Saturday, November 30, 2013

A "re-negotiations policy" for road projects?

I have blogged extensively on the moral hazard that have been unleashed with the widespread trend of re-negotiations that have gripped the infrastructure sector. Private infrastructure developers have internalized the norm that they can bid aggressively and irresponsibly, as many have done, with the assurance that they can always go back to re-negotiate the terms. India's pernicious culture of crony capitalism encourages the trend.

In this context, the Roads Ministry has proposed to break the gridlock with stalled National Highway Authority of India (NHAI) road projects by restructuring them. There are currently 48 road project developers who are renegotiating the restructuring of premium payments with the NHAI. However, instead of re-negotiating on a project-by-project basis, newspapers report that the Roads Ministry has effectively proposed a blanket policy (I am not aware of the details though) for restructuring premium payments owed by developers. It proposes that the premium payments of developers whose projects are stressed, mainly due to traffic shortfalls, be restructured in accordance with a general policy. The Mint reports on the crux of the Ministry's restructuring policy,
In principle, the roads ministry’s recommended restructuring involves back-ending the agreements with developers to reduce their payments to the government in the initial years of the contract—a move that could help them complete the projects. The ministry and its arm, NHAI, are worried that if projects are stuck on account of financing troubles, developers could start walking out of projects—resulting in a delay in building required infrastructure and losses on account of unpaid premiums. These projects will also have to be re-bid.
It immediately raises the question about why the same internal restructuring of its cash-flows cannot be done by the developers themselves. It needs to be borne in mind that most road developers have a portfolio of projects, with varying levels of profitability, which would facilitate the process of such re-balancing. In fact, the very objective of firms specializing in infrastructure and accumulating a portfolio of projects with a diverse risk-profile and cash-flow patterns, is to leverage their overall balance sheet and mitigate their individual project risks. GMR and the like have clearly internalized the norm that they will view each project as a stand-alone entity, and transfer commercial risks on to the government through the process of re-negotiations.

In simple terms, the Ministry is effectively proposing a re-negotiations policy for all road projects. It is a virtual fait accompli that developers will internalize this policy into their bids, thereby distorting the process of efficient price discovery in the forthcoming tenders. The tendering process would then become just a transit point in the process of arriving at the final contract conditions.

I have been thinking for sometime that, given the inevitability of re-negotiations with many infrastructure projects, it may be an efficient second-best approach, to transparently outline the principles that would define any process of re-negotiations. But we should be careful that it does not become codified into some policy, which would take away from the process of competitive bids that allot these projects. Re-negotiations should be done on a project-by-project basis, and not through a routine application of rules to qualify projects and renegotiate their terms.

Further, in order to discourage any moral hazard, the process has to be accompanied with prohibitive enough haircuts on equity holders. Promoters who bid irresponsibly or with other, less than transparent, considerations have to pay with their capital, and that too a prohibitive enough amount. It will be interesting to see what the Rangarajan Committee, entrusted with formulating a restructuring policy, comes out with. 

1 comment:

Anonymous said...

The World Bank recently blacklisted a major construction firm for 11 years (owned by a Cabinet minister) on account of fraud. I wish the state and central govts can be equally disciplined and principled in dealing with infrastructure companies.