PPP should not use public enterprise investments, says Mahesh PS Gandhi, who advocates a modified model for clean and effective financing and implemÂentation of infrastructure projects.
The birth and growth of public-private partnership (PPP) in India have happened effectively, partly because they were the need of the hour, partly beÂcause the availability of private capital for the state beÂcame a matter of abundance rather than a matter of selective investment, and more because of the political advantages of perceived development. It is now impoÂrtant that we revisit the original structure, propose and assist such amendments to the system that are now much needed.
PPP operates under the premise that private capital becomes abundant only when the profits from such opportunity far outweigh the risk—only in such premise will there be a competition amongst the lenders and bankers to invest in an option. The debate would begin where economic leaders could insist that it is extremely important and useful to have a market in which investors would want to put in their money and where the author would beg respect for the thin line of distinction for the ‘market’ for social infrastructure development and any other sector where private capital is encouraged and is the only path to a free market environ.
It’s also equally important not to ignore the political reasons for creating the perception of aggressive develoÂpment; of soliciting more marks from voters in the name of more and better roads, sanitation, water, housing and commercial development. What, however, is sorely lacÂking is a review and investigation of other models for inveÂstment, and educating citizens in the basic concepts of PPP and how it works.
PPP will not succeed in a country where the stock markets are not sufficiently developed—at the exchange, as also the private market for securities. A classic exaÂmple is the Turkish market that is as yet grappling with the first / second PPP projects. India, on the other hand, has mature investors—including investment companies, individuals, banks and FIs who would invest in a share that is likely to give good returns. In such market, Public Enterprises should take the lead in using the leverages available to create value and market cap for reinvestment in social infrastructure.
The present day private developer puts in the seed money; does effective management of the projects; issues equity tranches at step-up market valuations; implements the project through its own construction company at a natural construction margin inbuilt into the bid price; and retains the final tranche of equity within its group from the Engineering, Procurement, Construction (EPC) retention and profits; securitisation of receivables helping in taking out even such equity as was never inveÂsted; raise more equity—with help from market cap—at the HoldCo level at substantial premiums (at the last call – the PPP developers enjoyed multiples of 15-22); and also gain from the increasing traffic on y-o-y basis; and there could also be valorisation gains from land parcels that its land-leasing outfit would have acquired along the stretch of the expressway or land-air rights that would have been created upon proÂject development. Such valorisation may have effectively nullified the need of even initial equity tranches to be invested.
Modified PPP
The proposed modification of PPP would involve bringing in capabilities from globally successful private as well as government infrastructure companies (and not investment); provision of social/government equity for infusion of seed money; effective management of the projects; issue of equity tranches to interested investors at step-up market valuations; implementation of the proÂject on Cash Contract basis; substituting the final tranÂche of equity with the balance of securitised receivables; and using the best financial engineering structures to reduce the payback period. While this can enable more projects to become toll free for the society within a short tenure, the effective market cap and cap-surplus that it would build shall enable further developments.
Of course, it is not as simple as it seems in the preÂvious paragraphs, involve as it does intensive engagement of the professionals in the public system and a robust and transparent project management mechanism. But these requirements should also not come in the way of a clean execution for a public enterprise, given the political will. Such modified PPP methods can be used extensively in the transportation, power, water and other social infrasÂtructure projects where there was always a user fee or annuity provision by the government.
Many foreign companies that are experts in tunneÂlling, station development, development and operation of large expressways, high-speed rail, port operation, power project engineering and development are willing to share their capabilities but not invest, given the volatilities and uncertainties in the global market. Further, such companies are often invited by private and government investors worldwide to provide construction and project management capabilities. Hence they don’t really feel the need to invest.
In India, we have been witnessing over the last 6-8 years, since PPP became the norm following the footsteps of the expressway development programme of NHAI, that foreign companies have joined bidding consortiums, cooperated in the project but have effectively not broÂught in the capital that should have ensued commeÂnsurately with their share in the project values. The Indian partner happily shakes hand on the side with the foreign partner to invest on behalf of such foreign parÂtner—even though such Indian partner’s balance sheet on the date of such agreement doesn’t support the suggÂestion that the Indian partner can invest. Readers who have been watching the infra developers’ balance sheets in the past decade carefully would probably agree.
Modification of PPP in the manner proposed will, firstly, make it possible for the foreign construction comÂpanies to contribute their capabilities and eliminate the need for such unwarranted arrangements and investment partners who would like to use their credÂentials to gain entry into a project that is valuable from all perspectives to the developer and expensive to the community.
The current NHAI provisions for pre-qualification in a project entail that only such score of a technical partner shall be considered in a project as is a proÂpoÂrtionate to the promised equity investment by that partner. Hence, if a technical partner promised to conÂtribute 76 per cent to the project at the bid stage, and upon winning, is permitted to dilute and retain 26 per cent only for the tenure of the project with another 26 per cent required to be retained by the Indian partner. A project upon award commands such premiums in the market as are enough to contribute 26 per cent upon 48 per cent dilution. Hence, the foreign partner either sells its rights on a certain arrangement to the Indian partner and continues to provide basic services for a fee or performs part of the EPC, but never does it contribute the intended 76 per cent of the project’s requisites. The liability of the project is on the local project SPV that would be by the time project is over, owned directly or indirectly only by the Indian partner. The MPPP would encourage capable Indian and foreign partners, comÂpanies, to bid for cash contracts in their own right and remain directly responsible for the implementation and quality of the projects. It shall be seen that such enabling would finally reduce the effective cost of the projects by 10-15 per cent contributing to the profit for the community.
Especially in a country like India, where the vast majority of population is naïve to the intricacies of finance and polity, the modification and correction of the PPP programme becomes more relevant as it shall enable the utilisation of the capital market where the same individual ultimately ends up, for the benefit of the community; there’s nothing wrong with national enterprise having a large market cap since everyone can benefit from it.
REDUCING PUBLIC BURDEN
One of the classic examples of MPPP in India is in cooperation between a foreign government and Government of India for development of a large infrastructure project. While the original proposal of the Indian government was for awarding the project on PPP to some large developers under bidding route, the method and in principle, as recommended by us and agreed upon between the two governments, would entail:
- No investment by state on the project
- Project shall be conceived, managed and executed
- by both the parties in a national SPV to be created for the purpose
- State shall be submitted a detailed plan of action after completion of all initial studies by the foreign government company being the collaborator
- Most of the investments for the initial stage shall be brouÂght in by the collaborator
- No giving away of such projects in their totality to the priÂvate sector bundling in substantial gratuitous market cap
- No transfer of any development surcharge on to the end consumer
- The collaborator will help the Indian vertical/state to retain asset valorisation profits substantially within the system
- All the projects under MPPP will be cash-surplus projects for the state and will not require any viability gap finance from the Government of India.
The projects whose implementation is proposed under this programme
of modified PPP can easily exceed EUR 20 billion covering most of the
important cities in India. This would lead to creation of large scale
employment opportunities in India, as also make available world-class
infrastructure to the comÂmuÂnity at substantially reduced economic cost
with near-zero investment from tax payers.
The author is CEO, AFII Corporate Advisors, a Delhi-based full service corporate advisory firm.
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