Kamal Nath’s NHAI is building highways like there is no tomorrow and like it’s a law unto itself. It ignores cabinet decisions, busts budgets, sets its own rules, releases grants without collaterals, clears PPP projects with negligible private equity and lets them walk out of projects at will. Indeed, says a Planning Commission paper, there will be no tomorrow for NHAI beyond 2011.

n an after-dinner conversation some years ago, a distinguished editor recounted a story on subcontinental nonchalance for deficits. When the editor was on a visit to Pakistan, Nawaz Sharif insisted that they drive at plus 200 kmph on the eight-lane motorway connecting Rawalpindi and Lahore. Zipping in the prime ministerial cavalcade, the editor couldn’t help but ask how Pakistan’s doddering treasury would be able to pay back for the beautiful but hopelessly out-of-budget project. Sharif retorted, “Come on, janaab! Did Shah Jahan ask his finance minister before building the Taj Mahal? Did Sher Shah Suri worry about deficit while building the G T Road?’’ 

Kamal Nath, our pointsman for highways, has taken a leaf out of the book of these three failed rulers. By laying out a powerful visual of 20 km of new roads per day, shortly after ceding Udyog Bhavan to Anand Sharma, Nath has created a buy in which no Indian would want to repudiate (or refudiate!). But what Nath has not so unwittingly done is to expose the exchequer, our banks and future generations to a risk which will outlive him and the leadership he serves. This is highlighted in a Planning Commission “issues paper”. Nath has rubbished the paper but even for a powerful economy like India, this could be our sub-prime. Here’s how:

The public-private partnership (PPP) model has enabled concessionaires to raise a huge pile of debt from commercial banks. According to information sought by noted RTI activist Devashish Bhattacharya from four sources (department of economic affairs, department of expenditure, ministry of road transport and highways and the planning commission) on a the “issues paper”, in just 20 highways projects, with a total project cost of Rs 13,646 crore, the PPPs have been extended loans nearly double the TPC, Rs 25,940 to be precise.

Service of this mountain of debt hinges on future revenues of these highways and not on  the concessionaire’s balance sheet. Curiously, these excess loans have been given without any collateral or guarantees that average Joes like you and I must give. If the concessionaire walks out without completing the project, the only security that the banks have is the half-finished road. Such an asset can hardly be mortgaged or sold. In cases where the project has been completed, the additional recourse the banks have is by way of termination payments from the National Highways Authority of India (NHAI). Even here NHAI is liable to pay the bank only 90 percent of the TPC. The remaining 10 percent and all over-runs above TPC are the headache of the lending bank, according to the plan panel paper.

This is expected to protect NHAI from unending contingent liability. But since enthusiastic banks have approved escalations in the NHAI-determined TPC by huge margins (Rs 25,940 crore minus Rs 13,646 crore equals Rs 12,294 crore as we saw in 20 projects alone) when the concessionaire walks away, the banks will get back only 90 percent of the TPC and as we saw only if the project has been completed.

For example, the approved TPC of the Gurgaon-Jaipur project is Rs 1,674 crore, but the cost approved by banks is 80 percent higher at Rs 3,009 crore. So, if there’s a default, the banks would get only 90 percent of Rs 1,674 crore and the remaining Rs 1,500-plus crore will become sticky, the Planning Commission paper has pointed out. Similarly, the Pune-Sholapur project has a TPC of Rs 623 crore, but banks have approved Rs 1,371 crore. So, the banks may have to write off over Rs 800 crore (Rs 1,371 crore minus Rs 623 crore plus 10 percent of Rs 623 crore) here.

Now, banks are hardly the candidates for such sacrifices. So, in all probability their loss will be offset from doles by the government or in other words your pocket and mine.

Virtually unnoticed, the PPP model has been used to give an alarming concession to some private concessionaires, so much so that some of them have managed to transfer the entire risk of their projects to the exchequer.

In the name of the fiscal stimulus, the NHAI was ordered to pay 40 percent of TPC as viability gap funding (VGF). This VGF used to be 20 percent earlier. Here’s the impact: a four-lane project with TPC of, say, Rs 1,000 crore and a VGF of 40 percent comprises of roughly Rs 800 crore of construction cost and Rs 200 crore of financing cost (ie 25 percent, a very high number coming on the back of 40 percent VGF). The construction cost would typically have a 15% margin for the contractor, so the actual cost of construction would be Rs 680 crore. A VGF of 40 percent would give the concessionaire Rs 400 crore.

