Sunil Jain: The perfect murder

RATIONAL EXPECTATIONS

If the huge cost padding in the Enron-Dabhol project made people distrust private power projects in the 1990s, the Noida Toll Bridge Company Limited (NTBCL) is likely to do the same with the roads sector. Sadly, NTBCL may not be the only such project in the roads sector (there is still no one standard format for such projects and contracts differ across states), and consumers continue to be taken for a ride with or without the compliance of regulators in other sectors "" "Why have regulators" (22-1-07) and "Regulators and other disasters" (29-1-07) give several such examples from the shipping industry.

Of course, returns in these sectors pale in comparison with NTBCL, where they are in excess of 40 per cent and increase dramatically as the concession period (30 years to begin with) rises "" indeed, the worse the project does in terms of its primary objective (to get people to travel on the bridge), the more the returns go up! That sounds dramatic, but all you need to do is to download two documents from the NTBCL site "" the listing document filed as part of its process of raising money on the AIM exchange (http://www.ntbcl.com/files/AIM_Admission_Document.pdf) and its latest annual report (http://www.ntbcl.com/files/AnnualReport-NTBCL-2005-06.pdf). Both are in the public domain, though the full import came through only when Sheoli Pargal (an economist who's done a lot of work in the private provision of infrastructure space) put it all together (http://infrastructure.gov.in/pdf/NOIDA.pdf) after months of painstaking research.

Now that Pargal's (disclosure: we were together at the Delhi School of Economics "" she was one of the toppers, I wasn't!) spelt things out, the story is a simple one. The NTBCL toll bridge is a 552.5-metre bridge across the Yamuna, connecting Noida with Delhi, and six years after it began operations, the $92mn bridge still carries just a third of the 220,000 vehicles it was built for. The problem begins with the fact that IL&FS, the project sponsor, conceptualised the project and then got it implemented by a company that it promoted.

While people view projects which get an assured return of 16 per cent with suspicion, NTBCL was assured a 20 per cent annual return, not on the equity but on the entire project cost. NTBCL's chief Pradeep Puri has defended this by arguing that (a) at the time the project was finalised, interest rates were in the region of 16-18 per cent and (b) it was a no-recourse project "" so, if it didn't work, nobody would have bailed it out. The arguments don't hold water. For one, now that the loans have been renegotiated down to around 10 per cent, why not pass these benefits to the project?

What this does to the returns is awesome. Assume the project costs Rs 100 (70 of debt and 30 of equity) ""so, at the assured return, it has to generate Rs 20 to meet interest payments and profits for equity. If interest rates are 16 per cent, as they were for NTBCL, this leaves Rs 8.8 for servicing equity [Rs 20 less (16 per cent of Rs 70)], which is a return of 29.3 per cent. After corporate debt restructuring, NTBCL's average interest rates fell to under 10 per cent "" this left Rs 13 for equity, hiking the returns to 43.3 per cent!

Even this goes up dramatically since, as per the contract, if there is a shortfall in returns, this gets added to hike the project costs "" on which a 20 per cent return has to be paid! So, if the bridge generates no revenues for five years, the project cost goes up from the original Rs 100 to Rs 100 x (1.2)5, or Rs 249! If you think this is just a theoretical construct, in March last year, the AIM document says the project costs were up to Rs 953 crore ($211mn) "" as a result of this, the same document says, the concession period has already gone up to 70 years! A few more slippages in these 70 years, and the concession could well become one in perpetuity.

Put the numbers on a spreadsheet, and the results get more interesting. Assume, instead of giving the stipulated 20 per cent return per year, the project gives only half this and so the project costs go up each year. At the end of the 19th year, assume NTBCL is paid a 20 per cent return on this new project cost in cash; then discount the revenue stream. You get a number which is a sixth higher than in the case where the bridge generates the full returns each year "" that is, inefficiency pays. This difference gets higher each time the concession period rises.

This is where Puri's non-recourse argument comes in "" what's the point of having the bridge for 70 years if it doesn't generate any money? Evocative, but hardly the full story since NTBCL was given the rights to 99.4 acres of land, which it could develop and use the funds if the bridge didn't deliver "" so there was recourse. NTBCL has set up a wholly-owned subsidiary to develop the land and 30 acres have already been sold to it at Rs 103.5 crore "" had the project been properly designed, the NOIDA authorities, who own the land, would have unlocked its value, by auctioning preferably, instead of leaving it to NTBCL and its subsidiary.

You could ignore this as one of those experiences a country needs to go through while privatising, as some infrastructure experts have argued. But given how there is little evidence that a foolproof public-private-partnership model has been evolved, and not only in the roadways sector, investigating the matter at the government level may not be a bad idea.