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Anatomy of Risks in PPP Projects in India and How to Mitigate Them?

The infrastructure space has always been a capital-intensive sector. Particularly for a developing country such as India, the unique financing and project implementation models that Public-Private Partnerships (“PPP”) represent is considerable for enabling the construction of large-scale public infrastructure projects with significant long-term economic value and ensuring necessary infrastructure development is undertaken in the country.

However, considering the long timelines, involvement of multiple stakeholders, and significant capital expenditure in infrastructure projects, there are significant risks associated with them that are likely to emerge at any phase of the project. So far, in India, PPP seems to be the only viable model for the implementation of public infrastructure projects in an otherwise cash-strapped economy.

In this article, we will briefly discuss the broad phases of any PPP project, associated risks and the suggested risk mitigation measures.

Phases of a PPP Project

The broad phases of a PPP project are as below:

Phases of PPP ProjectEach of these phases is critical for ensuring the long-term success of viable PPP projects. In brief, the following activities are undertaken in each of these phases.

  1. Phase 1 (PPP Bidding Phase): Subsequent to the requisite feasibility studies by the government, the potential PPP project is given the go-ahead, commencing the bidding phase. As a first step to the bidding process, the authority issues an Expression of Interest (“EOI”) and/or a Request for Quote (“RFQ”) and/or a Request for Proposal (“RFP”), followed by the preparation of a Concession Agreement (“CA”). The highest bidder is chosen, the project is awarded to the successful bidder and the CA is executed thereafter. Post the issuance of the Letter of Award to the successful bidder, several procedures are to be followed, such as achieving financial closure, undertaking technical planning and design, obtaining necessary permits and approvals, and establishing a proper team for implementing the project.
  2. Phase 2 (PPP Development Phase): The next phase is the construction phase, where the project is implemented. After the construction of the facilities is completed, the authority inspects. If the inspection is satisfactory, it declares the project ready for operation and sets the commercial operation date (“COD”).
  3. Phase 3 (PPP Operation & Maintenance): Following the COD declaration, this phase designates a project in operation, which includes maintenance during the operation phase.

 

Risks and Their Mitigation Mechanisms

The most common and significant risks in PPP are:

  1. Delays in land acquisition or rights of way – This is one of the most critical risks in every PPP project. When the land acquisition processes fail, timely access to sites and other subsequent formalities stand compromised leading to unwarranted delays in the development project.
  2. Delays in obtaining relevant approvals/permits – Prior to large scale construction projects being commenced, there is a requirement to obtain different types of permits and approvals for commencing such activities, such as environmental clearance, permits for moving civic activities to other locations, etc.
  3. Design Risk – Usually means a faulty design that does not meet predetermined parameters of the facility, requiring changes, resulting in time and cost overruns.
  4. Inflation Risk – Inflation leads to an overall increase in the price of raw materials, transportation costs and general costs of services. This is aggravated by undue delays in projects translating to an increase in the overall project cost.
  5. Revenue/Demand Risk – This is where the forecasted revenue for the project and/or the potential that can be generated has been improperly projected or based on outdated data, thereby affecting the viability of the project.
  6. Construction/Completion Risk/Time and Cost Overruns Risk – One of the major risks in PPP project that causes delays in achieving COD is delays in construction and eventual completion.
  7. Financial Risk – Difficulty in raising project finances or raising very expensive financing that may not be feasible in the long run. Read a detailed analysis of the Project Cost in Infrastructure Projects
  8. Operational Risk – Inefficiencies in operating costs, lead to higher operating costs, arresting leakage of revenue.
  9. Political/Regulatory Risk – Changes in political and/or regulatory regimes that result in project devaluation, lower revenues or faulty project implementation.
  10. Performance/Default/Termination Risk – When the private contractor or consortium is responsible for investing funds in the project’s execution and becomes insolvent or undertakes faulty construction and erection of facilities due to lack of expertise on the part of the private contractor.
  11. Asset Value/Technology Obsolescence Risk – Occurs when the technology is not a proven one or when the asset value decreases significantly owing to policy or regulatory changes.
  12. Social and Environmental Risks – The project affects the local environment in the region of construction or has a significantly adverse collateral impact on the local population in the region, thereby creating obstacles in the implementation of the project or increasing time and cost overruns.
  13. Absence of renegotiation clause in CA – This is one of the oldest demands of many concessionaires in any PPP project in India, which is yet to be addressed by the authorities. As CA is valid for a longer duration, sometimes lasting 30 years, no concessionaire is in a position to perceive risk which may affect the project during the length of the entire concession period. The authorities should provide the necessary mechanisms for renegotiation of long-term PPP contracts.

