with respect to toll management and communication with various stake holders for optimum toll collection.KanoriaIn the present road concessions, ROW is the responsibility of the NHAI, which provides at least 80 per cent of ROW before concession commences. There are sufficient provisions under the CA for provisional commercial operational date (COD) with 75 per cent completion upon which tolling can be started.Political risks are limited to handing over balance 20 per cent of the land and political interference in toll collections. NHAI even provides additional time for achieving COD in case completion is delayed due to delay in handing over the balance 20 per cent ROW.The risks here vary from state to state and depend upon Centre-state relationships as well. However, these risks cannot be completely factored in and as of now, in India, insurance policies are not available to mitigate this risk.Competition-especially from non-tolled roads-must be critical for this type of bidding. How are you covered on that front?JalanYes, definitely nationwide tolled roads are facing competition wherever non-tolled road exists as an alternate route. Existing portfolio of R-Infra has 11 projects located nationwide, strategically at important places and connecting major cities of India, most of which have no parallel non-tolled road or other alternate route.In-depth traffic study, through which existence of the non-tolled road and other alternate routes are identified and impact, helps in formulating risk mitigation tool well in advance and facilitates in decision making of the potential project.JoshiAs a part of traffic surveys, traffic leakage through alternative routes is studied and the tollable traffic is discounted accordingly while establishing project viability.KanoriaCompetition from non-tolled roads remains. Diversion due to such existing roads may be factored. In case NHAI builds such a competing road, there is some compensation, although it is quite inadequate. However, in case a new competing road is built by a local authority or a state government, there is no compensation, and bidders remain exposed to this. We have made representations to the authorities on this issue and hope to get some resolution.VenkateshCompeting roads if any or any state road network which bypasses the toll plaza on the project corridor is disastrous for the project in terms of its viability. However, during the pre-bid stage, a detailed study will be done to identify the alternate roads and the same will be factored in the bid.State Support Agreements (SSAs) were essentially aimed at getting the state governments to commit not to construct/develop adjoining parallel facilities. There is a clear lack of coordination in road development policies between state and national agencies. Consequently, each is not aware of the development plans of the other. However, SSAs have not been effective and some states have decided not to sign such agreements.The MCA has clauses protecting the concessionaire from NHAI or other government authorities constructing or developing competing facilities; however, the definition of competing facilities does not offer much comfort to the concessionaires. Only a thorough due diligence at pre-bid stage would help, and alternate roads' conditions in some cases undergo wide changes with time and this creates new risks.Has financial closure been any different in NVGF than in other forms of contract, say, BOT with VGF? What has been your experience?KanoriaThe NVGF projects are also being funded by banks, but they go into full details to ascertain the viability of the project before taking any decision. For NVGF projects, lenders are more cautious and rightly so. Many bidders are getting aggressive which may not be healthy and result in multiple problems subsequently.VenkateshA rational bidder would quote a Negative Grant or Premium only if the project meets its investment thresholds in terms of returns for equity investors and adequate debt service covers. This being the case, closing a Negative Grant project and a VGF project is no different. Four laning to six laning projects have revenue collection rights during the construction period. Consequently, there will be premium payment requirements as well during the construction period. In the current system of capitalising all outflows during the construction period, there would be a big difference in costs as far as NHAI estimates and bidders' estimates are concerned.This creates an uncomfortable position with the lenders as any termination would be linked to a cost which is then much lower than actual costs and lenders might be looking at much lesser termination value than what they had funded.Having said this, in case the lenders perceive the premium shared to be very aggressive then the lenders may insist on additional guarantees and higher equity participation by the concessionaire.Current VGF rule requires concessionaires to pump in 50 per cent of VGF as equity and therefore in many cases, total debt component is on the lower side.Hence, as far as lenders are concerned, a VGF project may be little more risk-free when compared with a premium project.JalanAs told earlier, quoting VGF or NVGF by any bidder is pre-dominantly guided by requisite cash flow in the project. However if any NVGF is quoted which is detrimental to the project financial, then the bidder runs with possibility of facing hard time to do financial close. R-Infra is having projects in its portfolio won as mix of VGF & NVGF. However, all these projects have been won at strong project financial with requisite Debt Service Coverage Ratio (DSCR). Hence Financial Closure for R-Infra projects has been quite smooth. Since going forward R-Infra continues to maintain the same philosophy, financial closure will never be a challenge for R-Infra.JoshiThere is no fundamental difference for the financial closure as the financing plan is dependent on revenue potential of a project based on the tollable traffic. As long