Governance Now, Dec 1-15, 2011
Kamal Nath came to NHAI with a lot of pep. He promised 20 km of road a day. But during his time NHAI was artificially restricting bidders to a favoured few, lavishing them with up to 40% viability gap funding and was itself heading for fiscal doom. Now, e-tendering has opened up the game and increased competition. Contractors are paying huge premiums and NHAI is raking in the moolah. Oh, the man at the top does make all the difference!
Smarting from an apparent demotion from the commerce and industry portfolio, Kamal Nath wanted to appear in the next day’s headlines. So, on the day of taking over the ministry of road transport and highways in May 2009, he thundered that now that he was the man in charge, he would build 20 km of highways every day.
Now, this was good news for Indian economy. Highways are a key element in infrastructure. More and better highways mean smoother transport of goods and growth in economy. But how do you find funds for building highways at that speed?
One year and eight months later, when Nath was bundled out to another portfolio (in January 2011), the roads existed only on file notings. The ministry’s national highways authority of India (NHAI), mandated with the task of developing, contracting out and maintaining the national highways, wasn’t just thousands of miles away from the target, it was staring into an abyss of bankruptcy.
In fact, midway through 2010, the country was warned of a grave crisis building up in the NHAI – a crisis comparable to the ‘sub-prime mortgage’ crisis that triggered the downfall of the US economy. To put it simply, it means piling up the debt to the extent where repaying it becomes difficult and default is the only way out.
Gajendra Haldea, advisor to the planning commission deputy chairman, said in an internal paper that if NHAI continued its terrible policies, no further road development work would be possible after April 2011 because it would require an additional borrowing of `30,000 crore just to service the existing debt.
Mercifully, because of a series of court cases and even CBI raids on his pet concessionaires (as the private contractors are called), Nath didn’t get to run the NHAI that far. He was replaced with CP Joshi, a mild-mannered academic-turned-politician from Rajasthan.
Today, hoity-toity bluster is being replaced by real highways. The threat of bankruptcy has now receded and the future of NHAI is looking up.
But before we get into that here is a brief account of how Nath, who in his frustration due to their searching questions attacked Haldea and Yojana Bhavan folks as a bunch of arm-chair critics, endangered the NHAI by his ruinous strategy.
The details of his policies and practices were elaborated by Haldea in his “issues paper”. (Read the details in our cover story ‘Wrong Road, Kamal’, August 1-15, 2010.)
To recap briefly, here is what was happening: concessionaires (that is, private contractors) formed cartels, they made contracts for both the public-private partnership (PPP) and annuity mode projects expensive, and the bidding process was so restricted that projects were best bid only by three to four contractors, in many cases even less than that, though a large number of pre-qualified bidders existed in most cases (see box 1). All these, at the cost of the taxpayer.
Nath played a key role in some policy formulations (with a generous help from the union cabinet and the planning commission) that provided ridiculous financial concessions to the private partners and transferred the entire risk to the exchequer. These policies included a payment (by the NHAI) of up to 40 percent of the total project cost (TPC) to the concessionaires – know as viability gap funding (VGF) – and allowed the concessionaires to walk out two years after completing the project. The banks provided loans far in excess of the TPC, and without any collateral or guarantees. In case the concessionaires were to walk out without completing the project, it was the NHAI which was liable to pay 90 percent of the TPC to the lending banks (see box 2).
Thus, a private contractor needed to bring only a little amount by way of equity and could borrow far more public funds than the actual cost. If there are profits down the line, they can pocket it, otherwise they can exit the project, with NHAI and the lending institution holding the baby. All profits for private parties, losses, if any, are for public.
These lopsided policies that the union cabinet had lazily approved for the purpose of providing a stimulus to building infrastructure – highways – exist even now. Joshi hasn’t changed them and yet, sure bankruptcy is history now. Here’s how:
Joshi told Governance Now (see the accompanying interview) that he just changed the bidding process. He, with generous advice from Haldea who belongs to Rajasthan cadre of the IAS, threw it open and made the entire bidding process transparent through e-tendering, since March this year. This change attracted 25 or more bidders, instead of the artificially imposed constraint of three-four or less earlier. With the field opening up, many of these bidders not only refused to seek VGF from the NHAI, they promised to pay a “premium” instead.