Now we shall examine a few case studies that would demonstrate any combination of the above set of risk factors.

Case Study 1: Delhi – Gurgaon Expressway[1]

The National Highways Authority of India (“NHAI”) was entrusted with the task of executing the golden quadrilateral project wherein the four metro cities were sought to be connected. The Delhi-Gurgaon Expressway stretch of the golden quadrilateral project was to be executed via the Build, Operate and Transfer (“BOT”) method and was awarded to a consortium of Jaiprakash Industries Ltd. and DS Constructions Ltd. Right from the start, there were several issues with the execution of the project. They’re discussed as below.

  1. Land acquisition – NHAI was responsible for granting the right of way to the concessionaire, which was delayed significantly, leading to a delay in developing and a consequential delay in commissioning the project.

Mitigation mechanism: NHAI should not bid out any project until 90 % of the land is acquired and subsequent possession is taken over.

  1. Approvals – The obtaining of permits/approvals is another important risk to be addressed. NHAI shall assist the bidder in facilitating the said approval within the stipulated time as envisaged in the CA.

Mitigation mechanism: To speed-up the process, the government could have constituted a single authority that the concessionaire could approach to expeditiously obtain all the required permits/approvals.

  1. Design & Social Risk – Such large-scale projects possess the capability of displacing and affecting multiple lives and families.

Mitigation mechanism: Large-scale public consultations involving affected families and relevant government agencies should have been conducted prior to the commencement of the project, to mitigate their concerns and ascertain viable steps forward.

  1. Technology Risk – NHAI generally relied on older traffic studies to predict the volume of traffic to arrive at bid numbers. This was a gross underestimation of the eventual flow of traffic, leading to an improper estimation of traffic numbers.

Mitigation mechanism: NHAI should use the latest technology and traffic studies to finalise the bid numbers.

Case Study 2: Vadodara Halol Toll Road[2]

The Vadodara Halol Toll Road was one of the first projects involving the widening of state highways and commenced under the aegis of the Government of Gujarat. The Infrastructure Leasing and Financial Services (“IL&FS”) was roped in by the Government of Gujarat to develop the road project. A special purpose vehicle (“SPV”) was incorporated for this purpose and the project was developed using the Build, Own, Operate and Transfer (“BOOT”) model. Considering that the World Bank was one of the investors in this project, high standards of execution and implementation were followed, and this project turned out to be an example of best practises followed to mitigate various types of risks. The same is discussed below, along with a few mitigation strategies where appropriate.

  1. Environmental and Social Risk: One of the significant plus points of this project was the extensive environmental and social impact assessment that was undertaken during the project development phase itself. As per initial reports, around 300 families would have been affected by the initial plan of the project. However, intense public consultations were held at the development stage of the project and bypasses and various alternatives were introduced and the number of affected households was eventually reduced to 10. The project also complied with the environmental and social norms by creating wetlands, reducing emissions, constructing pedestrian subways, planting 550 trees across the sides of the roads, creating noise barriers at sensitive receptors and deepening the waterbodies in some villages along the project site.
  2. Policy Risk: The drop in revenues because of eventual changes in government policies certainly affected the concessionaire’s ability to recover their investment from the project.

Mitigation mechanism: Robust consultations and even ongoing consultations with several government departments and agencies to ensure government incentives to increase road traffic in this area might have been useful in mitigating this policy risk and enabling the project to recoup its initial investments.

  1. Financial Innovation / Risk: This is one of the first projects where innovative financing mechanisms were adopted such as the use of Deep Discount Bonds with the option of take-out financing, cumulative convertible preference shares and long-term loans from IL&FS. The project created several such examples of innovative financing, which were eventually replicated in other projects in the infrastructure industry.

