Can India’s roadways handle the country’s economic growth?
India’s poorly developed infrastructure is a major factor limiting its economic expansion. The country’s roads are a particular source of concern, given the important role they play in transporting people and products. While public-private partnerships (PPPs), strongly encouraged by India’s government, represent a promising solution to the infrastructure challenge, the number of such arrangements has declined recently.
Why? A team from Kellogg’s Global Initiatives in Management program attempted to answer this question in field research conducted in March 2010. As summarized below, they found that the answer is multi-faceted, including weaker-than-expected revenue recovery, financing-related problems, and insufficient government capacity. Overcoming these obstacles will be crucial if India is to put its roadway development plans back on track.
Infrastructure and Roadway PPPs in India
In a 2009 study, Goldman Sachs estimated India’s infrastructure-investment needs at $1.7 trillion over the next decade. Poor infrastructure results in a projected loss of up to 4% of India’s annual GDP (nearly $50 billion), including massive agriculture spoilage. An average truck in India covers 200km/day, one-fourth the global norm. China’s 53.6k kilometers of four-lane highways dwarf India’s 8k.
With traffic growth expanding at double-digit rates, these figures are even more alarming. Accordingly, the Indian government’s 11th five-year plan allocates one third of its estimated $500 billion of infrastructure investment to roads, including the National Highway Development (NHDP) project: 33 kilometers of roads in seven phases. Yet India lacks adequate public financing to cover all needed road development.
The Promise of PPPs
Since liberalization began in the 1990s, the government has looked to public-private partnerships to address roadway development. Beyond providing non-public capital, PPPs supplement the government’s capacity to manage projects and provide economic incentives to complete high-quality projects quickly. Private investors are expected to fund 80% of the NHDP.
Three primary types of PPPs address roads. (1) Build-Operate-Transfer projects (BOT; 80% of Indian roadway PPPs), in which the private party assumes most of the toll revenue risk, collecting tolls directly from drivers. Once the contract expires, the party transfers the asset to the government; (2) the BOT Annuity model (15%), in which the private party retains indefinite responsibility for toll collection, sometimes on behalf of the government, for an annual fee; (3) the Engineering-Procurement-Construction model (EPC; 5%), in which the government pays a contractor for construction only.
The government has established strict PPP-related guidelines by specifying terms in a Model Concession Agreement. Among its provisions are a 25-to-30 year term, a traffic-volume estimate, toll rates (including inflation), and dispute-resolution measures. The awarding of a PPP includes three stages: a project-feasibility analysis, a request for proposals, and selection of a winning bidder.
Most developers are fully integrated, providing substantial capital and construction capacity (e.g., GVK Industries). Multiple international private equity funds have been set up to invest in infrastructure assets, including those of Morgan Stanley, Blackstone, and KKR—though each suffered major setbacks during the financial crisis of 2007-2009. Most infrastructure developers expect annual returns on projects of at least 16%. Estimating traffic accurately and completing projects on time are thus paramount.
Despite the promise of PPPs, since 2006 the number of Indian roadway kilometers covered by PPPs has declined 90 percent, with PPP-investment dollar amounts dropping over 40 percent. Several projects failed to attract a single bidder. The next section considers reasons for this trend.
Analysis shows that several factors—beyond the global recession that began in late 2007—underlie the precipitous drop in Indian roadway PPPs.
Insufficient Revenue Recovery
Observers generally agree that revenue recovery from Indian roadway projects has been as much as 50 percent below expectations. Part of the problem is the low level of purchasing power in certain Indian regions: roads may be built, but the public can’t afford to use them. Other factors affecting traffic flow include distance from major cities and the level of industrial development in the region (i.e., more development means more traffic). Moreover, traffic forecasts are very difficult to make, given the long roadway-contract terms and India’s fast-changing economy. Even the most experienced bidders’ and consultants’ estimates have been significantly off the mark. Of course, users must be willing to pay tolls for developers to gain revenues from them. This has been problematic on projects such as Tamil Nadu’s Coimbatore Bypass. BOT Annuity contracts help spread the risk between public and private sponsors, but challenges remain. The government has also provided viability gap funding (VGF) to reduce capital costs, making some projects more attractive to investors. Still, many have shifted their focus to power, airport, and seaport projects, which offer better revenue prospects.
