Vinayak Chatterjee: The march of the rating agencies

INFRATALK

The grading and rating of infrastructure projects will significantly enhance investor confidence in PPPs.

The invitation to private capital to enter the infrastructure arena is, more often than not, accompanied by controversies and allegations of unfair play, and sometimes incompetence and malfeasance by the process managers.

In India, after the withdrawal of the licence-raj in the product-market economy, the political establishment appears to have gleefully discovered the great attractions of sovereign power in dispensing favours and decisions in public-private partnership (PPP) or pure P-projects in public utilities.

So, from the early days of Sukh Ram in telecom to more recent situations concerning spectrum allocation, not to forget the bidding and now revenue-sharing models of Delhi/Mumbai airports, tariff setting in ports and sweetheart JVs with state governments, the nation has been crying out for some structure, order and codes of behaviour in this area.

There are four ways to secure acceptable behaviour:

By having in place truly independent regulatory authorities.

By developing and using standard contractual documents like model concession agreements.

By keeping an eagle-eye on transparent procedures, and effectively using the judicial system.

By a method for grading and rating projects from the pre-bid stage itself.

On the issue of independent regulatory authorities, the current coalition government seems utterly disinclined to pursue the agenda in spite of paying obeisance to the matter in the Common Minimum Programme and subsequent Prime Ministerial speeches.

To be fair, on contractual documents and templates, a good deal of constructive work has been done for the roads and ports sector, as well as in some other key infrastructure projects. The initiative here has largely come from the Planning Commission "" for which it is both loved and hated!

On keeping an eagle-eye on transparency in bidding procedures, India's free press and some committed journalists have done a fine job in exposing instances of hera-pheri. Recent policy initiatives like viability gap funding also 'demand' transparency in bidding. The courts have also done a fair job by stepping in astutely, where necessary.

It is on the fourth point, that is, to attempt to create a rigorous and neutral method for grading and rating projects that the Department of Economic Affairs (DEA) in the finance ministry must be given credit.

Throughout 2007, the DEA has been in dialogue with key stakeholders and credit rating agencies to evolve a structure to

Improve transparency levels associated with PPP projects;

Provide comfort to investors and lenders through the opinion of recognised third parties; and

Help sponsoring agencies adjust risk-sharing arrangements where necessary.

The DEA, in discussions with CARE, CRISIL, FITCH and ICRA, has evolved a common framework for pre- and post-bid ratings. The rating agencies will use their own independent methodologies and criteria for evaluating project-related risks, but have all agreed to adopt a common framework.

The 'sponsors' of infrastructure projects are the central government, state governments and urban local bodies. For the sponsor, the risk-rating exercise is likely to lead to better application of mind on risk-sharing with the private sector and, therefore, get a quantitatively and qualitatively superior set of bidders and higher valuations. Bidders can choose different classes of PPP projects based on their risk appetite. They are also alerted to embedded risks, some of which they may have missed otherwise. For the selected special purpose vehicle (SPV), it would mean quicker financial closure and hopefully more competitive rates of financing.

While the risk-rating of the selected winner, or the implementing SPV, is part of the framework, the more interesting part of this whole initiative is the risk assessment of an infrastructure project at the pre-bid stage and the evaluation and grading of fairness and transparency in the bidding and selection processes. This is a development that is completely new to India and should be vigorously encouraged to clean up well known faultlines.

It is expected that with this rating/grading system coming into the infrastructure marketplace, four significant changes will occur:

The spotlight will be focused on transparency and impeccable management of the bidding process and selection criteria.

The natural inclination of the public system to bid out projects by either not taking responsibility for sovereign clearances and permissions, or by conveniently passing on to the private sector all inconvenient tasks and processes, will be curtailed for fear of receiving a poor rating. A poor rating will lead to uninterested bidders, which will also show the 'sponsor' in poor light.

It would provide a master check-list ex-ante of all project-related risks to be taken into account, including issues like land availability and title-possession, resettlement and rehabilitation, environmental clearances, off-take agreements, market and pricing risks, as well as the risks of regulatory bias and regulatory failure. There would, therefore, be less surprises post-award.

It will also push for more capacity building in the bureaucracy for handling PPPs in the right manner.

Projects are expected to be graded on a five-point scale with Grade one indicating minimal project risks and Grade five indicating very high project risks in comparison to other infrastructure projects at a pre-bid stage.

Critics of this scheme are quick to point out some deficiencies:

The complexities of one-off large-scale public utility infrastructure projects cannot simply be captured on a simple one-to-five scale.

There are no comparable benchmarks as ratings are all related to something, including past experiences.

There is regulatory and political risk across the life of a project which can impact any time from 15 to 99 years. Any attempt to capture "risk" along such timelines may well be meaningless.

Infrastructure PPP projects, being political-economic by definition, have a fine way of evolving and overcoming risks by continuous dialoguing and 'adjustments'. This is being seen even now in the telecom sector. Ratings have no way of capturing the art, science and illogical beauty of this iterative process.

Ratings tend to be conservative and there is a fear that a large clutch of PPP projects that would otherwise have found willing bidders will now languish on account of 'poor rating' fear.

It would be interesting to watch how many and what kind of private sector players will bid for Grade four and Grade five projects. More interesting would be to finally see central and state "sponsors" struggle to put up bankable projects with a one or two rating.

The rules of the game are changing. And for the better!

The author is the Chairman of Feedback Ventures. He is also the Co-Chairman of CII's National Council on Infrastructure. The views expressed are personal