Infrastructure is a key enabler for an economy to function at a competitive and sustainable growth rate. There is no denying to the fact that last quarter century has seen a remarkable expansion of Indian Infrastructure in its scale and reach.
But despite that impressive historical growth, the underdeveloped state of infrastructure still acts as a constraint on the possibility of realization of the full growth potential of India.
The heart of the Indian Infra reforms has been the Public-Private Partnership (PPP) model. Therefore, any attempt to know what went wrong must come to grips with how we, as a country, implemented the PPP model, where we made mistakes and what needs to be fixed?
A PPP project basically involves three major stakeholders- the government, the private developer and the banks, each of these has its fair contribution in carving a failure out of a potentially successful concept.
Though the model was basically developed to leverage the combined strengths of the government and private sector to meet India’s critical infra needs. But multiple flaws with the model have led to numerous projects facing a cash crunch, banks facing the risk of loans turning into NPAs and developers on the brink of bankruptcy.
The Government and the MCA
One of the fundamental mistakes done by the government was narrowing down the lens of constructing a partnership with the private sector under PPP model to financial necessity. The government initially tried to leverage the model just to attract private investment in infrastructure sector. Ironically, governments can often raise funds at lower costs compared to private developers!
The government did not focus on garnering other benefits of the partnership like private sector’s ability to bring in the latest technology, efficient managerial practices and complementary risk mitigation. Further, in seeing PPPs as a channel to attract private sector funds overlooked the critical need to build institutions that would have enabled efficient deployment of the capital.
The government also failed in ensuring that private sector would not be called upon to bear risks for which it was ill-equipped like land acquisition or environmental clearances, which were the critical reasons behind the stalled projects. The government could not foresee the need to establish an independent regulator to ensure an efficient dispute settlement mechanism.
The Model Concession Agreement (MCA) which was developed to build capacity for project designs was far too inflexible. It applied a ‘one size fits all’ solution to projects in a sector. It failed to recognize the fact that many projects may face unique technological or demand risks that may go beyond standardized templates.
MCA has also put a larger set of bindings on the private developers and hence not only limited the accountability of the government but also failed in ensuring equitable risk allocation. The Kelkar Committee has acknowledged the problem and provided a framework of renegotiation of MCA under various circumstances.
The Private Developer
A report on PPP projects submitted by Kelkar committee pointed out the game of inflating the Total Project Cost (TPC) played by the developer deliberately. By inflating TPC, developers sourced higher debts than the actual requirement. If the project is then jeopardized, there is virtually no “skin in the game” by the developer as the funds are at risk are those of lenders.
A 2016 submission of the parliamentary standing committee found that the National Highway Authority of India allowed concession agreements with cost estimates differ from those used in loan applications. It suggested that banks and other financial institutions must have authority to review MCAs along with ministries.
The Banks: Source of Funds
Unlike the international precedents, infrastructure was funded to a major extent by commercial banks in India. Since infrastructure projects have long gestation periods and banks raise funds from depositors for a tenure ranging from short to medium term, this created a potential for serious asset-liability mismatch.
Ignoring the problem, banks not only went ahead in lending to infra projects but also showed irrational exuberance in terms of lending to the sector. The share of bank loans to infra projects rose from 13% in 2002 to 31% in 2015. The mammoth NPA problem that the commercial banks in India are facing today could have had a lower scale if bankers acted with some foresight then.
The success of PPP to a large extent depends on optimal risk allocation, an environment of trust among the stakeholders and robust institutional capacity. The government must come forward with the establishment of independent regulatory institutions to have necessary regulatory oversight and an efficient dispute settlement mechanism.
Pricing and accounting reforms are required to improve fiscal sustainability of the projects, to have clearer projections of fund flows and to distinguish between losses due to social obligations and losses caused by inefficiencies.
Apart from sound regulatory and arbitration framework, a robust PPP enabling ecosystem includes diversified and liquid financial institutions. The private fund flow into the infra sector has been rightly streamlined by the establishment of National Infrastructure Investment Funds (NIIF) by the government and Infrastructure Debt Fund by RBI. Further, the green signal to Infrastructure Investment Trusts (InvITs) is a step in right direction as it would scale down the exposure of commercial banks to the Infra sector.
Besides that, the government while learning from its past experiences has rolled out Hybrid Annuity Model (HAM) under PPP which is a welcome step. HAM model successfully balances the risk mitigation needs of the private sector by providing about 40% of the project cost in terms of annual annuities in a five-year time frame and rest on the revenue sharing model.
The government must take swift actions to implement some of the key recommendations of Kelkar committee like setting up of national level PPP institution, a dedicated PPP tribunal and a formal framework of contract renegotiation.
Building institutional capacity, better regulatory oversight, diversified source of funding, efficient dispute settlement mechanism, flexible contract negotiation, and accounting and pricing reforms. By working on these initiatives, the government can leverage PPP model as a powerhouse to India’s growth and infrastructural needs.
The article was also published at Transfin.