Infrastructure projects for developing countries like India are essential for accelerating growth, both economic and social, related to faster, better modes of communication. The communication can be in the form of individuals plying on roads and highways or in the form of goods being transported by means of railways, ports etc.
With an increasing demand for highways, ports, etc in the country, to increase connectivity within the country as well as with the rest of the world, the involvement of the private sector has increased manifold, in addition to the involvement of the government. This article aims to discuss the common form of private investment in highway construction projects, which is the Hybrid Annuity Model (“HAM”), and the unviability of the same in the present Covid-19 pandemic. In such a background, the article aims to analyze the revival of the Build Operate Transfer model (“BOT model”).
The Covid-19 pandemic brought with it multiple impediments in the infrastructure sector and highway construction was one of the most affected of the same. The lack of labor coupled with the lack of finances both with the private entities as well as the Government forced a severe slowdown in the construction activities.
While the construction has been gradually gaining the ground lost during the pandemic, steps have been taken to involve much more of the private sector into highway construction projects through the BOT model, which was prevalent before 2012. To understand such a revival, it becomes necessary to understand the roots of private sector involvement in the infrastructure sector.
The Private Sector in Infrastructure Projects
With the emergence of India as a developing country, it could not have been on the sole shoulders of the Government to support the diverse infrastructure that the country needed. Hence, the need to incorporate the private sector into infrastructure development was materialized into reality with the Public-Private Partnership model (“PPP model”). The PPP model was derived from the Public Finance Initiatives and the Public-Private Partnerships in the UK and USA.
The PPP model was defined as, “a project based on a contract or concession agreement, between a Government or statutory entity on the one side and a private sector company on the other side, for delivering an infrastructure service on payment of user charges.” This definition so provided by the Government clearly encapsulates the kind of push that the Indian industrial sector needed.
While there are multiple models at present through which the private sector provides its services to the infrastructure sector, all of them emerge from the PPP model one way or the other. An example of the same is the Build Lease and Transfer model (BLT) whereby the developer finances the project and upon completion takes the facility on lease from the Government to recover the finances put into the project. Once the lease terminates, the ownership of the project is automatically transferred to the Government. Apart from this, there are various other such models which include the PPP model, however, the extent of participation of the private sector may vary as per the government rules and regulations.
The subsequent sections will take this basic understanding of a PPP model further by introducing the most common forms in which the PPP model is used in infrastructure projects, primarily highway road projects.
Build Operate Transfer model (“BOT model”)
As the term suggests, the BOT model focuses on the private entity or developer building the project, operating the constructed facility for a fixed period of time, and upon the termination of that time limit, transferring the facility over to the Government. The BOT model differs from other forms of PPP models owing to the lack of any form of financing coming from the Government and the financing of the project is the prerogative of the developer. The private entity could receive an annuity fees from the Government while arranging for the whole of the finances themselves.
This mode of financing highway projects was widely used owing to the induction of the PPP model and the inclination towards more private participation in the infrastructural development of the country. With the increasing trend of allowing for more privatization in the country and the BOT model allowing for 100% private investment, the model was instantly preferred over the others.
But over time the use of the BOT model of highway construction started to dwindle down. The primary reason for the same was the unwillingness of the private entities to handle the risks that the BOT model posed in the form of delays by the government in acquiring and allotting the land, the various risks in funding etc. Owing to such hurdles, the BOT model lost its relevance and post 2012, almost no highway projects were allotted by way of the BOT model, save for three projects in the years 2017-2018. Additionally, banks and other lenders were not willing to lend to private entities owing to the lack of guaranteed repayment.
With such a downward trend in the most popular form of the PPP model used in the construction of highways, alternatives for the same were sought. And such a search resulted in the emergence of the HAM.
Hybrid Annuity Model (“HAM”)
HAM stands for Hybrid Annuity Model and it refers to a model of infrastructure development wherein the Government as well as the private entities come together to develop the infrastructure facility. This model has been primarily used in the construction of highway projects and there is a specific percentage in which the contribution of the Government and the private entity is divided.
The HAM is a combination of the BOT model and the Engineering, Procurement and Construction model (“EPC model”). The EPC model provides for no role for the private player in the manner in which the road would be operated or the manner of toll collection and it is the Government that pays the developer for constructing the same. In contrast to it, the BOT model envisions the active involvement of the private entity with respect to financing the project and also operating the same for a certain period of time.
The HAM incorporates the payment to the private player part from the EPC model and the ability to infuse private funds and the ability to operate the road for a certain time period from the BOT model to create a hybrid of both. The Government supplies 40% of the total funds which would be needed by the project and it is upon the private entity or developer to bring forth the remaining 60% of the funds.
This model became popular post-2012 when there was a stagnation in the construction of highways owing to the lack of popularity of the BOT model. To revive the stagnant highway construction industry, extensive reliance was placed on HAM, as it provided relief to private entities who now had to supply only 60% of the finances to be incurred in the project. It is also noteworthy to mention that the construction projects were expedited as there was a lesser amount to avail from the banks as loans. The EPC model was also used in this revival.
