To revive PPPs, the govt should take on macroeconomic risks flowing from uncertainties in GDP growth rates. The private sector can absorb project management and execution risksOne of the major initiatives of recent years has been the pursuit of PPPs (public-private partnerships) in infrastructure. This was a necessity given the need to improve infrastructure and the limited funds with government, which also needed to contain the fiscal deficit.
In the years preceding the economic slowdown, a fairly large number of projects, primarily in the roads sector, were taken up through PPPs. The underlying presumption in the design of the PPP process was that the private sector could make informed judgments about the costs of a project and the revenue streams that would be generated through user charges for the duration of the concession agreement. Accordingly, it could bid for projects with capital subsidy through viability gap funding (VGF) becoming the bid evaluation parameter.
With the advent of the economic downturn, these PPP projects began to unravel. The assumption of eight-to-nine per cent sustained GDP growth year-on-year was misplaced. As the downturn persisted, awarded projects stalled and there were no takers for new projects. The new government inherited about Rs 1.50 lakh crores of troubled projects in the road sector, and is still trying to find a way forward.
It is now clear that a credible long-term forecast of GDP growth rates and hence a realistic estimate for revenue realisations for the life of the concession agreement is not feasible. The basis on which private promoters and their financiers could absorb risk turned out to be illusory.
A return to traditional fully government-funded contracting for project execution in the EPC mode appears, prima facie, an attractive option. This, however, has its natural ceiling flowing from the present necessity of lowering the fiscal deficit. As infrastructure is still a major constraint for growth, with work on expressways and high-speed trains yet to really start, creative ways for getting PPPs back into infrastructure need to be found.
The way forward would be to learn from recent experience and allocate risks realistically. This implies that the private sector needs to be assigned risks which it can manage and the government should take on those risks which only it can absorb. Hence government should take on the macroeconomic risks flowing from the uncertainties regarding GDP growth rates. The private sector can absorb project management and execution risks. It can also, separately, be a partner in revenue realisations where there is only the upside.
Thus there could then be two matching PPPs around the same project. One could be for project execution and maintenance on an annuity basis. The other could be for revenue realisation. The government as the sovereign could absorb the risk of the mismatch between the liability for annuity payments, which are fixed in the first PPP, and the uncertain revenue streams from the asset created through the other PPP.
With assured annuity payments the project becomes bankable and the private partner has the right incentives to execute it with the least cost and time and also high quality, as the costs of maintenance are disproportionately greater if quality is compromised.
Long-term fixed interest rate financing for these projects could also be put together as a part of project preparation and be made available to prospective bidders. For this government may need to absorb the risk arising from the asset-liability mismatch for long-term fixed rate lending by a consortium of lenders. If this were to be done, the bids received would be even more attractive as the bidders would not have to factor in any interest rate risk.
The revenue PPP works well for enhancing revenues through better marketing and sales efforts. These become quite effective for projects such as new airports, hotels, convention centres, new townships and industrial parks, including flatted factories, where demand needs to be generated. A good successful example of these from the pre-economic reform era are the two Taj Hotels of Delhi, where NDMC and DDA built the basic hotel structures on their land at their cost and the Taj Group did the finishing and furnishing, and ran the hotels paying a fixed lease rent and a share of the revenues. This was a win-win successful PPP, as the revenue shares for both partners rose with the success of the hotels. In natural networks such as expressways and tracks for high-speed trains, the potential for demand creation by the private partner is, however, somewhat limited.
The contingent liability arising from the mismatch between annuity payments and revenue streams can be comfortably borne by government. The liability for annuity payments would commence at least three-to-four years later, after project completion. By then, the fiscal situation should, hopefully, be more comfortable. With this approach a fairly large investment programme of, say, around Rs 5 lakh crore, could be initiated right now through PPPs on an annuity basis. Additional infrastructure projects of around Rs 5 lakh crore would generate considerable additional demand for steel, cement, construction equipment and commercial vehicles. This, in turn, would have a significant multiplier effect and add to the growth momentum in the economy.
A neat solution for stalled projects would be to take them over on an 'as is where is' basis. After take-over, these could be bid out again for completion through annuity-based PPPs. Due diligence through a credible third-party mechanism of valuation of assets created vis-à-vis expenditure booked would address transparency and fairness issues. This would take care of the huge risk of NPAs from these projects for banks and the entire financial sector. It would also restore market sentiment fully for infrastructure PPPs.
Restructuring debt, or permitting promoters to exit or bring in new partners, does not address the real problem of non-viability of the concession agreement. The fact is that a non-viable contract cannot be implemented.
Without government action to stimulate domestic demand the economic recovery is likely to remain feeble, as is the case at present. But with unorthodox measures, growth may well get back to eight per cent-plus.
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