Both debt and equity financing for roadway development in India present several challenges.
The short-term duration of available debt financing and limited number of potential credit sources constrain the volume of PPPs. While the typical infrastructure project has an “all-in” life of 30 years, bank debt terms are typically no more than five years, requiring frequent refinancing. This is complicated by India’s lack of a bond market, which would make longer maturity debt more available. Banks also have few options for selling the debt to third parties, limiting their capacity to issue loans for future projects. Moreover, while foreign investors could mitigate these debt-financing issues, regulations significantly limit developers’ use of funds from overseas players.
Equity financing has also been challenging, due in part to the suboptimal returns described earlier and to the global liquidity shortage of the late 2000s. The long-term nature of roadway development and the lack of a secondary market for related securities also play a role, just as for debt financing. With revenue sources limited to tolls, equity investors often can’t make the economics work. Those that might often face having most of their cash tied up in a limited number of projects for too lengthy a period. Roadway projects also suffer—compared, for instance, to airport deals—from their small size and perceived lack of glamour.
Despite India’s eminent domain policies, land acquisition hurdles cause the most roadway-project delays. Temples and mosques dot the landscape, making the appropriation of land for roads challenging. Residents also resist land acquisition, such as for West Bengal’s National Highway 33 project, where some lawmakers sided with protestors for political gain. One prominent Karnataka politician even rallied locals against a roadway project for which he would have had to part with valuable land at fair-market prices. Obtaining proper environmental clearances adds to the challenge. The delays reduce returns by pushing projected revenues farther into the future (lowering their present value) and diminishing toll-collection periods.
India’s capacity to oversee roadway projects is another constraint. The National Highways Authority (NHAI) often struggles to coordinate highway work with states—for instance in the area of land acquisition—delaying the approval process. Part of the problem is that each of the 28 states has its own bureaucratic procedures. Once approved, developers still have to find financing (within six months) and convince up to 80 percent of property owners in the targeted region to sell. The whole process depends further on the NHAI’s capacity to handle project flow. To enhance capacity, the agency recently opened 75 new offices, with 600 new staff members.
Driving Better Roadway PPPs
India has begun responding to its roadway-PPP situation through preliminary measures, such as incremental variable gap funding and lower concession fees. However, more comprehensive measures should be considered:
Innovative PPP models may be used to enhance returns for developers. For example, the developer of the Bangalore-Mysore highway was granted roadway-adjacent land for commercial development. Similarly, the government can attract foreign developers by owning initial project stages, rather than offloading all of the risk on investors. Increasing investment-project size may also attract private equity; wider and longer highways are more attractive.
Enhanced capacity and quality of government administration would improve PPP prospects. Reducing bureaucratic snafus at the state level (e.g., through more NHAI presence) is one measure that merits consideration. At the central level, the government can increase the pace of offering roadway projects and provide developers better transparency. Hiring more staff at all levels would help, as would a single-window clearance system.
On the financing side, a roadway-specific financial institution and better infrastructure bond market would speed development. India can take a cue from the US, where roadway projects are typically financed through municipal revenue bonds, which provide a better view of principal and interest payments and enhance developers’ liquidity.
Project investors can take steps, as well. Among these is partnering with local players and advocating government completion of initial project phases to reduce completion risk. Seeking larger upgrade projects, rather than new roadways, can mitigate revenue risk. Investors may also seek short/medium-term exit opportunities to recycle more funding through the sector. In Western countries, large insurance and pension funds often serve as the secondary market for securitized infrastructure assets. In general, concessionaires must advocate and practice transparency.
There are many routes to improved roadway PPPs in India. Taking these will reinvigorate the development of roadway infrastructure projects that India desperately needs.