Restructuring the Framework for Public-Private Partnerships

PPP has been much in news, most of time for negative than for its positive aspect. India has outlined ambitious target for funding the infrastructure deficit through the PPP Model, most recent being 12th Five years plans which outlined that approx 50% of funding for infrastructure would come from private sector (mostly through PPP model).

But real picture is not that rosy. It has faced many hurdles, most of which has to do with design of contract and model itself. The lack of regulatory capacity hampering implementation of PPP project was attempted to overcome through setting up of ‘3P India’ Institute in last budget with Budget allocation of Rs 500 Crore, but it also become a victim of bureaucratic red-tap (or vested interested).

The present Economic Survey while being superficial in most of the topics provides in-depth diagnosis of PPP projects covering – flaws in existing design, required changes and restructuring of existing contracts.

I have tried to analyse/scrutinize how correct the diagnosis is , is the remedy recommended workable and is there any improvement needed in the approach to revitalize the PPP model once again or do we need to abandon the model altogether.

We would adopt a Q&A Format to analyse the various issues:

What is situation of PPP Projects? What are concerns stemming from PPP Projects?  

What does Economic Survey Says: Many infrastructure projects are today financially stressed, accounting for almost a third of stressed assets in banks. New projects cannot attract sponsors, as in recent NHAI bids, and banks are unwilling to lend. This current state of the public private partnership (PPP) model is due to poorly designed frameworks, which need restructuring

So Basically ES highlight following aspects

  • Financial stress in infrastructure sector
  • NPA or stressed assets in banking sector consequence of this
  • Poor Design of Contract framework is blamed for this

My take: These are broader concerns related to PPP projects. But we also need to discuss and debate the merits, philosophies and efficacy of PPP model. Does PPP delivers what it promised (efficiency, better services, private financing etc)? Do we need to adopt PPP model in infrastructure starved country like India where most of population has low –paying capacity? In what sector PPP can be adopted? Are problems highlighted above are specific to India or they are global in nature? Is there deficiency in Design or implementation/Execution? What are lessons we have learnt from some of successful PPP Projects? By what matrix do we measure the success of PPP Project? Who should be competent authority to decide on whether to adopt the PPP model or not – should it be decided at national, state or local level?  These are some of issues which need a wider public consultation before proceeding further on the path to Public Private Partnership or People-Public-Private-partnership.

What are Flaws in Existing Design of PPP Models?

Take of Economic Survey:  

  1. Existing contracts focus more on fiscal benefits than on efficient service provision. In port and airport concessions, the bidder offering the highest share of gross revenue collected to the government is selected.
  2. They neglect principles allocating risk to the entity best able to manage it. Instead, unmanageable risks, e.g., traffic risk in highways, even though largely unaffected by their actions, are transferred to concessionaires. This is also true for railways and in part, for ports (though inter-terminal competition is possible) and airports.
  3. The default revenue stream is directly collected user charges Where this is deemed insufficient, bidders can ask for a viability grant, typically disbursed during construction. This structure leaves the government with no leverage in the case of non-performance, with few contractual remedies short of termination.
  4. There are no ex-ante structures for renegotiation. If a bureaucrat restructures a project, there are no rewards; instead it may lead to investigation for graft. Failed projects lead neither to penalties nor investigation. With such asymmetric incentives, bureaucrats naturally avoid renegotiation.
  5. Finally, contracts are over-dependent on market wisdom,g., bidders in ultra-mega power projects (UMPP) could index tariff bids to both fuel prices and exchange rates, but almost all chose very limited indexation. When fuel prices rose and the rupee fell, these bids became unviable. To enforce market discipline and penalise reckless bidding, these projects should have been allowed to fail.

My Take: The Economic Survey has done an excellent job of identifying the lacuna or shortcomings in present structure. Excessive focus on fiscal benefits rather than services provision, inappropriate risk allocation among the stakeholders, excessive focus on user charges (with no scientific approach to calculate user charges considering the paying capacity), absence of institutional structure for re-negotiations/adjustment to take into account various contingencies and changing market conditions and over-reliance on market mechanism are indeed the principle reason for sorry state of PPP projects in India. But Economic survey has left out the many crucial factors like –

  • Absence of Independent regulatory institution/Oversight Mechanism to protect the Public Interest in such projects. The Regulatory capture has reduced the bodies like AERB (Airport Economic Regulatory Authority) in aviation sector as mere rubber stamp failing to withstand the ground to protect publics or consumers interest. In road Sector, no such body exist which can decide the fairness of user charges or tolls. In electricity, though CERC and SERC have done some work, but they have failed to emerge as mature institution often falling prey to regulatory capture.
  • Political corruption via PPP route and crony capitalism – PPP have become the easiest way to make money for politicians. Whether it’s Mumbai-Pune Expressway or Delhi-Agra Expressway, the companies have grabbed the surrounding land at cheap-dirt price in connivance with politicians. They have built real-estate empire proceeding of which goes not in listed-companies executing projects but to the personal accounts of promoters and cronies of politicians. Viability gap funding is another mechanism to favour the one’s near and dear.
  • Opaqueness of procedure, Lack of transparency and accountability – lack of stakeholder consultation
  • Lack of Capacity among the Government/Public Sector authorities to handle the complex contract and ensure monitoring & evaluation. The capacity building requires persistent efforts, time and committeemen of leadership. The ‘3P India’ Institute announced in last budget is yet to take shape.
  • High User Charges and non-maintenance of service standard by Concessionaire
  • Lack of genuine competition as select number of private players complete in large projects. Public purpose could be better served by bundling them in smaller packages to ensure competition, innovation and better consumer services.

