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.
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.
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.