The “premium” was to come from the concessionaires’ future earnings from the toll tax – through which they are to recover their investment and make their share of 15 percent profit. Competition did the trick, just as it has done with our telecom sector.
The first change came with the contract for 88-km Kota-Jhalawar road project. The concessionaire, Keti Construction Ltd, sought no VGF but offered an annual sum of `3.5 crore to the NHAI for the entire contract period, with a provision of 5 percent annual increase. The premium was to be payable from the day of the commercial operation date (COD). The contract was awarded on April 27. Since then, the number of such contracts has climbed up.
It is not a picture perfect story though. Details of 16 contracts signed by the NHAI since April (see box 3) shows that in the case 5, the concessionaires had to be given VGF to the extent of `1,342 crore. Notwithstanding that the net gain to the NHAI is to the tune of `15,729 crore per annum for the next 20 years or so (without taking into consideration the annual hike.
As box 3 shows, the cabinet committee on infrastructure had already approved VGF for 12 projects. But open bidding and competition brought the actual number of concessionaires seeking the VGF down to 5.
NHAI officials, even though they haven’t had a full-time chairman for several months, say the change happened not only because of transparency and open bidding but also because of the change in overall economic scenario and the perception of the entrepreneurs that an investment in the road sector was a viable economic option. Since the NHAI fixes a “uniform” toll tax all over the country, irrespective of the traffic volume (which is another terrible policy that calls for another story), the concessionaires made calculations of their income from toll tax and offered a portion of that to the NHAI. Since collection of toll tax will begin after the completion of the project and hence there is still time for the actual accrual of the ‘premium’, the NHAI officials view it as a “windfall” gain that dramatically improves its balance sheet.
Those in the know say that this change in the financial prospect means a lower burden on the NHAI and a “fast receding” fear of bankruptcy. Open bidding has put an end to cartelisation. Competition is fierce and the bids are less taxing.
What would have happened had Nath hadn’t overturned open bidding at the outset? Those in the know say the VGF might not have disappeared altogether, at any rate on all roads, but it would have come down substantially. As mentioned earlier, just on 16 roads there’s now a `15,729 crore lesser burden on NHAI as against what Nath has persuaded the cabinet to giving!
Here is another indicator. When a 27-km Gurgaon Expressway was given the green signal in 2002, much before Kamal Nath came to the scene, the concessionaire (Jaypee-DSC Ventures) offered to pay NHAI `61 crore of premium (original TPC was `550 crore, which went up with the delay in completion), instead of seeking VGF. In that sense this was the first project that yielded premium and Kamal Nath would surely have been aware of it and the potential to generate money for the NHAI, instead of gifting it away.
RP Indoria, DG, Road Development, says had that contract been awarded in the present circumstances, it would have probably fetched `1,000 crore of annual premium to the NHAI.
Nevertheless, an air of optimism now hangs in the corridors of Parivahan Bhavan because of the turnaround, prompting disappointment among the chosen few and grudging admiration among the rest that Joshi and a certain armchair critic may have pulled NHAI back from its highway to hell. n
feedback@governancenow.com
Bix 3All benefit private, all risk public!
The planning commission’s internal paper pointed out how public funds were being exposed to grave risk. Two very well-disguised ways of helping the private partners of the PPP have been elaborated in the paper.
1. Lending by banks
The banks lend far in excess of the TPC (total project cost) arrived at by the NHAI. For example, in case of Panaji-Karnataka border project IIFCL has lent more than three times in excess of the TPC (minus the viability gap funding or VGF). This kind of bloated lending means that the private partner “may not only spend beyond reasonable costs but also siphon out funds at public expense”.
But in the event of project failure, “the banks will not be able to recover anything beyond 90% of the TPC”. In the case of the Panaji-Karnataka border project, this means that the NHAI will pay the bank only 90% of the TPC (`196 crore) and not 90% of the `832 crore (which is the inflated project cost agreed to by IIFCL). The problem is this is happening across projects and just for 20 projects, IIFCL has over-lent `12,294 crore.
“Since most of the lending is by public sector banks, including IIFCL, in the event of project failure, these banks could plead that the excess loans were granted with full knowledge and participation of NHAI and the finance ministry and may, therefore demand a bailout. No matter who pays for these lapses, it is public money that will be lost.”