What modifications are needed? What Remedy is required to rectify the flaws and make PPP Successful?

Economic Surveys Take:

  1. Continue combining construction and maintenance responsibilities to incentivise building quality. If a single entity is responsible for both construction and maintenance, it takes lifecycle costs into account.
  2. Risk should only be transferred to those who can manage it. In a highway or a railway project, it is not sensible to transfer usage risk since it is outside the control of the operator. But, it can be done in telecom projects and for individual port terminals that compete with each other, where demand can respond to tariff and quality.
  3. Financing structures should be able to attract pension and insurance funds, which are a natural funding source for long-term infrastructure projects.

Then coming to Concrete/specific solution Economic Survey says that

  • Rather than prescribe model concession agreements, states should be allowed to experiment. For example, in ports, terminals can be bid on the basis of an annual fee, with full tariff flexibility, subject to competition oversight. For electricity generation, bids can be two-part, with a variable charge based on normative efficiency, or alternatively, determined by regulators and a capacity charge.
  • It also recommend to adopt Least Present Value of Revenue (LPVR)a contract, where the bid is the lowest present value (discounted at a pre-announced rate) of total gross revenue received by the concessionaire. The concession duration is variable and continues until the bid present value amount is received. A key advantage of this contract is that it converts usage risk to risk of contract duration, which is more manageable for financial institutions. Since the bid is on gross revenue, it also selects bidders who can execute at low cost and demand relatively lower margins and by limiting the scope for renegotiation to the remaining uncollected value of the LPVR bid, it discourages opportunistic bidding. Further, since the present value is protected, this structure is suitable for pension and insurance funds.

My Take:

  • Moving away from model concession agreement may be good move, but it needs caution. On one hand it may promote innovation, creativity in framework to suit the particular condition and local context but it may also be used for self-serving purpose or put bluntly to siphon off the public exchequer via sophisticated corrupt deals.
  • As Safeguard, an oversight mechanism involving competent professionals to monitor, approve, and regulate all the concession agreement may be set-up. This oversight mechanism needs only to look at broader principles or macro aspects rather than micro-managing the all details.
  • The second option though theoretically looks innovative and attractive but in practical terms this may promotes propensities to corruption. We here many court cases where concessionaire continue to collect tolls even after expiry of their period and under-reporting of toll is universal phenomenon in India. Can e-tolls solve this problem? Can moving towards Shadow-tolling (in which only the traffic count is recorded and no actual toll collection from user takes place at toll location) using digital technology solves this problem? There need to implemented on pilot-basis to check their efficacy and efficiency before wide-spread roll out.

Can existing contracts be Restructured?

Economic Survey’s take:

  • Revival of private interest and bank lending needs existing contracts to be restructured, with burden sharing among different stakeholders. Lenders may have extended credit without necessary due diligence, assuming that projects were implicitly guaranteed. Without burden sharing, this behaviour will be reinforced. Similarly, many bidders may have assumed that they could renegotiate in the event of negative shocks. Thus, there was potentially adverse selection of firms who felt they had the capacity to renegotiate; rather than firms better at executing and operating the project. In particular, this may have limited participation by foreign firms. In the absence of burden sharing, such adverse selection would be supported. Thus, the guiding principle should be to restructure contracts based on the project’s revenues, differentiating between temporary illiquidity and insolvency. Equity can be the residual claimant.

 My Take: To avoid Problems of adverse selection and moral hazard (if you renegotiate the present contracts, it would set wrong precedents and parties would assume that government would come to their rescue at time of distress), it would be prudent to experiment with new models from prospective effect. The existing contract should not be re-negotiated (as there was no provision for same in original contract) neither they should be compensated for their business risk (Supreme court in Adami Power and Tata Power case has set as bad precedent). If we allow the failure, it would avoid the contagion effect and also bring a sense of discipline among the future bidders. Even if there is any renegotiation it should be applicable to all with transparent procedure and burden be shared by all stakeholder with equity being residual claimant as proclaimed in Economic Survey.

We need to have wider consultation and public debate on what kind of model we as a society want to adopt for building the Infrastructure which is backbone of Economy. In what way we want to finance the same? Though long term investment sources like Pension and insurance source be encouraged (hopefully increase in FDI in both would bring more of same) but they alone would be insufficient to fund the huge infrastructure requirement of nation. We need to utilise the multitude of sources of finance, execution mechanism and technology to bring prosperity to all Indian.


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