Table 1

Inadequate number of bids
Concerns relating to inadequate competition or cartelisation are reinforced by the fact that only one or two bids have been received in a significant number of cases even though a large number of bidders were pre-qualified in most of these cases. This table illustrates the lack of competition:

All that the concessionaire therefore needs to bring towards construction is Rs 280 crore (Rs 680 crore minus Rs 400 crore). For financing this amount, she can go to specialised lending agencies that give up to 20 percent of TPC. So, if the concessionaire is smart, she can get 40 percent plus 20 percent (that is  60 percent) of the TPC of Rs 1,000 crore (that is, Rs 600 crore) from NHAI and specialised lenders. Only the remaining Rs 80 crore (out of Rs 680 crore) need to come as her own funds.
Even here she can raise up to Rs 400 crore to finance her equity contribution of Rs 80 crore, after a few book adjustments. So, rather than fishing out money from her purse, she’s being left with a decent pile of extra cash and the wonderful situation of implementing projects without financial stakes of her own.

Things get even better! Recent changes in the model concessionaire agreement (MCA) allow exit after two years of completing construction. In simple terms, who would build a quality road to last 30 years and sit on a toll for that long, when she can exit in two?
In such an event, the report says, the impact on NHAI which would have already given VGF of Rs 400 crore would be Rs 940 (plus 90 percent or Rs 540 crore, of the project debt). So, on a highway which as we saw actually needed Rs 680 crore to construct, NHAI will be paying Rs 940 crore to take over!

A not-so-happy situation now is that some of the bids have come up at unexpectedly high prices. Also, the VGF finally approved by NHAI (against original approval by the union cabinet) for projects has been significantly higher and nearly always equal to the 40 percent cap. For example, going by the Planning Commission paper figures, the Moradabad-Barielly highway with a TPC of Rs 1,267 crore and an original VGF of 9.6 percent has seen a revised VGF of 35 percent (Rs 443 crore) implying a sweetening of Rs 322 crore in VGF alone. Similarly, the Charthalai-Ochira with TPC of Rs 1,535 crore and nil VGF envisaged originally has seen a revised VGF of 38 percent, that is, Rs 583 crore. As per the government’s own data, the additional VGF approved for four-lane highways with a TPC of Rs 19,575 crore is Rs 3,700 crore (Rs 7,516 crore of revised VGF versus half that amount approved by the cabinet). If we add six-lane projects too, the additional VGF is Rs 4,159 crore (Rs 8,527 of revised VGF versus Rs 4,400 crore approved by the cabinet). At this rate NHAI will not have the budgetary resources even to meet its VGF liabilities.

High bids for annuity projects
The bids received for annuity projects also seem to be very high and unjustified. In the absence of robust competition, it may be difficult to regard these outcomes as acceptable. The table below illustrates the bids for annuity payments as a proportion of the total projects costs:

If this weren’t enough, the government in its wisdom has diluted its own decision to implement the model RFQ (request for quotation: procurement guidelines) for highways. This model RFQ had come up as an answer to eliminating malpractices in the pre-qualification stage and has shown its uses in the Mumbai and Delhi airport bids where flawed pre-qualification could be set aside and more competition brought in. The model RFQ was drafted by an inter-ministerial group (IMG) mandated by the committee on infrastructure (COI) which the prime minister chairs. What the IMG produced was approved by the COI and then issued by the finance ministry in May 2007 and then reviewed and modified by a Planning Commission member one year later after approval of the finance minister. This modified document applies to all ministries, central entities and even several state governments. Only NHAI is allowed to deviate from it with the approval of its parent ministry.

The results have been noted by the finance ministry itself. They have created additional exposure to NHAI because projects are being approved in terms of physical parameters (remember 20 km roads per day!) rather than budgetary implications. In simple words, NHAI gets the approval of physical targets and gets down to the exciting job of awarding contracts (and incurring VGF and other liabilities) without worrying about budgetary constraints. A perfect example is annuities that NHAI has given to the tune of Rs 2,774 crore over a TPC of Rs 11,539 crore, clearly a situation where the government is committing deferred budgetary payments (table on page 29). As per the government’s own data, NHAI has committed an annual liability of Rs 4,828 crore for projects already awarded. This will go up by another Rs 1,500 crore as more projects currently under the bid process come up. A further Rs 3,200 crore of annuity has been approved by the ministry of road transport and highways, thus adding up to an annual annuity outflow of Rs 9,500 crore. On the revenue side, the current cess revenue is Rs 7,800 crore a year. So, all of NHAI’s future budgetary allocations in the form of cess revenue stand committed and pre-empted for the next 15-20 years for meeting committed liabilities. The surprising part is that under orders of the cabinet, the cap for this commitment is 35 percent.