Issues with the HAM
While the HAM appears to be a boon that brought back the highway construction industry, there have been hurdles in its way which have over time watered down the viability of the same.
The first concern, as highlighted in the September 2019 report of CARE Ratings Ltd., was the lack of a corresponding reduction in the cost of borrowing with a gradually reducing bank rate. The mismatch caused due to the same was unviable for the private entities as well as the banks which had provided the loans. Another concern was the delay in providing encumbrance-free land for the development of the highways by the Government. While the mobilisation advance by the Government is provided for only post securing 80% of the land for the project, the process of acquiring and allocating such encumbrance-free land proves to be a challenge.
An essential component of the HAM is 40% of the project cost which is financed by the Government. While this was considered essential and financially viable in the early years of HAM, over time there has been a manifold increase in the debt that the National Highways Authority of India (“NHAI”). The debt which stood at Rs. 24.188 cr. in 2014-15 has risen to Rs. 2.3 lakh cr. in 2019-20. And, in recent news, the debt of the NHAI grew from Rs. 2.49 trillion in March 2020 to Rs. 3.17 trillion at the end of the financial year 2021.
Additionally, in light of the ongoing Covid-19 pandemic and the kind of economic slowdown that the country has witnessed over the last year, the amount that the Government is willing to spend on highway projects and the actual amount with the exchequer stand at opposite poles. With a large portion of finances being derived from the Government and the finances of the Government being already under stress, HAM presents itself as a model which is financially unviable. Similar is the reason for the unviability of the EPC model as the entire financing of the highway project is undertaken by the Government.
It becomes evident from the above-mentioned reasons that the HAM is not viable in the present scenario owing to the various procedural delays, compounded by the lack of finances existing with the Government.
The way forward – Revival of the BOT model
In the present scenario, where the HAM and the EPC models have turned out to be financially unviable, the need of the hour is a model which constructs and develops highways without there being the need for finances from the Government. Additionally, such a need arises owing to the developing nature of India, where highways are a major component in ascertaining the extent of development. Thus, while the Government is itself not in a position to finance highway projects, private investment in such projects is warranted and the Government is making headway into looking for viable alternatives to the HAM and the EPC model.
The BOT model presents itself as the most viable in these financially stressed times. While the BOT model lost its popularity owing to financial and procedural hurdles, the aspect of the private entity providing for the finances without Government assistance provides for a lucrative alternative to the HAM and EPC model.
There is one advantage that makes the BOT model favorable over other models which require Government financing up to varying degrees. This advantage is that the financing of the project is left in its entirety to the private entity and the Government has to focus on other procedural aspects of the project. With the ongoing pandemic and the subsequent financial stress in the sector, this model provides significant relief to the government as it does not have to take the responsibility of financing such projects.
The Government has been making efforts to revive the BOT model and it was proposed that multiple projects under the BOT model would be opened for bidding in the financial year 2022. There have been significant amendments in the Model Concession Agreement (“MCA”) for BOT model projects which are beneficial to the private entities. The amendments include the reduction in the time period post which the revenue potential of the project would be re-assessed. The time period has been reduced to 5 years as opposed to the 10-year limit which was placed on these projects earlier. Other amendments include the ability to foreclose the ongoing project with the mutual consent of the private entity and the Government, the provision of allotting the BOT project only post the NHAI possesses 90% of the land for the project etc.
Additionally, the NHAI, post introducing the amendments had opened for bidding two highway projects in West Bengal under the BOT model, which received interest from big infrastructure companies like Adani Road Transport Ltd., IRB Infra, etc. This is indicative of the BOT model as a viable alternative to the other models of highway construction and can be termed as a successful first step in reviving the BOT model.
Summing up, Covid-19 had a heavy impact on the Indian highway infrastructure industry. This damage caused to the industry was slightly more severe than on the other sectors, owing to the financial crunch which the Government was and still is, in. The PPP models used more extensively, post-2012, were dependent heavily on financing by the Government and this is regarded as the reason for such a slowdown in highway constructions during the Covid-19 pandemic.
The move to revive the BOT model is a welcome one from the side of the Government and a consequence of the financial crunch post the Covid-19 pandemic. This move would serve a dual purpose. Firstly, it would allow for the Government to reserve its finances by not having to stretch the exchequer in funding highway projects and at the same time, the development of the said projects would not be hampered owing to private financing.
It still remains to be seen what the response of the private entities going to be on a larger scale as what was observed with the bidding for the West Bengal projects was a mere small-scale indicator of the intent of the private entities to operate with the BOT model. Obtaining finances for the whole project remains a daunting task even for the biggest entities in the market. To allow for better and higher bids being made for highway projects, the Government would have to step in with the banks and other institutional lenders to ease the procedure and the compliances for obtaining loans for such activities. And this process is one which is a necessity considering the vigour with which the Government is aiming to introduce more highway construction projects under the BOT model and the private entities will have to wait for a positive intervention by the Government in this regard.
About the Author
Aditya Shukla is a 4th Year Law Student of NALSAR University of Law, Hyderabad.
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Preferred Method of Citation
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