Taking stock: Domino effect – Too late to stop?

Is the worst over for infrastructure? The fact that this question lingers is perhaps testimony to the uncertainty that prevails. Unrealistic bids, bureaucratic slowdown, social groundswell, coal scam, mining scam … the list of factors that has created seemingly unstoppable negativity seems daunting. The government mainly the Prime Minister´s Office had to repeatedly intervene to address frustratingly sticky problems confronting the infrastructure sector.

Although major policy changes were enacted last year, the slide of both the economy and the sentiment has only hurtled, so much so that the industry hopes only a new reforms-oriented government at the Centre can save the day. Yet that optimism itself has been on shaky ground, as plunging stock markets in the new year indicate. In this year-beginner, Arvind Mahajan reflects on the year gone by and cautions that a course correction needs to be proactively effected this year.

Ministry of Statistics and Programme Implementation (MoSPI) data says that until May 2013, 100 projects, or 48.3 per cent, of the total 207 projects worth Rs 1,000 crore or above (termed as mega projects) faced delays and witnessed a cost overrun of 19.2 per cent. Infrastructure spending in India has been growing at a steady pace since the 11th Plan, reinforcing and testifying the government´s commitment to build the required infrastructure in India. But the pace of growth in capital formation in roads, ports, power and aviation has reduced considerably in the last 3-4 years for various reasons, triggered by the global slowdown and continued weak domestic investment environment, sustained inflation, high debt costs, poor economic growth and inertia in policy making.

The government took some concrete steps to expedite stalled projects last year, such as setting up a Cabinet Committee on Investment (CCI) to fast-track implementation of large projects, and a committee headed by C Rangarajan, Chairman of the PM´s Economic Advisory Council and former RBI Governor, to review proposals for restructuring of highway Build-Operate-Transfer (BOT) projects and expedite project implementation. The new land acquisition law the Right to Fair Compensation and Transparency in Rehabilitation and Resettlement Act, 2013ùcame into force from 1 January this year, and will provide a legal framework to resume pending land acquisition.

However, implementation is likely to lag. According to MoSPI, the major causes of delay relate to land acquisition, forest clearance, legal and regulatory issues. Added challenges have been financing constraints, long-term viability concerns owing to lesser traffic expectations and increasing cost of debt and inflation.

The high ramp-up required to bridge the gap between planned infrastructure spend and delivery would create demand pressure on the input supply chains of labour, equipment, raw materials and project management, pushing up prices or creating scarcity, and hence project delays. It is important for mid-course correction and this would be the focus for 2014. This course correction is expected to range between radical, ambitious measures which could face regulatory and implementation hurdles, to the moderate, de-bottlenecking initiatives depending on the economic and political environment.

The year did see major policy changes in civil aviation (allowing FDI by foreign airlines in Indian airline companies and reduction in sales tax on aviation turbine fuel (ATF)), notification of revised market-linked pricing guidelines by Tariff Authority for Major Ports (TAMP), incentive scheme for coastal shipping, direct cash transfer scheme for LPG cylinders, and implementation of reforms in state power distribution companies. However, the common refrain is that much more needs to be done on relaxation of minimum criteria for Indian carriers to fly international, enhance rail connectivity, introduce policy measures for power generation etc.We now take a closer look at each sector.

O&G: Addressing domestic E&P shortfall Upstream
The upstream oil and gas (O&G) industry continues to face challenges with decline in production.