Conclusion

In light of the discussed range of risks that one may encounter during the entire lifecycle of PPP projects and their potential impact; it is pertinent that the authorities approach every PPP project in every sector as a partnership and weighs the inputs of all the relevant stakeholders. If the government proactively strategizes to remove the unidirectional nature of PPP CAs in India, and both the private partner and the authorities work in resonance, the current risks plaguing the PPP project will be resolved, resulting in an active involvement and interest from the private sector in participating in PPP projects in India.

References:

[1] See “Case Study 8: Delhi Gurgaon Expressway” in Public Private Partnerships in India – A Compendium of Case Studies, available at https://www.pppinindia.gov.in/toolkit/pdf/case_studies.pdf. Last visited on November 1, 2021

[2] See “Case Study 6: Vadodara Halol Toll Road” in Public Private Partnerships in India – A Compendium of Case Studies, available at https://www.pppinindia.gov.in/toolkit/pdf/case_studies.pdf. Last visited on November 1, 2021

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Photo by Lance Anderson on Unsplash

Considering the long timelines, involvement of multiple stakeholders, and significant capital expenditure in infrastructure projects, there are significant risks associated with them that are likely to emerge at any phase of the project. So far, in India, PPP seems to be the only viable model for the implementation of public infrastructure projects in an otherwise cash-strapped economy.

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Project Cost in Infrastructure Projects: Concept, Challenges and Way Forward

The IMF and Central Statistic Organization had dubbed the Indian economy as the fastest growing economy back in 2019. Moving forward, in 2021 despite the havoc wrecked by the pandemic on advanced economies across the globe, the IMF has kept India’s growth forecast unchanged at 9.5%. In order to sustain India’s growth momentum, the development of country’s infrastructure sector is cogent. The National Infrastructure Pipeline has been the focus of current policies, with an unprecedented increase in capital expenditure allocation for FY 2021-22 by 34.5% to INR 5.5 lakh crore to propel infrastructure creation. However, the April-June 2021 report of The Ministry of Statistics states that 470 projects sanctioned by the centre suffered from a cost overrun of 61.5 percent, that is Rs 4,46,169.37 crore[1].

Project cost remains the central concern for any seminal discussion on infrastructural projects in India or around the world. This is the nebulous point where a host of stakeholders would converge to dispute, disagree, or litigate. This article aims to discuss the concept of project cost and its various implications for the different stakeholders involved.

Introduction to Infrastructure and Projects

 

Costs that are reasonably incurred for the acquisition and construction of infrastructure are referred to as infrastructure costs. Hence, Project cost could mean the total cost of an infrastructure project.  In India, there is no clear definition of the term infrastructure. However, on 1st March 2012, the Cabinet Committee on Infrastructure approved the framework to include a harmonised master list of sub-sectors to guide all the agencies responsible for supporting infrastructure in India. These sub-sectors include transports and logistics, energy, water and sanitation, communication, and social infrastructure. Out of the plethora of these sub-sectors, during the fiscals of 2020-2025, it is expected that sub-sectors such as Energy (24%), Roads (19%), Railways (13%) and Urban (16%) shall constitute 70%of the projected capital expenditure in infrastructure in India[2]. The total capital expenditure as per the report is expected to be 102 lakh crore Indian rupees. Furthermore, in India, the current investment in infrastructure is USD 3.9 Trillion, and the required investment is USD 4.5 Trillion, leaving a gap of USD 526 Billion[3]. Therefore, the energy and infrastructure sector are instrumental in generating tremendous employment opportunities and drive a substantial increase in GDP per annum in India as well as countries all over the world.

 

Structure of Project Finance Transactions

 

The main parties involved in a project finance transaction structure are (i) The Authority or the Government (ii) The Private Party Investors/Developers, Sponsors or Promotors and (iii) the Lenders. These three parties are key players responsible for the determination of project costs in infrastructure and construction projects. The principal point of convergence for these three players is the project company (i.e., also known as special purpose vehicle) set up by the private party investors under which the infrastructure project is formed and under which the project exists in the concession agreement. The project cost is mainly estimated by the private party and the lenders who would finance in the form of equity and debt. The typical financial structure for infrastructure projects has a debt-to-equity ratio of 75:25. However, the ratio may vary depending upon the risks involved.

