The
Case for Free Markets in India
Part
2. Roads and Highways
Written
by Dr. Seshadri Kumar, 12 May, 2014
Copyright © Dr. Seshadri
Kumar. All Rights Reserved.
Disclaimer: All the
opinions expressed in this article are the opinions of Dr. Seshadri Kumar alone
and should not be construed to mean the opinions of any other person or
organization, unless explicitly stated otherwise in the article.
*********************************
Abstract
Socialism,
India’s current economic system, has failed India in its 67 years of
independent existence. India must
rapidly move towards free-market systems in every aspect of its economy to
avoid sliding into a disastrous abyss.
The evidence for these assertions is presented in the form of a 12-part
series.
In this
part, I discuss the poor condition of roads and highways in India, discuss the
structural factors responsible for this state of affairs, and propose solutions
to deal with these problems.
The
report is broadly divided into two parts: one concerned with the poor quality,
the systemic inefficiencies, the inherent corruption, and the reason for
failures in government-built and government-operated city and local roads; and
another concerned with the all-important highway sector. I discuss the importance of the role of private industry in highway construction, the main causes of
the current slow rate of construction, the key bottlenecks hampering
the highway sector, and proposed solutions to quickly improve the situation.
Executive
Summary
The roads sector in India consists of two distinct parts:
local (city and village) roads, which are meant for low-load, low-speed
passenger traffic, and highways which are meant for heavy traffic and high
speeds. There are serious shortcomings
in the roads sector in India on both counts, which have seriously hampered
productivity, efficiency, and quality of life for the last 67 years and
continue to do so.
Local roads are managed by the public works divisions (PWDs)
of state governments and city municipalities, and often are managed by
sub-contracting parts of construction to small firms. There are systemic problems of corruption and
inefficiency that plague the planning, tendering, and execution of these
projects, such as rigging of tenders, selection of tenders based on lowest
cost, poor quality control, extensive bribery, and the use of item rate
contracts instead of lump-sum contracts.
All of these can be improved by transparency, competition, and skill
development.
Highways were also managed and constructed by the government
until 1998, when the NDA government started the National
Highway Development Project (NHDP) to vastly expand the national
highway network, under the aegis of the nodal agency National
Highway Authority of India (NHAI). While there have been impressive gains in the
Indian highways infrastructure, further expansion of the network is not
possible unless groundbreaking reforms are carried out.
The deficiencies in the highway sector are because of two
main causes: financial bottlenecks and project execution delays. In order to understand these, it is important
to understand the financing models for highway construction: the EPC, BOT-Toll,
BOT-Annuity, and VGF models. The financial bottlenecks are related to
limitations faced by banks and financial institutions as well as construction
companies. These bottlenecks can be addressed by opening up the playing field
to more players internationally.
Project delivery delay has many components: administrative
delays, such as obtaining clearances; engineering incompetence; poor dispute
resolution; and land acquisition. Some
of these can be remedied by better administrative processes; some can be
remedied by free-market measures, such as removing restrictions on foreign
construction company participation in the Indian highway sector or offering
better incentives for foreign players to enter the Indian construction space.
One of the measures that have been introduced last year to
deal with the issues surrounding land acquisition is the new Land Acquisition
Bill of 2013. This bill has wide-ranging
ramifications that can seriously impede rather than advance the development of
highways in the country, and should be repealed or amended as soon as possible.
In all cases, the solutions for improvements in the road
sector are greater competitiveness, more transparency, more free enterprise, fewer
restrictions, and better leadership – in all making a compelling case for free
markets in the roads and highways sector.
The
Sorry State of Roads in India
Everyone who has visited India after the monsoon has seen
the potholes that abound in India. In the
15 years that I lived in the USA, I have never seen incompetence on this
scale. Some might be tempted to counter
my statement by saying that the US does not have monsoons; let me remind them
that many parts of the US experience plenty of snowfall in the winter. To keep the snow from freezing and becoming
ice on the roads, which would make the roads very slippery, the government
spreads salt liberally on the roads. A
quarter of the total consumption of salt in the US is for this purpose. Salt, as everyone knows, is a very corrosive
chemical. At least in India, rainwater
is pure water, and our roads disintegrate even with pure water. The American roads have to handle huge
quantities of saltwater; yet never have I seen a pothole there. Potholes regularly cause miscarriages
in pregnant women and deaths in India, yet this situation
has never been satisfactorily addressed, despite the outrage that accompanies
every such tragedy.
