The National Democratic Alliance government's focus on infrastructure development may have become clearer after a 50 per cent increase in the allocation for national highways in the Union Budget with the outlay for 2015-16 going up to Rs 42,912 crore. Pumping in more funds is fine but what the sector actually needs is the inflow of private investment. It is this realisation that has made the government look at newer models of financing to attract investors.
One such model being considered is the hybrid annuity, which attempts to de-risk private capital in highway projects. The new model being discussed in government circles is an innovation that builds on the more widely used build-operate-transfer (BOT) model. In the BOT annuity mode, the government bears the commercial risk of toll collection. The government pays the private operator the project cost along with interest in the form of a half- yearly annuity. However, the hybrid annuity will involve the government paying a part of the capital cost at the commencement of the construction work, thus giving the private company a revenue stream even before the actual commercial operations begin. Besides, up to 10 per cent of the project cost will be paid by the National Highways Authority of India, or NHAI, as a mobilisation advance.
The hybrid annuity model will also have a reference index with 70 per cent weightage accorded to the wholesale price index and 30 per cent to the weekly Consumer Price Index. This would imply that when companies quote a cost for carrying out a highways project, such cost would be eligible for revision based on changes in the price index. In addition, 60 per cent of the completion cost would be payable during the operation and maintenance period, and the reducing balance mode would be employed to pay interest at the rate of 2 per cent plus the prevailing bank rate.
Not ready for use
Though there is a set of 13 projects in the third, fourth and seventh phases of the National Highways Development Project -totalling a length of 1,093 km and involving a cost of Rs 14,443 crore - which is expected to come up for bidding, some experts caution that further fine-tuning of the hybrid model is required before adopting it. "The government should start with three or four projects first to test the model and then improve and refine it," says Vishwas Udgirkar, senior director, Deloitte India. "There could be distortions, so it is better to phase the projects over a period of time to get a better response."
There are vexing issues in project execution too. According to Rohit Inamdar, senior vice-president, ICRA, the overall execution rate declined 17 per cent to 3.41 km/day during the first eight months of 2014-15 from 4.14 km/day during the same period in the preceding year. A major slippage in execution occurred in the first quarter of this year when the pace slowed to 3.98 km/day owing to the general elections against the 6.04 km/day recorded in the first quarter of 2013-14. The execution during July-November 2014 stood at 3.08 km/day as against 3.00 km/day in the quarter before this.
"Although the new government has taken several initiatives like delegating the powers to grant forest clearances to the regional offices, leading to possible saving of six to eight months in time taken for clearances, providing for online filing for clearances to construct rail over bridges and under bridges-both were earlier major bottlenecks - and increasing limits on sand mining, the actual execution is yet to gather momentum," Inamdar says in a recent report.
ICRA believes that starting from the first quarter of 2015-16, these measures will start yielding positive results, giving a fillip to the pace of execution.
Udgirkar says the market is waiting for a new project line to be announced. According to him, the new hybrid annuity model will take care of some of the financing issues in road projects. There will be reduced risk for the private sector since the government will disburse a part of its funding during the construction phase itself. "To that extent, the cost of raising money for the private developers will come down. Besides, future interest rate risk will also be neutralised since the government payments will be linked to prevailing rates."
The concern of debt-laden corporate balance sheets would, however, continue to persist. ICRA's analysis of 113 BOT road projects, covering almost half of such projects awarded in the country, points to a steady deviation from the earlier debt/equity (D/E) norm of 70:30, with around 37 per cent of the projects having a higher debt component. Around 10 per cent of the projects, mostly annuity based, have contracted debt to the extent of 90 per cent of the initial project cost.
Mismatched cost estimates
The study shows that for around 40 per cent of the total projects, the debt sanctioned is higher than total project cost estimated by NHAI, presumably because the project debt is based on the developer's cost estimates that is, on average, higher by 35 per cent than the NHAI project cost. "In such cases, the lenders are exposed to a higher risk particularly in the event of termination of the Concession Agreement wherein NHAI guarantees compensation based on its own appraised project cost and not the developer's estimate," says ICRA.
Part of the trouble stems from the fact that companies have stretched themselves to bag these projects. Udgirkar says that no amount of innovative modelling by the government will help reckless bidders. "It is more a discipline issue that no funding model can address. Banks and companies need to introspect," he says.
To that extent, the hybrid annuity model will only address a fraction of the financing problems by derisking some of the funding cost. The overall effort, however, may just be a drop in the ocean of unresolved issues in the sector.