The consequence of liabilities from projects awarded up to March 2011 is going to be a stoppage of further development works from April 2011. The Planing Commission paper estimates that additional borrowings for repaying existing debt will be approximately Rs 30,000 crore. That’s why the paper claims, a sub-prime crisis is looming.

Table 3

All benefit private, all risks public!
Information relating to some individual projects suggest that in several cases, the banks have been lending far in excess of the duly approved TPC. By way of illustration, the TPC fixed by NHAI on the one hand and the capital costs approved by banks on the other hand are shown below:

The Planning Commission paper points out public funds are being exposed to grave risk. Two very well-disguised ways of helping the private partners of the PPP have been elaborated in the paper.

1. Lending by banks

> As can be seen in the table along side, banks are allowed to lend far in excess of the TPC (total project cost) arrived at by the NHAI. See for example item no. 9 (Panaji-Karnataka border) where IIFCL has lent more than three times in excess of the TPC (minus the viability gap funding or VGF). This kind of bloated lending means that the private partner  “may not only spend beyond reasonable costs but also siphon out funds at public expense”.

> But in the event of project failure, “the banks will not be able to recover anything beyond 90% of the TPC. In the case of the Panaji-Karnataka border project this means that the NHAI will pay the bank only 90% of the TPC (Rs 196 crore)  and not 90% of the Rs 832 crore (which is the inflated project cost agreed to by IIFCL). The problem is this is happening across projects and as you can see from the table just for 20 projects, IIFCL has over lent Rs 12,294 crore.

> “Since most of the lending is by public sector banks, including IIFCL, in the event of project failure, these banks could plead that the excess loans were granted with full knowledge and participation of NHAI and the finance ministry and may, therefore demand a bailout. No matter who pays for these lapses, it is public money that will be lost.”

> Thus, private concessionaires brings little by equity to the table, can borrow public funds far in excess of project costs, can exit when they wish. All benefit private, all risk public.

2. Grants for construction

> Another big give-away for the private concessionaires is the viability gap funding (VGF). The Model Concession Agreement specifies a VGF of 20%. This was doubled by the Committee on NHDP to 40% of TPC. This “stimulus” allows the concessionaire to transfer most of its financial risks to the public.

> To understand how this works, let’s take the example of a project with a TPC of Rs 1,000 core and VGF at 40%. Because TPC involves 75% construction cost and 25% financing cost, the construction cost works out to Rs 800 crore. Construction cost includes the contractor’s profit at 15%, so the money she spends on construction works out to Rs 680 crore or 68% of TPC. But a 40% VGF on Rs 1,000 TPC would mean, NHAI gives the contractor Rs 400 as VGF.

> This means the contractor has to arrange for only Rs 280 crore (Rs 680 crore minus Rs 400 crore). Here again, he can raise a loan of up to 20% of TPC from IIFCL which works out to Rs 200 crore, leaving the contractor to raise bank loans of up to Rs 400 crore to finance his/her contribution of Rs 80 crore. “That actually leaves a substantial surplus in their hands. This nominal equity means that the contractors can implement the project without any financial stake of their own.”

> The bonanza for the contractors does not end there. By a recent amendment to the MCA, they are now allowed to walk out of the project barely two years after completion of construction. “This reduces their incentive to build a project that would last longer and have lower life cycle costs, defeating the very purpose and objective of adopting the PPP model.”

> NHAI releases these huge grants to the contractors without any bank guarantee as do the banks without any security. So when a contractor ups and goes, NHAI and the banks will be left holding the baby, which is always a highway, either half-done or completed. But look at the cost to the NHAI. It would not only have sunk in Rs 400 crore (VGF), but it will have to pay up 90% of Rs 1000 crore, the TPC to the banks. That works out to another Rs 540 crore. Thus NHAI would end up paying Rs 940 crore for a highway whose construction cost was only Rs 680 crore.

> If it were any asset other than a highway, NHAI or the banks can sell them and recover some money. But a highway cannot be sold. So the money lent to the runaway contractor will have to be borne by the exchequer. Once again, all benefit private, all risk public.

This first appeared in the September 1-15 issue of the Governance Now magazine (Vol.01, Issue 15).

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