as the financiers are convinced about the revenue potential to service premium (NVGF), debt servicing and other O&M costs, there is no issue on financing. As of today, we have no road project under development with NVGF.Is this a way for NHAI to reduce its own risk at the cost of developer risk?VenkateshIn the current avatar of the bidding, while the concessionaire carries the revenue risk, NHAI will get a fixed premium escalated at 5 per cent year-on-year (y-o-y) and is free from risks. In short, the bidder pays an escalated annuity on a y-o-y basis to NHAI. So the bidder takes a higher risk.So, the answer is yes. In the case of four- to six-laning projects under NHDP Phase V, wherein toll collection is allowed during the construction period. Invariably, it has been seen that NHAI has not been revising the toll rates on corridors being tolled by it through various tolling contractors. Toll rates have not been revised in some cases as in the case of Kishangarh-Udaipur-Ahmedabad project since 2006. When the concessionaire begins to toll, the toll would be revised to 2011 rates, causing a significant increase in the rates, especially for multi-axle vehicles (MAVs). In addition, the public funded projects are still following the old toll policy, wherein all kinds of trucks (2-axle, 3-axle and MAVs) along with buses are being charged the same toll rate. In terms of passes, vehicles can make any number of trips in a day (daily pass) or in a month (monthly pass).With the advent of the new toll policy in December 2008, which was applicable for both the public and private funded projects, NHAI chose not to move to the new toll policy. This has led to a wide gap in terms of the toll to be charged and the operation of passes which, according to the new toll policy, is based on number of trips (daily passes restricted to two trips and monthly passes 50 trips). When the concessionaire steps in for six-laning of projects, they are faced with opposition and resistance from the users.This way, NHAI has passed on the risk of compliance and toll revision to the developer. The current rule of fixed premium, rather than a share in revenues, is indeed a 100 per cent risk transfer from NHAI. Although the bid letter reads that "offer to pay premium of so much out of the revenues collected", the fact remains that irrespective of toll collections, concessionaires are required to pay the premium. Hence, if the revenue does not meet expectations due to lower volumes or willingness issues or other law and order issues, NHAI is unaffected as far as premium receipts are concerned.JalanNHAI concession agreement clearly allocates risk sharing between NHAI and concessionaire. NHAI risks are mainly associated with providing requite ROW and necessary governmental permission and clearance within stipulated time. With regards to the NVGF, it is the price to be paid by the concessionaire to NHAI for getting rights and entitlement for toll collection for the concession. Earlier NVGF was directly proportional to revenue collection by the concessionaire. NHAI, by changing this mechanism of quoting NVGF, has certainly increased the risk exposure of concessionaire. Earlier, risk of obliging such NVGF would have adjusted to the traffic risk. Thereby the mechanism created a natural hedge. Now bidders are exposed to NVGF payment risk along with traffic risk also.KanoriaNVGF was recently converted to fixed payments over the concession period subject to a 5 per cent escalation every year after the B K Chaturvedi Committee recommendations. Earlier, it was based on revenue sharing with NHAI.`We feel that NHAI has reduced their risk to a great extent with this change and developers are taking on a higher risk now.On this issue also, we have made representations to the Authority to revert to the revenue sharing model as the essence of PPP is in risk sharing.Does the Feasibility Report for an NVGF project include special exercises and indicators?VenkateshWith the advent of DBFO, NHAI during the pre-bid stage takes a lesser load and consequently the Feasibility Reports (FR) is day-by-day becoming thinner, mostly sketchy. The way FR is used is highly specific to the executive in NHAI and it appears that there is no standard policy. In some cases, some parts of the FR like the plan and profile drawings are made binding and in some cases FRs are fully ignored. Quite ironically, when an entire FR is termed as indicative, a cost estimate that comes out of it is used as the backbone in the MCA as far as termination payment is concerned. There is no policy on sharing the contents of the FR. So the answer is yes. When projects are recommended for VGF and NHAI is getting premium bids, NHAI may ask an internal question as to whether the bid is sustainable although they are contractually not bound to do that. Also, FR can include certain worse case scenarios under which performance of the concession can be mapped. However, the FR in the current form cannot achieve any of these due to less time and scope of the FR consultant and NHAI's over involvement in many recommendations. There have been instances of arbitrary cost cuts and changes in scope without getting into detailed analysis and the implications of the same. Additionally, FR uses certain standard assumptions of growth rate, cost template, financing assumptions, return expectations, etc, which are never project-specific and are far from market realities. If proper time and energy is spent on FRs, this can be a good guiding document for bidders.KanoriaThe Project Feasibility Report needs to be improved significantly in its overall quality and aspects which require special attention are OD survey, study on project influence area, traffic growth study, study on traffic diversion, alternate route survey, among others. Also, the reports become quite old for any use to the bidders due to the huge gap in timing between preparation of the Feasibility Report and announcement of the project. On an average, there is a gap of two years.