Address administrative deficiencies

The new EPC framework is a great beginning and incorporates some very good ideas. If MoRTH and NHAI can address the administrative deficiencies that have been afflicting the regulatory and project management systems of the highways sector, EPC and PPP can work much more effectively, writes Anshuman Chauhan.

The roads and highways sector has been facing one of the biggest crises since the sector was opened to significant private sector participation in the early 2000s. This crisis has been slowly building up over the years. The 2008 economic crisis acted as a catalyst which created a perfect storm for the sector.

Although there are various factors contributing to the current state of affairs, the genesis or the starting point of this crisis was the government decision to dramatically expand the role of public-private partnership (PPP) projects in developing the national highways network. This shift occurred as policymakers started to see PPP as desirable option for developing highways network on the following counts:

• Both BOT (Annuity) and BOT (Toll) model of project developments under the PPP framework shifted responsibility of project finance from government to private developers. This was seen as an effective mechanism of keeping government expenditure under control
• Under PPP contracts, private developers become responsible for post construction project mainte¡nance, which has long been a weakness of govern¡ment agencies implementing infrastructure projects

Before 2003, a majority of highway projects were executed under the engineering, procurement and construction (EPC) mode. In fact, most of the initial National Highways Development Programme (NHDP) work was carried out under EPC mode. However, from 2005 onwards, the role of PPP expanded dramatically. During six years ranging from 1997 to 2003, approximately 29,000 km of highways were developed with only 17 projects totalling 930 km being awarded under the PPP mode. In next nine years, from 2004 to 2013, project development contracts for over 20,800 km of highways were awarded under PPP mode while approximately 16,000 km of highways network got developed.

This shift in government policy had a number of significant consequences for the industry. Traditionally, most of the companies in the sector were EPC contractors with limited experience of managing an infrastructure project over its entire life cycle. Dramatic expansion of PPP project awards forced many of these traditional contractors to become project financiers and developers, a role for which in hindsight they were not prepared.

Most construction companies underestimated the project development risk entailed under the PPP framework. A number of them bid aggressively and won projects believing that transformation from an EPC contractor to project developer would be easy and seamless. However, their inexperience in PPP, coupled with problems arising out of muddled environmental approval and land acquisition processes, created severe stress for the companies themselves and brought the highway development process to a grinding halt.

This is amply exhibited by the fact that for almost 20,817 km of project awards under the PPP mode, only 3,511 km has been completed. Even if we include only 2005-09 time frame in our analysis (considering that it takes approximately three years to complete a highway project) only 3,414 km of PPP highway projects were completed under PPP contract mode against award of 7,177 km, a success rate of less than 50 per cent.

EPC in a new avatar

Recognising the grave challenges that the sector faced, government has belatedly started to take steps to revive the National Highway Development Programme (NHDP). Some of the key decisions approved by the government recently were to ease environmental approvals for the highway projects and to ease exit norms for the highway developers. In addition to the initiatives taken by the government, other government agencies also got into the act. Reserve Bank of India (RBI) allowed loans to PPP projects to be treated as secured loans. Simultaneously, financial institutions such as IIFCL initiated the process of creation of Infrastructure Debt Funds (IDF). This move is expected to provide a sorely missing alternative channel of long term financing for infrastructure companies which till now have been completely dependent on commercial banks.

However, these decisions are more tactical in nature aimed at alleviating the problems faced by the sector in the short-to-medium term. What may turn out to be a long term game-changer for the sector is re-recognition of the importance of EPC in developing the roads network.

In 2012, Ministry of Road Transport & Highways (MoRTH) and National Highways Authority of India (NHAI) started to roll out projects under the new ‘fixed price’ EPC contract framework. It differed from the traditional EPC in that traditional EPC contracts in India have been ‘unit rate contracts’ (contractors charging the government for the inputs that went into a contract), while the new EPC framework is an output-based contract. This new EPC framework was seen by the government as a solution to the problems of corruption and delays that have marred traditional EPC contracts. In addition, the new EPC contract had feature of contractor obligation for project maintenance for a few years after project completion. This step is likely to improve the construction quality of highways.

The new EPC framework was supposed to be a significant improvement over traditional EPC or PPP contract framework as it seeks to combine the advantages of EPC framework, i.e., continuous payment to contractor linked to progress of construction, and the advantages of PPP framework, i.e., output-based contracting with contractor responsible for maintenance of road asset he has created. However, the project awards under the new EPC framework have run into rough weather from the word go. NHAI awarded first four project packages under the new EPC contracting in April 2013. The average bid price for the projects reportedly came out to be approximately 20 per cent below the NHAI estimated contract price. Winning bid for one of the projects was approximately 40 per cent below the NHAI estimated contract price. On the face of it, this seems like great success with NHAI being able to extract excellent price for its contracts. However, most experts are sceptical that projects can be executed at such low rates. This seems to be continuation of a trend seen in PPP-BOT space where a number of companies, both big and small, made over-aggressive bids to win projects. These companies went on to announce their ‘success’ to stock markets. However, once the initial euphoria was over they were unable to execute the projects.

Learning from past mistakes

While it will not be right to put all the blame on the poor condition of the sector on the doorsteps of the government, MoRTH and NHAI are definitely guilty of not being able to learn from their past mistakes. Take for example the challenge posed by over-aggressive bidders. Other government departments have implemented simple yet creative solutions which have mitigated the problem of over-aggressive bids to a large extent. For example, Ministry of New and Renewable Energy (MNRE) in Jawaharlal Nehru National Solar Mission (JNNSM) bids introduced the concept of variable bid security. More aggressive the bid by a company in comparison to the benchmark estimate of the ministry, higher the bid security company has to submit. This created an automatic trip wire for over-aggressive bids.

Similarly, a number of countries around the world follow the concept of price band in infrastructure projects. Essentially, any bid which falls outside of a price band around the estimated government bid price is automatically rejected with the implicit understanding that the over-aggressive bidder has failed to understand the scope and size of services to be provided.

These problems and their solutions are well known to both MoRTH and NHAI. However, bound by the rigid framework of the model concession/contract agreements (MCA), MoRTH and NHAI seem unable to offer new ideas for the sector. The paradox here is that the bid documents which NHAI used in the past (in pre-MCA days) had a number of features that could have mitigated the problems being faced by the sector. For example, NHAI used to ask for and include in the concession agreement the financial projections of the concessionaire for the project. This simple step forced bidders to be more careful with their bid assumptions as they knew that those will need to be shared with NHAI and any abnormal assumption (overtly aggressive or overtly conservative) would have to be justified.

The lack of flexibility on account of straight-jacketed contract agreements being imposed on NHAI has already played havoc with PPP projects and now EPC seems to following the same trend. Effectiveness of this ‘single model document’ philosophy can be judged by the fact that of 68 PPP road projects awarded before the introduction of MCA, almost 90 per cent of the projects have been completed while 104 projects awarded under the MCA from 2007-10, only 14 have been completed till date (projects after 2010 have not been taken into account for this analysis as it normally takes three years for completing a project).

A great beginning, but…

New EPC framework is a great beginning and incorporates some very good ideas. However, trying to create a single document which meets the requirements of a continent sized country such as India is a futile exercise. If MoRTH and NHAI really want to get maximum bang for its EPC buck then it will have to start seeing each set of the region under their jurisdiction as unique and start creating contracting frameworks accordingly. This would mean empowering its staff to effect changes in contract documents based on ground realities of each individual project. Unless MoRTH and NHAI address the administrative deficiencies that have been afflicting the regulatory and project management set-up of the highways sector, neither EPC nor PPP projects will see much success.