                Illustration I: Key parties that influence the project cost of an infrastructure project

                                                                                                                     

 

Risks that affect the Determination of Project Cost

 

Every project has certain risks attached to its completion. These risks influence the determination of project costs by the authority, the private parties and the lenders. The risks, in turn, then affect the total cost of the project. The risks affecting the three parties are explained below:

 

                                Illustration II: Risks that affect the determination of project cost

    

 Risk for Authority

Risk for Private Party
Investors

Risk for Lender

Technical or physical risks

Economic or market risks

Economic or market risks

Risk relating to land acquisition

Construction and completion risk – cost overrun/time
overrun/delays

Financing risks

For eg. Technical or physical risks may include risks
associated with
technology during
construction and operation as well as social and environmental risks.

For eg. Economic or
market risks may include input and output price variations, variation in
demand, debt/equity financing as well as counterparty risks.

For eg. Economic or
market risks may include input and output price variations, variation in
demand, debt/equity financing as well as counterparty risks.

The other risks that affect the cost of the project are contractual and legal risks, resource and raw material availability risks, demand risks, design risks, force majeure, property damage, permits, licenses, authorization, supply risk, social and environmental risks.

 

The Major Risks affecting Project Cost in India: Cost Overrun and Time Overrun

 

Out of the myriad of risks affecting project cost, the major risks in India are the risks associated with cost and time overruns. As many as 525 infrastructure projects were hit by time overruns, and as many as 470 infrastructure projects, each worth Rs 150 crore or more, were hit by cost overruns of over Rs 4.38 Trillion owing to delays, according to a report by the Ministry of Statistics, cited previously[4] The main causes for time overruns are delay in obtaining forest and environmental clearances, delay in land acquisition,  and lack of infrastructure support.  As per the report, there are other reasons like delay in project financing, delay in finalisation of detailed engineering, alteration in scope, delay in ordering and equipment supply, law, geological issues, contractual complications and delay in tendering.

 

The Key Elements of Project Cost

 

The elements of ‘costing’ include variables such as raw materials, labour, and expenses. Thus, for infrastructure projects as well, at the time of estimation of cost, these variables would come into play. The factors affecting cost for a public-private partnership project could be the following:

 

                        Illustration III: Factors affecting Cost of Projects: PPP model projects

FACTORS AFFECTING COST OF PROJECTS : PPP MODEL PROJECTS

Materials

Labour

Consultants

Contractor

Client

External
Factors

Dispute
Resolution

Costs and delays
associated with procurement and delivery of materials, import costs

Availability or non –
availability of skilled labour.

Recurring changes in
design

Poor site management
and supervision

Change orders

Force Majeure events
and weather changes.

International dispute
resolution in outside jurisdictions[1]

Unavailability of raw
materials

Poor management of
labour

Delay in approvals and
inspections

Inept subcontractors

Political and policy
changes such as MII[2]

Approvals from
authorities

Costly and time-consuming
domestic litigation

Wastage and theft of
materials – 13 to 14 million construction waste (FY 2000-2001)[3]

Increasing cost of
labour

Inaccuracy in design,
costs associated with knowledge transfer

Poor planning,
scheduling and cash flow management by Contractors

Poor communication for
quality and cost

Accidents

High legal costs and high
arbitrators fees[4].
Non-realisation of arbitral awards and court decree amounts.

 

 

Case Study: The Mumbai Monorail – An EPC Contract Model

 

Time and cost overruns in projects lead to disputes and arbitrations. A suitable example is the  Mumbai Monorail which has entered disputes and arbitration between the Contractor and the Authority over its project cost[9]. The development authority MMRDA entered into a contract with L&T Scomi Engineering for the construction of the Mumbai Monorail project. The original project cost between the Private Party Investors and the Authority was estimated to be Rs 2,700 crore, after which disputes arose. The Authority had claims against the Contractor for not completing the project task on time. The arguments of the Contractor pertained to the cost escalations caused by delays due to the fault of the Authority.  In 2019, the Bombay High Court appointed an arbitrator to settle the dispute. Currently, the dispute is still in the arbitration stage. Furthermore, post-December 2018, the MMRDA had taken over the Operation and Maintenance of the Mumbai Monorail project from L&T Scomi Engineering. Due to the Make in India policy, the tenders for manufacturing of the Mumbai Monorail were altered to encourage manufacturers and Indian technology partners to participate and fulfil the demands of manufacturing the additional monorail rakes[10]. Among other issues currently plaguing the Mumbai Monorail project, such as unavailability of a sufficient number of rakes to keep the services running and an inadequate number of spare parts, the widening deficit between revenue and O&M costs, remains primary.   

