Annuity lures private developers in road projects
By Harish Rao
The lack of resources and managerial and operational skills is compelling governments the world over to outsource many of their requirements. Besides helping to cut costs, outsourcing is also prompted by the fact that the private sector often provides better facilities and makes life easier for the end user.
Similarly, the Government of India has, over the last few years, tried to rope in private participation in the creation of better infrastructure in the country. Various projects have been offered to the private sector on BOT, BOOT and BOO basis. In the roadways sector, for instance, the developers have been given rights to collect toll from the users. It is much too early to comment on the success of these initiatives, since to date only a handful of projects like the Coimbatore bypass, Noida-Delhi, Pune-Mumbai Expressway and Mattencherry bridge projects have been executed on this basis.
Even as the private developers prefer to adopt a wait-and-watch policy, the Union government has taken yet another initiative to attract the private sector in the road-building process.
For the time being, however, the government's efforts to involve private parties in the infrastructure sector has received lukewarm response. Lack of adequate returns has been the bone of contention for the private parties, most of who have restricted their activity to construction, leaving the operations and maintenance of the projects to the government. The government, which is in desperate need of funds for carrying out various infrastructure projects, is trying out various innovative ways to attract private resources into this sector. The recently introduced Annuity Scheme in road construction seems to have got an encouraging response if the number of bids received from the private parties is any indication.
In road projects, where the developer is given the right to collect toll by way of compensation, unpredictability of traffic is a major risk. If traffic on the road is less, the developer may not be able to recover his investments through road tolls within a specified period. The annuity concept does away with this risk. Under the scheme, the government and not the road developer will be responsible for collecting tolls from the users. In fact, the government will pay the developer a sum of money, semi-annually, termed as "annuity" during the concession period. This annuity payment is aimed at compensating the developer for the capital costs, operation and maintenance expenses of the project, and returns thereon.
Annuity will be determined by the government based on the total cost of the project, the likely annual maintenance expenses, period of annuity (usually varying between 15-20 years), prevailing interest rate and the likely inflation rate. Annuity so determined will become the base for the government while inviting bids from the private parties.
Annuity projects would benefit the government in the sense that it spreads its fund outflow over a long period of time. For example, for a 75-km four-lane road the government may have to spend Rs 300 crore at a conservative estimate. In addition, there will be an interest outgo of Rs 400 crore over a period of 15 years. Against this, the government may have to pay an annuity of Rs 1,250 crore over 15 years. On the face of it, the difference may appear huge but it should be noted that under the annuity method maintenance expenditure has to be borne by the developer. Further, if one considers the annual inflation rate there will be no loss to the government. At the same time, under annuity the government would have full rights to collect toll, which would help reduce the total outgo from its coffers.
Besides, the annuity approach has an in-built incentive for delivering quality. Says Dr, Anupam B Rastogi, Vice-President (Policy Advisory), IDFC, "As the responsibility of the road maintenance is with the private party, it will automatically improve the quality of service." If the quality of construction is not up to the mark, the developer may have to shell out more money later by way of maintenance because, under annuity, most of the contracts are composite in nature where the responsibility of maintenance lies with the developer.
For road developers, this system is better than the previous ones as it removes the biggest risk in any road project, that of lack of traffic. Also, the government's commitment to pay annuity could enhance the chances of developers getting loans on better terms.
The benefits under the annuity scheme are, however, not without obligations. The project has to be completed in time and operated and maintained to specific standards. The annuity payout is linked to strict standard specifications laid down by the government. The developer has to obtain a certificate from an empanelled engineer before he or she can receive the annuity payment.
The risk of cost and time overruns are inherent in any big project, more so in the case of road projects. Under annuity, this risk will be borne entirely by the developer. Further, any delay beyond the scheduled date of commissioning would lead to a pro-rata reduction in the annuity, in that annuity payment period. Also, the liability to pay annuity usually begins only six months after the project is commissioned.
At present, NHAI has assigned seven projects of the Golden Quadrilateral under the annuity concept. It has been made clear that no single party would be allotted more than two contracts. The government is following this principle to avoid concentration of projects in only a few hands, as it could delay the implementation of the projects. Also, the initial annuity payment contracts were on the higher side, as they were decided when interest rates were ruling at 17-18 per cent as against the current 13-14 per cent. As the interest and inflation rates are on a downslide, annuity obligations for the new projects would be much less than in the past. This would naturally encourage the government to implement more and more projects under this scheme.
"The concept of annuity method gained popularity in the last three-four years. As such its experiences in other countries (as a tool to attract private investment) cannot be fully measured at present. In Latin American countries, many village roads have been developed under this method," Dr Rastogi states. Going by the response to the annuity method in India, this innovative scheme could well play a dominant role in the country's infrastructure development in the coming years.