• The delay in obtaining the required approvals has had a negative impact on the investor interest in Indian exploration and production (E&P)ùthe exit of a foreign company being a case in point. While the 10th round of the National Exploration Licensing Policy (NELP-X) with 86 oil and gas blocks is likely to be up for bidding in 2014, it remains to be seen whether it will attract companies to invest in upstream activities in India, given the slow decision-making environment. To accelerate investments, a single window clearance mechanism is needed.
• Exploration of shale gas requires adoption of new technologies in India. The Cabinet Committee on Economic Affairs (CCEA) approved policies governing auction of coal blocks and exploration of shale gas in the country in 2013. While the cabinet approval on the long-awaited shale gas policy allowing national oil companies (NOCs) is a welcome move, it would be important to lay down the roadmap to allow private sector participation.
• Benefits of the fuel pricing reformsùwhereby a roadmap was announced in January 2013, providing for a gradual price increase for reducing diesel under-recoveriesùhave been offset by rupee depreciation that dented participants´ balance sheets. Upstream NOCs face the brunt of the current subsidy sharing mechanism, reducing their ability to invest risk capital in new E&P projects. It is important that government persists with the fuel reforms and expands the LPG direct cash transfer mechanism to rationalise the fuel subsidy bill.
• The recent cabinet approval for near-doubling of natural gas prices from April 2014 is a shot in the arm for investments in the upstream. With the new formula based on the Rangarajan Committee´s report, the gas prices are expected to rise to $8.4 per mmbtu and help boost India´s producible gas reserves that became unviable at a lower gas price of $4.2 per mmbtu. Furthermore, with a reducing differential between imported and domestic gas prices, gas price pooling could help increase gas supply for stranded power plants.

Downstream: City gas distribution saw some action, as the Petroleum and Natural Gas Regulatory Board (PNGRB) invited bids for building a city gas distribution (CGD) network across 14 cities and started with awarding cities bid out in round 3.

Some key concerns such as regulatory uncertainty, end user pricing, and gas supply persist. With priority sectors remaining supply-constrained due to shortage in domestic gas, CGD operators would have to rely on imported LNG for meeting demand.

Power: Towards reforms
Generation: The country´s power deficit is projected at 6.7 per cent for FY2014 which is expected to be 70,232 MU. At present, more than 55 per cent of India´s installed capacity is coal-based and hence critically dependent on coal mining and international prices of coal. The auctioning of over 50 new coal blocks is long due, and can now be expected only after the formation of a new central government later this year. These new coal blocks are typically more difficult to mine compared to the existing blocks and would need better technology and longer lead times (4-7 years to start production). In the short-to-medium run, India would have to depend on imported coal for power generation and the total imports could go beyond 300 mt by 2017.

There has been a slowdown in renewable installed capacity in the current and previous years.
Central and several state governments have evolved policies to promote the installation and usage of solar power. Jawaharlal Nehru National Solar Mission (JNNSM) Phase-II has set up an ambitious target of achieving 20 GW of solar power through Viability Gap Funding (VGF) by 2022 in three phases. Andhra Pradesh and Tamil Nadu have new policies to encourage installations of rooftop solar among domestic, commercial and industrial consumers.

Distribution: The central government approved the financial reforms package in September 2012, providing for an incentive mechanism to disburse funds for ongoing reforms. Rajasthan and Tamil Nadu have, issued bonds backed by a state government guarantee as per the formula suggested by the Cabinet Committee. Uttar Pradesh, Haryana and Andhra Pradesh are expected to issue bonds soon. On the other hand, the process of involving franchisees in discoms is moving ahead steadily, with Madhya Pradesh and Bihar appointing new franchisees. Financial restructuring of state utilities mandates the involvement of private sector in state distribution through franchisee arrangements, and other states like Rajasthan, Tamil Nadu and AP are expected to follow suit.

The outlook:

• Increased Open Access transactions
• Substantial capacity addition in solar power
• Better solar rooftop penetration
• Distribution franchises in high loss pockets.
• Clearing quantity of Renewable Energy Certificate (REC) volumes set to get boost

Roads: Revisit ppp

A key component of India´s highway development is via public-private partnership (PPP) mode, ie, on design, build, finance and operate basis (DBFOT), where the private sector is involved in the entire project life cycle and shares commercial risks. However, the investment in this sector that caters to a large proportion of India´s logistics requirements has been falling behind the target.

