Mint reports that India's Comptroller and Auditor General (CAG) has found the Government of India's Civil Aviation Ministry guilty of favoring the private concessionaire modernizing Mumbai airport with "undue benefits" amounting to atleast Rs 5887 Cr (~ $1 bn). The airport modernization project, initiated in 2006, is being executed by Mumbai International Airport Ltd (MIAL), a consortium led by GVK Power and Infrastructure Ltd (GVKPIL).
The latest cost of the project, originally estimated to be commissioned in 2010 at a cost of Rs 5826 Cr, is Rs 11647 Cr and the last completion deadline was for end-2013. The Government, through the Airport Authority of India (AAI) has 26% of equity in MIAL. A few observations from the report.
1. The report finds fault with the MIAL promoters' refusal to raise their equity investments despite the AAI offering their willingness to pare down debt and raise equity. It writes, "It appears that government of India, acting through AAI, was ready to infuse more equity ... the private party was not willing to take risk which is not acceptable."
This is a surprising observation. Undoubtedly, raising equity would have lowered the cost of capital and the project riskiness, both of which would benefit the government. However, altering the original project capital structure would affect profitability of the original investments. Raising equity, as in this case, would lower the returns on equity investors. Why should MIAL or any other private investor agree to this, even if the government stakeholder is volunteering with more capital?
2. Another observation by the CAG about the implications of the doubling of project cost on the capital structure is more pertinent. It writes, "It was also noticed that the debt of MIAL has not altered even as the project cost nearly doubled. This indicates that the finance risk for the project was not appropriately transferred to the concessionaire." Most of the increased project cost was passed on to the passengers in the form of higher Development Fees (DF).
However, it may not be as simple as that. Though it is not clear as to how the upfront investment capital for the cost over-run was raised, it was most probably done through debt issued against the DF cash flow. If that is the case, and even if this debt did not reside with MIAL and is held by another SPV, then it may not be that bad. Then the question of how the cash-flow waterfall (which lays out the charge of various financiers on the net profits) is structured then assumes significance.
3. The CAG report also finds fault with the Aviation Ministry for not imposing liquidated damages for the construction delays and allowing extension till 2013. Now, almost all big projects, done as PPP or otherwise, suffer delays. Most of these delays are due to context-specific factors that are beyond those of any one actor. Liquidated damages are imposed under exceptional circumstances when the cause of delay is obvious. It is of course possible that the poor governance within the Ministry, a very real possibility, contributed to mis-aligning the incentives of the developer.
While such omissions are not to be condoned, an indiscriminate application of this principle (that all delays should be penalized with liquidated damages), without regard for the extenuating project circumstances (and there are many of them), can be a death knell for many projects. Fear of being hauled up by the auditors is already causing project engineers to not take decisions on even genuine requests for time extension and cost escalation, thereby causing further delays. Policy paralysis is never far away.
4. The CAG attributes a presumptive loss of Rs 5887 Cr for 11 acres of additional land, over and above that contractually agreed, transferred to MIAL. The basis of this is the estimation that the earning potential of 196.1 acres of land over a 60-year lease period is Rs 104,897.81 Cr. Such presumptive loss estimations are hazardous. In the instant case, as the AAI pointed out in its reply, such estimations may not be reliable in view of the fact that a significant share of the land is filled with encroachments, some including wholesale slums.
5. The CAG also point out that the creation of eight subsidiaries by MIAL, without permission of AAI, and the outsourcing of its activities on revenue sharing arrangements would be detrimental to AAI's interest. This assumes great significance since MIAL has to share 38.7% of its revenues with AAI and the outsourcing of work will create conflict of interest concerns involving transfer pricing (paying higher prices to the subsidiary and thereby transferring profits) and profit dilution.
The latest cost of the project, originally estimated to be commissioned in 2010 at a cost of Rs 5826 Cr, is Rs 11647 Cr and the last completion deadline was for end-2013. The Government, through the Airport Authority of India (AAI) has 26% of equity in MIAL. A few observations from the report.
1. The report finds fault with the MIAL promoters' refusal to raise their equity investments despite the AAI offering their willingness to pare down debt and raise equity. It writes, "It appears that government of India, acting through AAI, was ready to infuse more equity ... the private party was not willing to take risk which is not acceptable."
This is a surprising observation. Undoubtedly, raising equity would have lowered the cost of capital and the project riskiness, both of which would benefit the government. However, altering the original project capital structure would affect profitability of the original investments. Raising equity, as in this case, would lower the returns on equity investors. Why should MIAL or any other private investor agree to this, even if the government stakeholder is volunteering with more capital?
2. Another observation by the CAG about the implications of the doubling of project cost on the capital structure is more pertinent. It writes, "It was also noticed that the debt of MIAL has not altered even as the project cost nearly doubled. This indicates that the finance risk for the project was not appropriately transferred to the concessionaire." Most of the increased project cost was passed on to the passengers in the form of higher Development Fees (DF).
However, it may not be as simple as that. Though it is not clear as to how the upfront investment capital for the cost over-run was raised, it was most probably done through debt issued against the DF cash flow. If that is the case, and even if this debt did not reside with MIAL and is held by another SPV, then it may not be that bad. Then the question of how the cash-flow waterfall (which lays out the charge of various financiers on the net profits) is structured then assumes significance.
3. The CAG report also finds fault with the Aviation Ministry for not imposing liquidated damages for the construction delays and allowing extension till 2013. Now, almost all big projects, done as PPP or otherwise, suffer delays. Most of these delays are due to context-specific factors that are beyond those of any one actor. Liquidated damages are imposed under exceptional circumstances when the cause of delay is obvious. It is of course possible that the poor governance within the Ministry, a very real possibility, contributed to mis-aligning the incentives of the developer.
While such omissions are not to be condoned, an indiscriminate application of this principle (that all delays should be penalized with liquidated damages), without regard for the extenuating project circumstances (and there are many of them), can be a death knell for many projects. Fear of being hauled up by the auditors is already causing project engineers to not take decisions on even genuine requests for time extension and cost escalation, thereby causing further delays. Policy paralysis is never far away.
4. The CAG attributes a presumptive loss of Rs 5887 Cr for 11 acres of additional land, over and above that contractually agreed, transferred to MIAL. The basis of this is the estimation that the earning potential of 196.1 acres of land over a 60-year lease period is Rs 104,897.81 Cr. Such presumptive loss estimations are hazardous. In the instant case, as the AAI pointed out in its reply, such estimations may not be reliable in view of the fact that a significant share of the land is filled with encroachments, some including wholesale slums.
5. The CAG also point out that the creation of eight subsidiaries by MIAL, without permission of AAI, and the outsourcing of its activities on revenue sharing arrangements would be detrimental to AAI's interest. This assumes great significance since MIAL has to share 38.7% of its revenues with AAI and the outsourcing of work will create conflict of interest concerns involving transfer pricing (paying higher prices to the subsidiary and thereby transferring profits) and profit dilution.
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