Recently major infrastructure players such as GMR and GVK have pulled out of high-profile road projects, collectively valued at ₹107 billion (US$1.7 billion). While they claimed that the exit was prompted by issues relating to obtaining statutory clearances, the real cause appears to be their inability to raise equity in the present economic climate.
In light of these developments, the Indian government is set to announce a bailout policy for road developers based on recommendations of a committee on premium restructuring headed by C Rangarajan. Premium is the annual upfront amount paid by the developer to the National Highways Authority of India (NHAI) during the bidding of build-operate-transfer projects, which increases annually. Expecting high returns and profitability, developers had quoted extremely aggressive premiums which have now been discovered to be financially unviable.
The Rangarajan model
The model suggested by the C Rangarajan committee allows restructuring of 75% of the developer’s commitment for the first three years during the construction phase for both four-laning and six-laning of highway projects. The entire premium will be recovered within three years of completion of the contract.
Since the construction period is capital intensive, a substantial cut in the rate of premium during the first three years is likely to be a big relief to road developers. Further, any annual cash flow surplus to debt servicing and operation and maintenance costs will be set off against the deficit in premium payment obligations.
The committee has recommended that NHAI conduct a traffic study for a project to ascertain if existing traffic trends will help meet projected revenue and in a case where there is a shortfall, the project will be considered for benefits under the bailout package.
Proposed policy amendments
The Ministry of Road Transport and Highways is also considering amendments to the exit policy for the road sector which was announced earlier in 2013 and did not find any takers. The exit policy in its current form only allows substitution of the developer after which a new special purpose vehicle must be formed and does not allow the transfer of perks to the new developer.
The proposed changes would allow the developer to sell its stake in the special purpose vehicle set up for the project along with transfer of perquisites such as the 10-year tax holiday to the new developer. NHAI is also in favour of removing the penalty of 1% of the project cost imposed on developers opting to exit from road projects.
The bailout policy was expected to be finalized by the Finance Ministry by the end of 2013. Once the policy is finalized, it is expected that lenders and over-leveraged private developers will derive some comfort resulting in revival of activity in the road sector and countering some of the effects of the severe economic downturn. However, on a more fundamental level, the issue that needs to be addressed is what has led to this situation where the government, which is itself in a precarious financial condition, is allowing rescheduling of premium of more than ₹1,000 billion.
Apart from aggressive and often irresponsible bidding by private players, the bidding parameters set out by the government focused on the lowest premium being quoted instead of assessing the long-term sustainability of the premium, based on realistic revenue projections. If bailing out of financially stressed infrastructure projects is the beginning of a trend, then this is also likely to lead to bid distortions since bidders will factor in renegotiation of premium payments at the time of formulating their bids. Further, this is likely to create a domino effect, with other financially stressed infrastructure sectors such as ports seeking similar bailouts.
Bailouts are “systemic rescues” intended to stabilize the financial system and, in the case of the road sector, provide the impetus to revive stalled projects and investor interest in the sector. The bailout of the road sector may have become a necessity today, however, going forward the approach of all the stakeholders should be to identify the causes that led to this situation and build in appropriate checks and balances from the bidding stage itself.
While the government has stated that this bailout will be a one-time benefit, there is a serious need to re-evaluate the bidding parameters so as to discourage irresponsible bidding by developers. It is unlikely that a one-time quick fix will resolve the underlying issues plaguing the road sector, or the infrastructure sector at large, such as developers being over-leveraged or undergoing corporate debt restructuring or over-cautious lending, which require long-term solutions.
Shruti Sahu is a counsel at Trilegal and Megha Kaladharan is an associate. Trilegal is a full-service law firm with offices in Delhi, Mumbai, Bangalore and Hyderabad.
A-38, Kailash Colony
New Delhi – 110 048
Tel: +91 11 4163 9393
Fax +91 11 4163 9292