The government had embarked on a massive PPP regime over the past decade and awarded to private companies a number of projects, some of which have now run into financial problems. Lack of timely regulatory clearances, environmental issues and problems pertaining to land acquisition are some of the key challenges in the road sector.

This year, the road ministry had to scrap seven projects worth Rs 3,000 crore due to land acquisition issues in Kerala and Goa. After failing to get good response from the private sector for BOT projects over the last two years, the Ministry of Road Transport & Highways (MoRTH) has decided to award 5,000 km of road projects under the Engineering Procurement and Construction (EPC) route.

In the current environment, the government seems inclined to award projects through EPC contracts, but the long-term solution will be to clearly identify ways of managing the infrastructure deficit through a combination of both EPC and PPP contracts, subject to viability considerations.

It is imperative for the government to look at re-engineering PPP contracts and creating an effective institutional framework. There are many lessons available from the UK, US, Europe and Latin America where contractual risk sharing and risk management have evolved with time.

Some of these may be useful to review, customise and experiment in the Indian context. For example, there is an increasing preference for availability-based service models in the UK, which have evolved from traditional BOT and DBFOT contracts and known to address traffic and operational risks equitably without diminishing value for money considerations.

Civil Aviation: Good Tidings
The past year has seen some bold decisions by the Ministry of Civil Aviation. These include the opening up of foreign routes to private Indian carriers, allowing direct import of ATF, removing import duty on aircraft spares, allowing External Commercial Borrowings (ECB) ECB for working capital of airlines and the most significant allowing 49 per cent FDI by global airlines, etc. The ministry has also worked hard with various state governments to reduce the excessive sales tax imposed on ATF.

The easing of foreign investment last year will be a game changer in the Indian aviation skyscape. We saw the arrival of foreign airlines in India. There are more expected to follow. The willingness of foreign air carriers to do business in India is a harbinger of interesting times to come. While the long term outlook of Indian aviation is bright, the short term is highly challenging. To improve the operating environment, the central and state governments need to work towards reducing ATF and MRO taxes, speed up clearances and approvals by various aviation regulators and departments, support the growth of regional no-frills airports (NFA), promote growth of air-cargo and general aviation. ATF accounts for nearly 50-55 per cent of the operating cost of Indian carriers as against 30-35 per cent globally. While the states of Chhattisgarh, Jharkhand, MP, West Bengal and Orissa have reduced ATF taxes, others like Maharashtra, Goa and Karnataka are expected to announce ATF tax rebates shortly.

The 5/20-aircraft rule for global operations by Indian carriers prevents Indian carriers to fly international until they complete five years of operations and have a fleet of 20 aircraft. This is not applicable to a day-old foreign airline, with just one aircraft in its fleet, flying into India. It is expected that domestic traffic in current financial year is to grow by around 5-7 per cent over the previous year, and international traffic by around nine to eleven per cent. The next financial year is expected to witness a healthy growth on the back of expected reforms in ATF and MRO taxes, growth of regional no-frills airports, reduction in airport charges, new entrants and the likely abolition of the 5/20 rule.

Ports: unexecuted drives
The ban in iron ore mining adversely impacted iron ore exports from India resulting in Paradip and Goa ports losing a large share of traffic This affected the BOT developers with iron ore terminals such as Ennore. Although the Ministry of Shipping did not facilitate a change-over of the terminal from iron ore to coal, it was open to providing an option for handling non-coal cargo in the terminal.

In order to deliver a big push to capacity addition, Major ports have launched various terminals in the past few months (Chennai Mega Container, Mumbai general purpose, Kandla Mega Container, JNPT T-4, Ennore Container, Kolkata Diamond Harbour, amongst others) which have seen renewed interest from domestic investors. The Cabinet has also approved rail projects for port connectivity of minor ports that would enable the realization of capacity as evacuation from the coastline has been a critical bottleneck. The government also announced an incentive scheme for facilitating coastal shipping later in the year and relaxed cabotage for Vallarpadam to enable greater coastal movement of cargoes

Other various initiatives introduced during the year are yet to be executed, viz revision of TAMP pricing guidelines, policy on use of land in major ports, acts on captive ports and minor ports and a comprehensive policy on coastal shipping. These are pending discussions with industry stakeholders and are likely to be executed only later next year or the year thereafter. The concerns are expected to continue on three aspects: attracting interest from international investors that are currently watching the sector cautiously, responsiveness of port sector policies to non-sector developments on port traffic, and expediting the terminal award process.