   

Way Forward

 

As per the report by the Ministry of Statistics cited above, the reason for cost and time overruns can be largely attributed to the state-wise lockdown due to the COVID-19 pandemic, which has been causing great hindrance to the implementation of infrastructure projects. Time and cost overruns in projects lead to disputes and arbitrations. Furthermore, in the procurement stage of projects, biddings in India happen with the project sponsor underbidding for the project so as to survive the competitive market. However, the underbidding combined with lack of margin included in the overall costs by contractors or sponsors often overlook inevitable hidden and unforeseeable costs which in turn enhance the final costs of the project. For instance, the Mumbai-Monorail project is a classic example of cost overrun. The solution would be to have a clear understanding of the project agreements, risks involved in the project particularly the conditions of force majeure, an objective evaluation of project cost while bidding taking into account uncertainties relating to raw material procurement, labour laws, land acquisition and risks related to cost and time overruns due to decisions of the awarding authority or public policy or any of the factors described above. The compensation clauses should be coherent and unambiguous, and in line with actual project cost incurred in the project leaving less scope for future disputes and arbitrations. Furthermore, it would be useful for the contractors / concessionaires , while making claims in an infrastructure project, to do it in a timely manner while maintaining clear and systematic evidentiary documentation, to substantiate the claims that may have arisen during the course of the project.

References: 

[1] http://www.cspm.gov.in/english/flr/FR_Mar_2021.pdf

[2] Finance Minister Smt. Nirmala Sitharaman releases Report of the Task Force on National Infrastructure Pipeline for 2019-2025, dated 31 December 2019, Press Information Bureau, pib.gov.in (2019), https://pib.gov.in/Pressreleaseshare.aspx?PRID=1598055 (last visited Sep 17, 2021).

[3] Forecasting Infrastructure Investment Needs and gaps, Global Infrastructure Outlook – A G20 INITIATIVE, https://outlook.gihub.org/ (last visited Sep 17, 2021).

[4] 422nd Flash Report on Central Sector Projects (Rs.150 Crore and Above), March 2021, Ministry of Statistics and Programme Implementation Infrastructure and Project Monitoring Division (2021), Available at: http://www.cspm.gov.in/english/flr/FR_Mar_2021.pdf (last visited Sep 17, 2021)

[5] Joseph Mante, Issaka Ndekugri & Nii Ankrah, Resolution of Disputes Arising From Major Infrastructure Projects In Developing Countries Fraunhofer, https://www.irbnet.de/daten/iconda/CIB_DC24504.pdf (last visited Sep 17, 2021).

[6] Make in India Initiative, Government of India.

[7] Sandeep Shrivastava and Abdol Chini M.E. Rinker Sr., Construction Materials and C&D Waste in India, School of Building Construction University of Florida, USA, https://www.irbnet.de/daten/iconda/CIB14286.pdf (last visited Sep 17, 2021).

[8] Amendments to the Arbitration and Conciliation Act, 1996, August 2014, Law Commission of India, Report No.246.

[9] Larsen and Toubro Limited Scomi Engineering BHD vs. Mumbai Metropolitan Region Development Authority MANU 2018 SC 1151, Arbitration Petition (C) No. 28 OF 2017.

[10]Adimulam, S. (2021, March 2). Mumbai: Monorail rakes will be made in India. Mumbai. Retrieved September 17, 2021, from https://www.freepressjournal.in/mumbai/mumbai-monorail-rakes-will-be-made-in-india.

 

 

Image Credits: Photo by Wade Austin Ellis on Unsplash

The solution would be to have a clear understanding of the project agreements, risks involved in the project particularly the conditions of force majeure, an objective evaluation of project cost while bidding taking into account uncertainties relating to raw material procurement, labour laws, land acquisition and risks related to cost and time overruns due to decisions of the awarding authority or public policy or any of the factors described above.

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