PERSPECTIVE

HIGHWAYS

Contract renegotiation in highways

The change in bidding conditions, including that by altering the timing of bid premiums, goes against the grain of bidding process, writes Rohit Chaturvedi.

he level of success of PPP in India has been a function of contract design, regulations, and implementation framework in the respective sectors. Road sector in India has attracted signicant investment from private players through the PPP mechanism, especially in the construction of the national highways. It may be noted that the mechanism has evolved over a decade through continuous learning and as a response to the environmental changes. Before we delve into the problems being faced by the national highways in the wake of changed socioeconomic context, it is important to get a perspective on the scale of private investment and thus the importance. Investment in roads and highways sector increased at a CAGR of 11 per cent to Rs 827 billion in 2011-12 from Rs 500 billion in 2007-08. The interest of the private sector continuously deepened from a share of 25 per cent of total investment in 10th Plan to 36 per cent during the 11th Plan on the back of facilitative framework and belief in sustenance of such growth in the foreseeable future. Although the private investment boosted the development, the bids have started witnessing irrational exuberance, which was exhibited in the vast overestimation of trafc with the concomitant high bids. The participation levels also saw a high, especially in 2011 and a part of 2012, where a sizable number of projects witnessed more than 20 bidders for each project, especially at the lower and medium ends of project size. The winning bids were then marred by winners curse, ie, the winner loses money despite winning the bid. The problems became acute with the slackening growth and the actual trafc numbers emerging to be far lower than the estimates, thereby jeopardising the entire economics and viability of the projects. The problems from regulatory and nancing sides have not helped the matter either. On the regulatory front, the uncertainty over land acquisition and environmental concerns has delayed the projects, thus increasing the costs. The higher nancing costs due to the ination taming emphasis of RBI have also affected the projects negatively. The question now arises if the existing PPP

framework is adequate in dealing with problems being faced, especially the projects already awarded. The quick answer will at best be cautiously afrmative. Since the existing contracts cannot address the problems in changed socio-economic paradigm, should the contracts be renegotiated? In theory, they could be. However, any changes in the contractual obligations have to be put under the test of fairness, ie, bidding conditions ought not be changed post-award. At the same time, public interest cannot be overlooked. This adds another layer of complexity as public interests may not be protected without renegotiations of the existing contracts due to lack of nancial wherewithal on part of the government to implement these projects. Reopening of bids may lead to delays. Also, lack of clarity on the regulatory front may again lower the interest, and perceived risks by the bidders will be high, resulting in more outgo for the implementing agency. The answer lies in prioritising the requirements and looking at not only todays requirements but also the impact of putative steps in future development of this sector. Renegotiation of contracts has been done in many jurisdictions. The learning from such historical

Uncertainty over land acquisition and environmental concerns has delayed many highway projects. to be continued on pg 29...

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May 2013 Infrastructure Today 27

PERSPECTIVE
deposited in the court such that once the courts dismiss the appeal, the amount can be realised by the awardholder immediately. REGULATORY AUTHORITIES Issue: Independence of regulatory institutions still to be established. Recommendation: Sectoral regulatory authorities need to be developed into truly independent bodies free from political and bureaucratic capture. Implement draft legislation, prepared by the Planning Commission, to create a new regulatory architecture to enable true independence of functioning of sectoral regulators. repayment schedule; (ii) Change in repayment schedule: If there is a delay in a project from the original documented DCCO on account of sovereign reasons like land acquisition, legal and statutory approvals. ROAD SECTOR Issues: The current system of toll collection (by cash) is prone to being misused. NHAI is currently the nal arbiter in case of a dispute between itself and the concessionaire. NHAI is, therefore, in conict; lower total project cost estimates by government hindering funding by lenders, restricting termination payments and increasing contingent liabilities on the balance sheets of sponsors, and leading generally to most disagreements. Recommendations: Switch to electronic tolling to ensure transparency; Establish a separate agency to settle disputes between NHAI and the concessionaire; System of nalising total project cost needs revamping by: (i) aligning schedule rates with market; (ii) providing for lead adjustments, where necessary; (iii) providing realistic escalations for input prices; and (iv) aligning IT non-EPC costs with market estimates.

INFRA FINANCING Issue: Asset is classied as impaired when there is a change in the date of commencement of commercial operations (DCCO). Recommendations: Asset should not have to be classied as impaired when there is a change in DCCO under the following circumstances: (i) Repayment of the loan is regular and no change is being sought from the original documented
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precedence could provide a possible solution to current problems and may provide a framework for future renegotiations. However, contracts should be renegotiated ensuring that bailing out should not lead to unnecessary aggressive bidding and moral hazards in future bidding. Specically discussing the recent instances of request for renegotiations, it may be observed that the developers did not opt out because of the failure of conditions precedent cited previously. Instead, the new proposal in certain cases requires commercial restructuring of the contract by back-ending the premiums committed during bidding. Interesting perspectives emerge if we put this particular idea through the criteria of public interest and fairness. First, it is simple to appreciate that projects of this sort are essential for the economy and, thus, renegotiation should pass the test of public interest. However, it has to be determined whether few months delay in project (if they go for re-bidding) will really affect the public interest signicantly, especially when the renegotiations are also likely to take some time. Second, the principal of fairness also seems to be getting satised if the offer is net present value (NPV) neutral as apparently is the case. Once again, delving little deeper, it is important to understand the factors behind any bidding. These factors include not only
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expectation of positive NPV but also the timing of cash ows, which is particularly important for debt nancing. Any bidder would take the liquidity issues into account while bidding. Thus, any change in the timing of premium payments amounts to changing the bidding condition post-award. Moreover, the assessment of the discount factor is tricky and open for subjective interpretation. Another complexity is different bidders have different discount rates, and if the renegotiation terms were known to them, the premium amounts would have been different from what they have bid. In the wake of the above mentioned problems, it may be noted that the change in bidding conditions, including that by altering the timing of bid premiums, go against the grain of bidding process. Thus, in order to keep faith in the bidding process, re-bidding emerges as a better solution despite changed social and economic scenario for existing contracts. However, the bidding framework for future projects may incorporate the learning from the current issues. Of IT course, the principal of fairness should be upheld.
The author is Director Transport & Logistics Practice, CRISIL Infrastructure Advisory. Views are personal.

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