PPPs or not, building roads requires fiscal support

Newspapers point to a directive to the Roads Ministry to shift away from the current approach of building national highways. In particular the directive from the office of the Prime Minister apparently talks about three things - discontinue direct construction of roads, encourage private sector to take up construction, and monetise completed road projects.

The most worrisome thing for government apparently has been the rise in the volume of debt accumulated by the National Highways Authority of India (NHAI) over the last five years.

The NHAI has pursued a Hybrid Annuity Model (HAM) whereby the developers are paid out 40% in five instalments during the construction period and the rest as annuity over the concession period. It lowers the construction and traffic risks for the developer, and makes the government put upfront a significant share of the construction cost. 

Some observations

1. There is no point trying to assess the relative merits of Hybrid Annuity Model (HAM) and Viability Gap Funding (VGF) models. They are all variants of de-risking the model for commercial investors. We should be doing both (and BOT Toll), each depending on the commercial viability of the specific project. HAM is after all a form of annuitised hybrid VGF. 

2. Whatever the private participation model envisaged, global experience shows that any ambitious nationwide road building program required significant upfront fiscal support. In the absence of adequate fiscal support, the NHAI had to leverage up.  

In fact, the belief that BOT Toll approach (or any other market-based PPPs) will help crowd-in private capital is a stretch. It did not happen when it was tried out by the last government and it is unlikely to happen this time too. And whatever happened spawned renegotiations and bad loans for the banks. 

3. In fact, I imagine that all the road stretches which would have some reasonable commercial viability have already been developed or contracted, and we are now left with the vast majority of the stretches where commercial viability is questionable and large VGF/subsidy (of any kind) is inevitable.

4. The idea of "aggressive monetisation of existing assets" (using whatever approach, InvIT or other) is naive. The NHAI could not even get any bids for the second round of monetisation tender - nobody turned up for the second round. As I have written with V Ananthanageswaran in Can India Grow? (see pages 39-43), the pool of domestic and global non-banking money chasing infrastructure financing is very limited. The belief that there are vast pools of domestic and foreign capital willing to invest in roads in India is completely wrong - see this, this, this, and this. 

And it is most likely that Macquarie overbid for the first round where NHAI got nearly 50% above the off-set price. And we will reap its consequences in the form of skimping and asset-stripping in the years ahead. It has been the standard operating procedure for Macquarie from other parts of the world.

It again highlights the value of a development finance institution which focuses on long-term financing of infrastructure. Anyways, what is the NIIF doing? But it too pull this off without being sufficiently capitalised, and the projects themselves getting significant subsidy support. There are no free private sector lunches!