Thus, private concessionaires bring little by equity to the table, can borrow public funds far in excess of project costs and can exit when they wish. All benefit private, all risk public.
2. Grants for construction
Another big give-away for the private concessionaires is the viability gap funding (VGF). The Model Concession Agreement specifies a VGF of 20%. This was doubled by the committee on NHDP to 40% of TPC.
This “stimulus” allows the concessionaire to transfer most of its financial risks to the public.
To understand how this works, let’s take the example of a project with a TPC of `1,000 crore and VGF at 40%. Because TPC involves 75% construction cost and 25% financing cost, the construction cost works out to `750 crore. Construction cost includes the contractor’s profit at 15%, so the money she spends on construction works out to `652 crore or 65.2% of TPC. But a 40% VGF on `1,000 TPC would mean, NHAI gives the contractor `400 as VGF.
This means the contractor has to arrange for only `252 crore (`652 crore minus `400 crore). Here again, he can raise a loan of up to 20% of TPC from IIFCL which works out to `200 crore, leaving the contractor to raise bank loans of up to `400 crore to finance his/her contribution of `52 crore.
“That actually leaves a substantial surplus in their hands. This nominal equity means that the contractors can implement the project without any financial stake of their own.”
The bonanza for the contractors does not end there. By a recent amendment to the MCA, they are now allowed to walk out of the project barely two years after completion of construction. “This reduces their incentive to build a project that would last longer and have lower lifecycle costs, defeating the very purpose and objective of adopting the PPP model.”
NHAI releases these huge grants to the contractors without any bank guarantee as do the banks without any security. So when a contractor ups and goes, NHAI and the banks will be left holding the baby, which is always a highway, either half-done or completed.
But look at the cost to the NHAI. It would not only have sunk in `400 crore (VGF), but it will have to pay up 90% of `600 crore, the TPC to the banks. That works out to another `540 crore. Thus NHAI would end up paying `940 crore for a highway whose construction cost was only `652 crore.
If it were any asset other than a highway, NHAI or the banks can sell them and recover some money. But a highway cannot be sold. So the money lent to the runaway contractor will have to be borne by the exchequer.
Once again, all benefit private, all risk public.
Kamal Nath came to NHAI with a lot of pep. He promised 20 km of road a day. But during his time NHAI was artificially restricting bidders to a favoured few, lavishing them with up to 40% viability gap funding and was itself heading for fiscal doom. Now, e-tendering has opened up the game and increased competition. Contractors are paying huge premiums and NHAI is raking in the moolah. Oh, the man at the top does make all the difference!
Smarting from an apparent demotion from the commerce and industry portfolio, Kamal Nath wanted to appear in the next day’s headlines. So, on the day of taking over the ministry of road transport and highways in May 2009, he thundered that now that he was the man in charge, he would build 20 km of highways every day.
Now, this was good news for Indian economy. Highways are a key element in infrastructure. More and better highways mean smoother transport of goods and growth in economy. But how do you find funds for building highways at that speed?
One year and eight months later, when Nath was bundled out to another portfolio (in January 2011), the roads existed only on file notings. The ministry’s national highways authority of India (NHAI), mandated with the task of developing, contracting out and maintaining the national highways, wasn’t just thousands of miles away from the target, it was staring into an abyss of bankruptcy.
In fact, midway through 2010, the country was warned of a grave crisis building up in the NHAI – a crisis comparable to the ‘sub-prime mortgage’ crisis that triggered the downfall of the US economy. To put it simply, it means piling up the debt to the extent where repaying it becomes difficult and default is the only way out.
Gajendra Haldea, advisor to the planning commission deputy chairman, said in an internal paper that if NHAI continued its terrible policies, no further road development work would be possible after April 2011 because it would require an additional borrowing of `30,000 crore just to service the existing debt.
Mercifully, because of a series of court cases and even CBI raids on his pet concessionaires (as the private contractors are called), Nath didn’t get to run the NHAI that far. He was replaced with CP Joshi, a mild-mannered academic-turned-politician from Rajasthan.
Today, hoity-toity bluster is being replaced by real highways. The threat of bankruptcy has now receded and the future of NHAI is looking up.
But before we get into that here is a brief account of how Nath, who in his frustration due to their searching questions attacked Haldea and Yojana Bhavan folks as a bunch of arm-chair critics, endangered the NHAI by his ruinous strategy.