Railways: Focus on existing projects
The 11th Five Year Plan that targeted an outlay of Rs. 233,289 crore with a Gross Budgetary Support (GBS) of Rs 63,635 crore, Internal Resources of Rs 90,000 crore and Extra Budgetary Support (EBS) of Rs 79,654 crore has fallen short of the target by Rs 42,449 crore at Rs 190,840 crore.

In the 20th Report on DFG (2013-14), there was a great concern that the Railways had as many as 88 projects which were sanctioned more than 10 years ago and some of them even 20 years ago which were lying incomplete. A key challenge with the railways has been and continues to be resource mobilisation and project management and implementation capabilities to handle the large shelf of sanctioned projects.

Additionally, projects such as Dedicated Freight Corridor (DFC), high speed rail (HSR), new rolling stock manufacturing facilities, world-class stations, etc, are getting impacted by capacity of the organisation, viability and PPP structures in a moderate economic environment. Despite the bottlenecks, the Railways has prioritised the implementation of the coal mine linkage projects, awarded construction on select stretches of the Western DFC (EPC contract signed for the construction of 626 km of a double track corridor from Rewari in Haryana to Iqbalgarh in Gujarat, via Rajasthan) and Eastern DFC (contract awarded to construct a 337 km double track line and 14 km of single track line between Bhaupur and Khurja in Uttar Pradesh).

Indian Railways plans to invest around Rs 548,802 crore under the 12th Five Year Plan. All efforts are being made by Ministry of Railways to mobilise the resources for the Plan, however mobilisation of Rs 1 lakh crore towards PPP would be difficult to realise, keeping in view the inherent challenges in PPP models in the rail sector with projects having long gestation periods and processes involved in undertaking these projects, given the nuances involved in each type of project.

In summary, the expectation would be to see faster progress on ongoing projects whereas new projects are likely to take longer in order to obtain greater stakeholder buy-in and mobilisation of resources.

Urban Infra: THe real boom?
The Jawaharlal Nehru National Urban Renewal Mission (JNNURM) has been the flagship programme for funding investments/reforms in urban infrastructure. It started in December 2005 and is in transition with phase 1 ending and the next phase, also referred to as the New Improved Jawaharlal Nehru National Urban Renewal Mission (NIJNNURM), expected to be taken up next year.

Only 217 out of the 567 sanctioned projects under Urban Infrastructure & Governance (UIG) for larger cities have been completed. In case of Urban Infrastructure Development Scheme for Small and Medium Towns (UIDSSMT) for small and medium towns, only 213 out of 807 projects have been completed.

The huge backlog has resulted from implementation issues as well as funding concerns as the urban local bodies (ULBs) have not been able to contribute their share. In terms of reforms, 72 per cent at the state level, 73 per cent of the optional reforms and 54 per cent of ULB reforms have been completed. Implementation of Property Tax and User Charges for basic urban services has been pending and will take significant effort going ahead.

The Vote on Account budget may see additional funds being budgeted as part of the central share for buses under the stimulus package as some states are still to finalise their DPRs/procure buses under the second tranche JNNURM funding for this purpose. However, the NIJNNURM could kick off in the latter half of the next year.

finance: More needed
The current Five Year Plan envisages $1 trillion of investments in the infrastructure sector with almost half the investments coming from the private sector. Given the large investments required from the private sector, a number of measures have been announced to attract investments and new sources of funds. The Reserve Bank of India (RBI) asked banks to consider PPP infrastructure project as ´secured´. Infrastructure debt funds (IDFs) have been launched and refinancing deal has been done. The IDFs were introduced with the objective of increasing the flow of long term debt in infrastructure projects, especially foreign investments and funds (pension and insurance funds).

