7/28/2019 Contract Renegotiation in Highways in India - A Perspective

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Contract Renegotiation in Highways in India : A Perspective

Given the huge infrastructure needs, India requires trillion dollar investment in this space over the span of5 years, that is, between 2012 and 2017. Approximately half of this investment is expected to be sourcedfrom the private sector. And to facilitate the flow of money from the private sector, the projects need to be

structured in manner to balance the needs of the users, government, and private players. The solutionthat has emerged is in the form of public-private partnership or P3 or PPP, to address the needs of allstakeholders.

The P3 framework in India has seen mixed success in the infrastructure sector. The level of success hasbeen a function of contract design, regulations, and implementation framework in respective sectors.Road sector in India has attracted significant investment from private players through the P3 mechanism,especially in the construction of the national highways. It may be noted that the mechanism has evolvedover a decade through continuous learning and as a response to the environmental changes.

Before we delve into the problems being faced by the national highways in the wake of changed socio-economic context, it is important to get a perspective on the scale of private investment and thus theimportance. Investment in Roads & Highways sector increased at a CAGR of 11% to Rs 827 billion in2011-12 from Rs 500 billion in 2007--08. The interest of the private sector continuously deepened from ashare of 25% of total investment in 10th Plan to 36% during the 11th Plan on the back of facilitativeframework and belief in sustenance of such growth in the foreseeable future

Although the private investment boosted the development, the bids have started witnessing irrationalexuberance , which was exhibited in the vast overestimation of traffic with the concomitant high bids. Theparticipation levels also saw a high, especially in 2011 and a part of 2012, where a sizable number ofprojects witnessed more than 20 bidders for each project, especially at the lower and medium ends ofproject size. The winning bids were then marred by winners curse, i.e., the winner loses money despitewinning the bid. The problems became acute with the slackening growth and the actual traffic numbersemerging to be far lower than the estimates, thereby jeopardising the entire economics and viability of theprojects. The problems from regulatory and financing sides have not helped the matter either. On theregulatory front, the uncertainty over land acquisition and environmental concerns have delayed theprojects, thus increasing the costs. The higher financing costs due to the inflation taming emphasis of RBI

have also affected the projects negatively.

The question now arises if the existing P3 framework is adequate in dealing with problems being faced,especially the projects already awarded. The quick answer will at best be cautiously affirmative. Since theexisting contracts cannot address the problems in changed socio-economic paradigm, should thecontracts be renegotiated? In theory, they could be.

However, any changes in the contractual obligations have to be put under the test of fairness, i.e.,bidding conditions ought not be changed post-award. At the same time, public interest cannot beoverlooked. This adds another layer of complexity as public interests may not be protected withoutrenegotiations of the existing contracts due to lack of financial wherewithal on part of the government toimplement these projects. Reopening of bids may lead to delays. Also, lack of clarity on the regulatoryfront may again lower the interest, and perceived risks by the bidders will be high, resulting in more outgo

for the implementing agency.

The answer lies in prioritising the requirements and looking at not only todays requirements but also theimpact of putative steps in future development of this sector.

Renegotiation of contracts has been done in many jurisdictions. The learning from such historicalprecedence could provide a possible solution to current problems and may provide a framework for futurerenegotiations. However, contracts should be renegotiated ensuring that bailing out should not lead tounnecessary aggressive bidding and moral hazards in future bidding.

7/28/2019 Contract Renegotiation in Highways in India - A Perspective

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Specifically discussing the recent instances of request for renegotiations, it may be observed that thedevelopers did not opt out because of the failure of conditions precedent cited previously. Instead, thenew proposal in certain cases requires commercial restructuring of the contract by back-ending thepremiums committed during bidding.

Interesting perspectives emerge if we put this particular idea through the criteria of public interest and

fairness.

First, it is simple to appreciate that projects of this sort are essential for the economy and, thus,renegotiation should pass the test of public interest. However, it has to be determined whether fewmonths delay in project (if they go for re-bidding) will really affect the public interest significantly,especially when the renegotiations are also likely to take some time.

Second, the principal of fairness also seems to be getting satisfied if the offer is NPV (net present value)neutral as apparently is the case. Once again, delving little deeper, it is important to understand thefactors behind any bidding. These factors include not only expectation of positive NPV but also the timingof cash flows, which is particularly important for debt financing. Any bidder would take the liquidity issuesinto account while bidding. Thus, any change in the timing of premium payments amounts to changing thebidding condition post-award.

Moreover, the assessment of the discount factor is tricky and open for subjective interpretation. Anothercomplexity is different bidders have different discount rates, and if the renegotiation terms were known tothem, the premium amounts would have been different from what they have bid.

In the wake of above mentioned problems, it may be noted that the change in bidding conditions,including that by altering the timing of bid premiums, go against the grain of bidding process. A

Thus, in order to keep faith in the bidding process, re-bidding emerges as a better solution despitechanged social and economic scenario for existing contracts. However, the bidding framework for futureprojects may incorporate the learning from the current issues. Of course, the principal of fairness shouldbe upheld.

(views are personal )

Rohit Chaturvedi

Director Transport & Logistics Practice

CRSIL Infrastructure Advisory