The details of his policies and practices were elaborated by Haldea in his “issues paper”. (Read the details in our cover story ‘Wrong Road, Kamal’, August 1-15, 2010.)
To recap briefly, here is what was happening: concessionaires (that is, private contractors) formed cartels, they made contracts for both the public-private partnership (PPP) and annuity mode projects expensive, and the bidding process was so restricted that projects were best bid only by three to four contractors, in many cases even less than that, though a large number of pre-qualified bidders existed in most cases (see box 1). All these, at the cost of the taxpayer.
Nath played a key role in some policy formulations (with a generous help from the union cabinet and the planning commission) that provided ridiculous financial concessions to the private partners and transferred the entire risk to the exchequer. These policies included a payment (by the NHAI) of up to 40 percent of the total project cost (TPC) to the concessionaires – know as viability gap funding (VGF) – and allowed the concessionaires to walk out two years after completing the project. The banks provided loans far in excess of the TPC, and without any collateral or guarantees. In case the concessionaires were to walk out without completing the project, it was the NHAI which was liable to pay 90 percent of the TPC to the lending banks (see box 2).
Thus, a private contractor needed to bring only a little amount by way of equity and could borrow far more public funds than the actual cost. If there are profits down the line, they can pocket it, otherwise they can exit the project, with NHAI and the lending institution holding the baby. All profits for private parties, losses, if any, are for public.
These lopsided policies that the union cabinet had lazily approved for the purpose of providing a stimulus to building infrastructure – highways – exist even now. Joshi hasn’t changed them and yet, sure bankruptcy is history now. Here’s how:
Joshi told Governance Now (see the accompanying interview) that he just changed the bidding process. He, with generous advice from Haldea who belongs to Rajasthan cadre of the IAS, threw it open and made the entire bidding process transparent through e-tendering, since March this year. This change attracted 25 or more bidders, instead of the artificially imposed constraint of three-four or less earlier. With the field opening up, many of these bidders not only refused to seek VGF from the NHAI, they promised to pay a “premium” instead.
The “premium” was to come from the concessionaires’ future earnings from the toll tax – through which they are to recover their investment and make their share of 15 percent profit. Competition did the trick, just as it has done with our telecom sector.
The first change came with the contract for 88-km Kota-Jhalawar road project. The concessionaire, Keti Construction Ltd, sought no VGF but offered an annual sum of `3.5 crore to the NHAI for the entire contract period, with a provision of 5 percent annual increase. The premium was to be payable from the day of the commercial operation date (COD). The contract was awarded on April 27. Since then, the number of such contracts has climbed up.
It is not a picture perfect story though. Details of 16 contracts signed by the NHAI since April (see box 3) shows that in the case 5, the concessionaires had to be given VGF to the extent of `1,342 crore. Notwithstanding that the net gain to the NHAI is to the tune of `15,729 crore per annum for the next 20 years or so (without taking into consideration the annual hike.
As box 3 shows, the cabinet committee on infrastructure had already approved VGF for 12 projects. But open bidding and competition brought the actual number of concessionaires seeking the VGF down to 5.
NHAI officials, even though they haven’t had a full-time chairman for several months, say the change happened not only because of transparency and open bidding but also because of the change in overall economic scenario and the perception of the entrepreneurs that an investment in the road sector was a viable economic option. Since the NHAI fixes a “uniform” toll tax all over the country, irrespective of the traffic volume (which is another terrible policy that calls for another story), the concessionaires made calculations of their income from toll tax and offered a portion of that to the NHAI. Since collection of toll tax will begin after the completion of the project and hence there is still time for the actual accrual of the ‘premium’, the NHAI officials view it as a “windfall” gain that dramatically improves its balance sheet.
Those in the know say that this change in the financial prospect means a lower burden on the NHAI and a “fast receding” fear of bankruptcy. Open bidding has put an end to cartelisation. Competition is fierce and the bids are less taxing.
What would have happened had Nath hadn’t overturned open bidding at the outset? Those in the know say the VGF might not have disappeared altogether, at any rate on all roads, but it would have come down substantially. As mentioned earlier, just on 16 roads there’s now a `15,729 crore lesser burden on NHAI as against what Nath has persuaded the cabinet to giving!
