How to pay for roads and airports

How to pay for roads and airports
The Financial Express, November 17, 2009, Page 6

Shyamala Shukla

India’s public-private partnership (PPP) programme in infrastructure has acquired substantial size over the last few years. To fill the gap in public infrastructure investments, the government created future obligations in the shape of the PPP programme, which started with a large annuity-based road sector programme. The government committed a part of its fuel cess for 25-plus years for payment of annuity and for facilitating additional borrowing by NHAI. In addition, various clauses of concession agreements in user fee-based PPPs were framed such that the government undertook guarantees to lend comfort to investors and lenders entailing substantial levels of future payments contingent upon specified events. These are off-balance sheet.

The findings of a study on infrastructure financing that commercial banks, with public sector banks as major contributors, have provided a large part of debt financing so far have additional implications for the government’s fiscal management, especially because many of these institutions are characterised by substantial government interests. Out of the total availability of debt financing for infrastructure in the Eleventh Plan of $206.38 billion, almost 70% would come from domestic bank credit, non-banking financial institutions and pension/insurance companies, again many would be institutions with government interests.

Considering the model concession agreements (MCA) for the road, railways (container), urban metro and port sectors currently in use, the transmission service agreements and the share purchase agreements of the power sector and limited clauses of the draft MCAs for the airport and railway sectors, the contingent liabilities of the ‘authority’ are in three major categories: compensation for change in law, penalties for authority default and termination payments, of which the first and the third are more important.

The concessions in different sectors provide coverage for change in law with minor differences. For the road sector, for example, the concessionaire is to be compensated if aggregate financial effect exceeds the higher of Rs 10 million or 0.5% of realisable fee.

The basis for termination payments in all agreements is the debt due or book value or replacement value. A partial answer to the obvious question on why the GoI did not consider market value as a basis lies in the level of comfort demanded by lenders. The substitution agreement which forms part of the concession agreement states that: “Lenders are entitled to receive from the concessionaire, without any further reference to or consent of the concessionaire, the debt due upon termination of the Concession Agreement.”

This means that government, through termination payments, is essentially paying its banks or itself. Bluntly, it means that private debt will almost fully be paid for by government should the private sector fail to do its job. Over the course of time, with more financing coming from other sources, the situation would change, but the prospects of large contingent liabilities are indeed alarming.

A draft World Bank report, GoI: Managing the fiscal implications of PPPs, states that GoI’s exposure to PPP termination payments is approximately Rs 40,000 crore ($10 billion, 1% of GDP in 2007) with current value of obligations at about 1% of the exposure, which is relatively low at present. Under similar assumptions, we can calculate somewhat loosely that the combined exposure of 17 state governments could be around $16 billion and additional exposure of GoI and the state governments combined could increase by approximately $50 billion in the next five years.

PPP experts in GoI have suggested the notion of ‘Net Contingent Liabilities’ based on the reasoning that most PPP projects are monopolies; services rendered cannot be replaced and demand inelasticity will keep revenue streams intact. On termination, the asset reverts to government and a new operator can be procured. Therefore, net contingent liability would take into account the current value of the asset and the NPV of earnings for the remaining period. This reasoning has an obvious flaw: a project with intact revenue streams would probably not require termination.

An institutional framework for controlling contingent liabilities would consist of investment planning, sector strategy, adequate project design, risk appraisal involving other than line ministries, risk sharing, limiting contingent liabilities overall, disclosure, separate promotion and oversight functions, tracking variables impacting probability of termination, tracking lifetime budgetary implications of PPPs and creating a reserve fund for called liabilities.

—The author is working as advisor to India’s executive director, at The World Bank. These are her personal views