The key challenge has been to attract pension funds and strategic investors. The pension funds largely prefer to invest in already existing infrastructure assets and look for stable, relatively-risk free returns. However, the infrastructure sector in India is currently facing challenges due to changing regulatory and tax regime, lack of infrastructure, project delays, currency risks, repatriation risks etc. The pool of brownfield assets is limited and restrained infrastructure development over the last few years has further constrained the pool of existing investible infrastructure assets.

Conclusion
There is an urgent need for restoring investors´ confidence through simplifying tax regime, clearance processes and to hasten the dispute resolution mechanism. Steps need to be undertaken to provide systematic, longer term view to investors with increased clarity on engagement procedures that can be provided through changes in traditional model concession agreements, clear norms regarding forfeiture risks and provide a well defined recourse mechanism. There is a need to resolve projects that are stuck owing to issues such as delays owing to land / environmental clearance or cost escalation that were not envisaged during the time of bidding. An empowered institution can be established that can grant regulatory approvals and clearances for certain large projects even before starting the bidding process for a project. Further the processes for approval of funds/grants needs to be revamped in order to ensure speedy implementation of projects.

At this stage, the overall outlook for infrastructure sector appears dependent primarily on the government policies and regulation across both the respective sector and financing. Possibly the most important factor for 2014 is the general elections that are accompanied by a model code of conduct both before and after the elections till government formation. This is likely to restrain major government decisions for a period of four to five months. Further, the budget in 2014 would not be a full budget but a Vote on Account that would focus on on-going and critical budgetary requirements/ expenditures. In a moderate economic outlook for India driven by the international geo-political scenario, global economic volatility and domestic democratic process, the infrastructure sector is looking out for relief and stimulus in the form of innovative and unique project implementation solutions, but it may come in the latter half of 2014- by which time it may be too late as we move closer to FY15.

Key power amendments this year
The Ministry of Power drafted amendments to the Electricity Act 2003, National Tariff Policy (NTP) and new Competitive Bidding Guidelines. The implementation of these changes would be a key development in the year:

Electricity Act 2003 amendments

• Supply licensee apart from existing distribution licensee (within three years) to encourage open access, to be done by a transfer scheme
• Additional supply licensee allowed within the area or to certain category of consumers by paying cross-subsidy to incumbent supply licensee.
• Appropriate commission shall reduce cross-subsidy surcharge (CSS) in a time bound manner
• Performance of State Electricity Regulatory Commission (SERC) will be monitored by Appellate Tribunal for Electricity (ATE)
• NTP/ NEP binding on all stakeholders, ie, SERC, state, utilities
• National Tariff Policy amendments
• Separate computation of the CSS under surplus and deficit situations, to protect interests of both the distribution licensee and Open Access consumer
• Setting of a five-year Renewable Power Purchase Obligations (RPPOs) to encourage clean energy
• Modified Standard Bidding Documents
• Fuel cost is a pass-through. Bidder quotes tariff for first year with predetermined escalation rates for the contract period
• Certain portion of contracted capacity reserved for Merchant sale to create short term market

The author is Partner and Head of Energy, Natural Resources and Global Infrastructure Practices at KPMG in India, a leading financial and business advisory firm. Views are personal.

Some key facts on Indian roads and highways sector
? 239 PPP projects have been awarded since 2001
? 316 EPC projects have been awarded since 2001
? 7,464 kms: Target for award of projects via BOT in 2012-13
? 1,115 kms: Projects actually awarded via BOT in 2012-13 (11 projects)
? 5,000 km: Target for award of projects via BOT in 2013-14
? 257 km*: Projects actually awarded via BOT in 2013-14 (3 projects)