Monday, September 29, 2008

Moral hazard in infrastructure contracts

The recent concession agreement (here and here) signed between the Maytas Metro Ltd (MML) and the Government of India to build, operate and transfer a 71 km long, Rs 12,132-crore metro rail project in Hyderabad raises important contractual questions.

Of the four bidders, three demanded government support, whereas MML offered to pay up a massive Rs 30,311 crore over the 34 year concession period. It even declined an option to access a Rs 2300 Cr Government of India's viability gap funding support for PPP projects. The reverse annuity promised by MML is a major surprise given the well acknowledged fact that such mass public transit are not considered commercially viable, even in developed economies. There are apprehensions that MML, with no expertise in the sector, outbid its competitors to grab the 269 acres that came along with the package.

This development has to be seen in the backdrop of numerous instances of contract or concession agreement re-negotiations in infrastructure projects. Starting with the failed Enron, this list includes major projects in power, water (ViWSCo), real estate development (satellite townships in Hyderabad) and roads (Delhi-Gurgaon expressway), and is growing. Especially a cause for concern is contracts in power sector. Even though none of the merchant power projects and those bidded out on competitive tariff based bidding have started functioning, most of them have already undergone re-negotiation. In fact, many of them were re-negotiated even before the Power Purchase Agreements (PPAs) were signed!

These precedents carry strong moral hazard signals. With re-negotiations becoming a norm, contracts and concession agreements appear to have lost their sanctity. Potential bidders realize that they can bid low in order to bag the project, and then re-negotiate more favorable terms later. With expectations becoming entrenched and technical pre-qualification being diluted, there arises strong possibility of fly-by-night operators and cherry-pickers grabbing these projects. The large land holdings that come with many of these projects are an attraction for those looking at quick wins.

The floodgates have been opened and it may be difficult for the government to rein in expectations. But it is important that such expectations be rolled back by strong legislative and regulatory signals against contract re-negotiations. In the absence of such action, the PPP and other projects in infrastructure will fail to achieve their objectives and degenerate into land grabs and asset stripping.

Update 1
Michael Walton has this to say on incomplete contracts, "According to a World Bank data base some 74% of water and sanitation and 55% of roads contracts were renegotiated by the early 2000s. Over 60% of renegotiations were initiated by the operator, and a majority were resolved in favour of the private company... Initial bids may have been low in the expectation of holding up the government later, with bribes or other means."

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