The new Chaturvedi norms for highways encourage fly-by-night operators.
At the BNP/CII/Feedback Ventures infrastructure investor conference in Hong Kong and Singapore last week, to which I was an invitee, investors were quite categorical in their views. They were worried about the lack of progress on the restructuring of the power sector, the ongoing Mukesh-Anil fight over gas and the government’s role in it, the post-bid changes in the Sasan UMPP and the lack of progress over “open access”. As for the roads sector, they were enthused by the fact that a more dynamic Kamal Nath was now in charge; when it was spelt out that the Chaturvedi Committee had suggested some pretty major modifications in the policy (likely to be cleared this week) and the highlights given, this enthused them further.
Given that Chaturvedi has accepted most of the suggestions of the contractor lobby, this should ensure more bids for the new road projects that the National Highways Authority of India (NHAI) is bidding out. Briefly, Chaturvedi has recommended (i) there be no restrictions on the viability gap funding (VGF) — under the current policy, only half the VGF can be paid out in the pre-completion period (the rest is paid in quarterly instalments over two years) and at no point in this period can it be more than what the concessionaire has put in; (ii) the conflict-of-interest clause be modified to allow cross-holdings of up to 25 per cent; (iii) investors in projects be allowed to fully divest from the SPV after two years of the road being completed as opposed to the current practice of them having to always retain at least 26 per cent. There are a few more relating to leaving more of the upside — if traffic increased on the roads — for the concessionaires.
It is too early to say if this will help Kamal Nath achieve his target of completing 20 km of roads a day as compared to the current three or so, given the NHAI’s history of delays (see ‘Kaise khilega Kamal?’, https://www.business-standard.com/361082/) and the vastly larger sums of money that Nath will now have to get from the government — construction targets have been hiked as has the VGF per road. A few points, however, have to be made about the Chaturvedi recommendations since the net result could be a road programme that has a lot of takers but with no corresponding guarantees on its quality.
There is little doubt that the initial ceiling of 1 per cent (later increased to 5 per cent) for cross holdings — that is, one bidder holding an equity stake in another bidding company — was absurdly low, especially since several of the companies bidding have the same financial investors as equity partners. But hiking this all the way to 25 per cent will encourage investors to ask bidding companies in which they own a 25 per cent stake to collaborate on bids.
The exit clause is equally problematic. In order to provide liquidity, concessionaires can divest up to 26 per cent of their equity two years after the project is up and running — retaining 26 per cent ensures they have a stake in maintaining the road in good condition for the rest of the franchise. If they can get out fully, how is this to be achieved? NHAI’s argument is that even if the new buyer is a pure financial investor, it will take on all the obligations with, if need be, another contractor to look after the project. This sounds convincing but the reason why the government wanted bidders with a track record in handling road projects was that they had an expertise which mattered. If it was so easy for financial investors to take care of matters, why look for a construction track record for even the initial bid?
This gets more problematic when linked to the VGF and the fact that 90 per cent of debt on the project is government-guaranteed. If the VGF is 40 per cent, and the debt-to-equity ratio 4:1, this means 83 per cent of the cost is paid/guaranteed by the government and the concessionaire has just a 12 per cent equity stake in the project. This 12 per cent, in the case of a fly-by-night operator, is more than made up by cutting corners in construction, some padding of costs (costs of BOT projects are now up to Rs 10 crore a km from the Rs 6 crore estimate in 2006) and from the toll revenues in the first two years. In other words, after two years of the project coming on stream, the concessionaire has zero interest left in the road.
There are obviously good contractors who will not default, but there is ample scope for the fly-by-night ones to construct poor-quality roads and get away with it — the furious pace at which roads are to be given out will ensure that, like it or not, the fly-by-nighters will thrive. Think about it.
