Insights into Editorial: Renegotiation of PPP contracts becomes a reality
04 March 2016
India’s finance minister Arun Jaitley announced three new initiatives on building infrastructure through the so-called public-private partnership (PPP) mode in the national budget he presented to Parliament on 29 February.
The three initiatives are:
- Public Utility (Resolution of Disputes) Bill:
It will shortly be introduced in the parliament to streamline institutional arrangements for the resolution of disputes in infrastructure-related construction contracts, PPP and public utility contracts.
- Guidelines for renegotiation of PPP:
The government has also proposed to introduce the guidelines for renegotiation of PPP concession agreements, keeping in view the long-term nature of such contracts and potential uncertainties of the real economy, without compromising transparency.
- New credit rating system:
A new credit rating system for infrastructure projects which gives emphasis to various in-built credit enhancement structures will also be developed, instead of relying upon a standard perception of risk which often results in mispriced loans.
All the three have a bearing on investments in the ports sector but it is the announcement on re-negotiation of agreements that has the maximum impact.
PPP in India:
India has emerged as one of the leading PPP markets in the world due to several policy and institutional initiatives taken by the central government and a sustained effort in various sectors to accelerate the implementation of PPP projects and programmes.
- India has also developed a strong framework for the approval of PPP projects at the central government-level with appropriate oversight exercised by bodies independent of the projects and aware of the fiscal implications of PPPs.
Challenges:
However, in recent years, various challenges have arisen along with the acceleration in the pace of the roll-out of PPPs.
- With the perception that participation in PPP projects has become too risky in the country, developers and financiers are not showing any interest to participate in any project bidding.
- Besides, the common themes that emerge across infrastructure sectors are that risk allocation is viewed as one-sided and several sovereign obligations are not being met.
- Also, unrealistic bidding in terms of revenue sharing that has placed concessions at risk of failure as economic conditions worsened over the past five years.
- As far as the contractual elements of the PPPs is concerned, there is a general consensus that the model concession agreements (MCAs) are inflexible with no ability to change the terms of the concession.
What needs to be done?
- For the next generation of PPP contracts, amend the model concession agreement to include provision for renegotiation with adequate safeguard built in to deal with uncertainties inherent in long-term contracts and protect the developer from unexpected changes beyond his control. Besides, it should also be ensured that the option of renegotiation is not misused.
- Post-award changes are almost always fraught with moral hazards and political risks. Hence, it is necessary to establish a set of criteria or benchmarks to be applied to each proposed renegotiation that are quantifiable and ascertainable. That is, the case for a renegotiation can be made explicit and recorded so that the decisions made are rational and defensible.
- The criteria or benchmarks for renegotiation should include evidence that the project distress is material and likely to result in default under the concession agreement in future should it continue.
- Also, there should be evidence to show that this distress is not caused by the private party and is likely to cause adverse outcomes for the government and/or users of the concession assets.
- It should also include evidence that a renegotiated concession agreement is likely to have direct cost implications for the government that are less than the financial outcomes of doing nothing.
- The final decision for a renegotiated concession agreement must be based on full disclosure of long-term costs, risks and potential benefits.
Conclusion:
Besides renegotiation, the government, to ward off allegations of crony capitalism or litigation from bidders who lose out in the first stage, has to create a credible institutional mechanism. Also, pricing should combine public purpose considerations with those of risk and efficiency. Pushing big ticket reforms is no cakewalk in a raucous polity such as ours. Yet, a robust PPP framework can make a difference in cranking up investment and growth.
