The price of PPP

Everything about public-private partnership (PPP) in infrastructure is mega-scale, including the concession period, the commitment period, and the price of a failed project. Ajay Saxena says Reserve Bank of India’s (RBI) decision to allow project revenues as bank security should be welcomed with a sigh of relief.

In March, RBI made a dramatic allowance: it permitted revenues from PPP projects to be consi¡dered as security to raise loans. This is a major change, albeit new. This will not only ensure all qualified bidders are eligible, but also help companies avoid securi¡tisation on the bases of corporate or personal assets and guarantees.

The best project bidders bring in cost efficiencies through design and management efficiencies and tech¡no¡logical superiority. Now, there is limited scope to optimise scales of cost-especially if you want to use superior technology and design efficiency, and since government agency costs are relatively low anyway.

On the other hand, governments-including state governments-already have 20-year project plans at hand, and know when each needs to be implemented. Once PPP became a preferred method, governments could breathe easy to the extent that they had to only learn how to bid out, not implement projects. The question that follows, though, is how many private players have the capacity and qualification to conform to the criteria.

In 2011, developers grew so competitive that they did not want to be left out of project bids. As we know, this resulted in extra-high bids, sometimes unrealistic. Aggression was revenue-driven. In other words, the window to convert viability gap funding (VGF) into negative VGF (also called premium) bids is small. Cost efficiency can be projected over the construction period of, say, three years, whereas aggressive revenue projections can be amortised over the entire concession period of, say, 30 years.

The Kishengarh-Udaipur-Ahmedabad National Highway is a perfect example of this problem. It is easy to see why GMR (the winning consortium lead on the basis of a whopping Rs 636 crore-per-year premium bid) withdrew from the project. Having to pay that amount each year starting from the day they take over means they would have needed to take care of outflow before any inflow ensues, perhaps having to take out capital assets for the purpose.

Unchecked viability claims: That is where the problem is. No one can correctly predict what surprises would spring before us beyond five years. For example, the concept of mixed land use intends to limit city mobility. This would change the entire scope of traffic flow. Competition made the game more about winning a bid. Project viability came later. So bidders made lots of positive assumptions about the future environment-traffic flow spurt, decrease in non-revenue water, and so on. Not being able to achieve the desired results not only has financial problems embedded (banks’ confidence levels dip, the company loses shares, etc), but puts market pressures on the companies, impacting brands and credibility.

This is a major reason new projects under PPP are not able to attract adequate bids. Unfortunately, there is no mechanism in any of the government agencies to flag unrealistic bids. On the contrary, denying a bid will only attract unnecessary questioning. In a Mumbai case, the court ordered that a seemingly unrealistic bid must be considered with additional security. If a bidder believes the figures to be a part of his strategy-it could be on a no-profit basis simply to make an entry into a state or a sector to gain experience-that is too internal a strategy for any external agency to intervene. Even if an agency questions the potential success based on the figures and market testing, the response from the approving authority is usually that the projected figures should be believed. Therefore, much of the financial closure depended on personal guarantees, not so much on project viability.

Operational grants: In case of a project that becomes unviable, it is therefore often on the basis of an unchecked projection. To overcome this, there should be an operational grant that can be applicable to greenfield mega-projects.

Locking in large sums of investment with no available data and no guarantee of revenues is risky. It would be safer to buy the project as an operational stage. In other words, selling projects is not necessarily bad news, because selling entails a buyer who would like to avoid exposure to high-risk bidding for perhaps a marginal drop in internal rate of revenue (IRR). So, a contingent operational grant support may be more desirable in such cases, where the threshold size of the project is determined at the policy level.

A reduction in the exit clause to three years can only be beneficial to PPP projects. This might help make bids become more realistic over time, because unrealistically bid projects would come under buyer scrutiny. A variable VGF (either more or less than the optimum figure) may also work, with margins set before bidding out. This will help control windfall gains. For example, in a tolled road project, a range of traffic can be set; if the revenues fall below a certain limit, there can be a claim for more VGF, but if they are more than the range, VGF can be deducted.

Until the RBI’s March decision, there was no real way to check unrealistic bids. Banks, which have been exhausting their group and sector exposures, have limited scope to lend further to the infrastructure sectors-even if a bid is realistic. So, they also ended up believing the figures.

We observe the practice of selling assets or debt restructuring. That is why the RBI announcement should be considered seminal, and will enable private players with good credentials and capabilities to bid confidently and take a project to its fruition.