Conventional wisdom would have it that infrastructure contracts should be structured in a manner that bundles construction with long-term maintenance so as to minimize life-cycle costs and maximize efficiency gains. Accordingly, the orthodox approach for PPP contracting in roads, that hitherto pursued by India, has been to allot projects as long-term Build-Operate-Transfer (BOT) concessions. It was hoped that this would align the incentives of the concessionaires to construct the project in a manner that minimizes maintenance costs.
But this search for first-best contract structuring betrays an ignorance of the complex dynamics that drive long-term infrastructure contracting, especially in certain sectors like transportation and urban infrastructure. I have written about incentive distortions that detract from the achievement of desired objectives and how it squares up with global experience. This blog has therefore consistently, for a very long time now, held the view that infrastructure contracts should preferably be constructed through arms-length public procurement, construction risk off-loaded, concessioned out as long-term contracts, and be supported with an incentive compatible renegotiations framework.
The Ministry of Road Transport in India embraced the public procurement based EPC model last year after the classic PPP BOT models failed to generated bidder interest. Now, the Ministry has apparently identified 104 commissioned toll roads for monetization and hopes to earn Rs 800-1000 bn from these public funded projects over the next 20-25 years. What remains is the adoption of enabling renegotiation frameworks.
As to the present proposal to monetize toll roads, there are certain concerns that should be addressed. I had co-written earlier about them here, describing them as second generation issues. One in particular assumes significance. A 20-30 year operation and maintenance (O&M) concession naturally raises the issue of mid-term upgradation of the asset. There is ample evidence that concessionaires generally tend to skimp on this or demand renegotiations when the time comes. It is therefore essential that the bids can accommodate the resources required for such capital investment. Further, project lenders should ensure that the project cash-flow waterfall be structured accordingly.