Here is another indicator. When a 27-km Gurgaon Expressway was given the green signal in 2002, much before Kamal Nath came to the scene, the concessionaire (Jaypee-DSC Ventures) offered to pay NHAI `61 crore of premium (original TPC was `550 crore, which went up with the delay in completion), instead of seeking VGF. In that sense this was the first project that yielded premium and Kamal Nath would surely have been aware of it and the potential to generate money for the NHAI, instead of gifting it away.
RP Indoria, DG, Road Development, says had that contract been awarded in the present circumstances, it would have probably fetched `1,000 crore of annual premium to the NHAI.
Nevertheless, an air of optimism now hangs in the corridors of Parivahan Bhavan because of the turnaround, prompting disappointment among the chosen few and grudging admiration among the rest that Joshi and a certain armchair critic may have pulled NHAI back from its highway to hell. n
feedback@governancenow.com
Bix 3All benefit private, all risk public!
The planning commission’s internal paper pointed out how public funds were being exposed to grave risk. Two very well-disguised ways of helping the private partners of the PPP have been elaborated in the paper.
1. Lending by banks
The banks lend far in excess of the TPC (total project cost) arrived at by the NHAI. For example, in case of Panaji-Karnataka border project IIFCL has lent more than three times in excess of the TPC (minus the viability gap funding or VGF). This kind of bloated lending means that the private partner “may not only spend beyond reasonable costs but also siphon out funds at public expense”.
But in the event of project failure, “the banks will not be able to recover anything beyond 90% of the TPC”. In the case of the Panaji-Karnataka border project, this means that the NHAI will pay the bank only 90% of the TPC (`196 crore) and not 90% of the `832 crore (which is the inflated project cost agreed to by IIFCL). The problem is this is happening across projects and just for 20 projects, IIFCL has over-lent `12,294 crore.
“Since most of the lending is by public sector banks, including IIFCL, in the event of project failure, these banks could plead that the excess loans were granted with full knowledge and participation of NHAI and the finance ministry and may, therefore demand a bailout. No matter who pays for these lapses, it is public money that will be lost.”
Thus, private concessionaires bring little by equity to the table, can borrow public funds far in excess of project costs and can exit when they wish. All benefit private, all risk public.
2. Grants for construction
Another big give-away for the private concessionaires is the viability gap funding (VGF). The Model Concession Agreement specifies a VGF of 20%. This was doubled by the committee on NHDP to 40% of TPC.
This “stimulus” allows the concessionaire to transfer most of its financial risks to the public.
To understand how this works, let’s take the example of a project with a TPC of `1,000 crore and VGF at 40%. Because TPC involves 75% construction cost and 25% financing cost, the construction cost works out to `750 crore. Construction cost includes the contractor’s profit at 15%, so the money she spends on construction works out to `652 crore or 65.2% of TPC. But a 40% VGF on `1,000 TPC would mean, NHAI gives the contractor `400 as VGF.
This means the contractor has to arrange for only `252 crore (`652 crore minus `400 crore). Here again, he can raise a loan of up to 20% of TPC from IIFCL which works out to `200 crore, leaving the contractor to raise bank loans of up to `400 crore to finance his/her contribution of `52 crore.
“That actually leaves a substantial surplus in their hands. This nominal equity means that the contractors can implement the project without any financial stake of their own.”
The bonanza for the contractors does not end there. By a recent amendment to the MCA, they are now allowed to walk out of the project barely two years after completion of construction. “This reduces their incentive to build a project that would last longer and have lower lifecycle costs, defeating the very purpose and objective of adopting the PPP model.”
NHAI releases these huge grants to the contractors without any bank guarantee as do the banks without any security. So when a contractor ups and goes, NHAI and the banks will be left holding the baby, which is always a highway, either half-done or completed.
But look at the cost to the NHAI. It would not only have sunk in `400 crore (VGF), but it will have to pay up 90% of `600 crore, the TPC to the banks. That works out to another `540 crore. Thus NHAI would end up paying `940 crore for a highway whose construction cost was only `652 crore.
If it were any asset other than a highway, NHAI or the banks can sell them and recover some money. But a highway cannot be sold. So the money lent to the runaway contractor will have to be borne by the exchequer.
Once again, all benefit private, all risk public.
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