Another shocking bit of incompetence in India is how even
the best roads are always uneven – you keep getting a slight bump every 20
seconds, even on roads like the Mumbai-Pune expressway and other toll roads. In most asphalt-topped (tarred) roads in
India, one can observe one half of one side of the road at a higher level and
another half at a lower level. Why? What is the reason for such shoddy work? In the USA, you can read a book without
strain while being a passenger on a bus, even though traffic moves much faster
than in India. It is not that the
technology is not available. It is
because there is no interest in India in doing good quality work, and no
interest in enforcing good quality work.
The reason is that everything is managed by the government; and government
infrastructure is inefficient.
Recently, in Thane, near
Mumbai, where I live, the local municipality dug one side of all the roads in
the neighbourhood, causing huge traffic problems for a few months. The ostensible reason was the laying of gas
pipelines. When the job was completed,
rather than properly re-asphalt the dug roads, the municipality just filled the
cavities with mud and stones, and did a half-hearted job of asphalting
them. A nice, smooth road had been
replaced by a surface that looks like the craters on the Moon. This is a typical story of shoddy work done
in India – because there is no accountability when the government is entrusted
with things.
The assigning of such responsibilities to the government
also robs the citizen of his initiative.
Years ago, when I was living in Pune, the apartment complex I lived in
was home to some affluent people, in a neighbourhood called Anand Park in the Aundh area of Pune. When you opened the gate of the building,
there was a huge pothole on the road right outside, so that in the rainy season
it would fill up with water and to get out of the compound without getting your
feet wet, you had to do acrobatics. I
asked one of my neighbours there why we did not get this repaired. He replied that we could not even if we
wanted to. This is the province of the Pune
Municipality, and only they are authorized to repair the
road. And they have submitted a request
for them to take care of this, but no one has bothered. Unless someone knew a politician high up, the
problem could not be fixed. That pothole
is still present, nearly 9 years later.
See the problem with the government running things? A group of well-off, private citizens cannot
fix an immediate inconvenience even if they want
to pay for it and can pay,
because repairing roads falls under the Government’s responsibilities. Left to themselves, this group of people
would have hired a private contractor and finished the job within a week – and
to the highest quality standards, because this would not be done “for free,”
but would come out of the pockets of the citizens themselves, who would demand
a job well done.
It is also the Indian experience that toll roads, which are
built by private parties who are authorized to collect money in return for
constructing highways in order to recoup their costs and their profit, are much
better than government roads. Why? The reason is that government roads are considered
“free” (even though they are not – they are funded from our taxes, and we are
paying a “toll” to use them), whereas toll roads, such as the Mumbai-Pune
expressway, are usable only on payment of a per-use fee, and so the
idea that you are paying for it is very visible and immediate. When you feel you are paying for something,
there is a demand for accountability; but no one looks a gift horse in the
mouth.
Time
and Cost Overruns
The dreadful inefficiency, incompetence, and corruption
associated with road-building in India that is common have lowered expectations
so much in India that the few achievements of the road sector are hyped up way
more than they deserve to be. A prime
example of this is the Bandra-Worli
sea-link, a cable-stayed bridge spanning 5.6 km across the Mahim bay,
part of the Arabian
sea,
in Mumbai, connecting the suburb of Bandra with south Mumbai. The bridge, executed by Hindustan Construction Company, cost
$270 million and took 10 years to complete.
This bridge has been hailed around India as an “engineering
marvel.” Compared with the abysmal state
of most public works in India, it indeed may be a marvel that such a bridge was
even completed.
“The Economic Times was critical of the Bandra–Worli Sea
Link in every particular. First, the cost was not the projected 3 billion (rupees)
but actually cost 16 billion (rupees) or about 430% cost overrun. Second, the
project was 5 years behind schedule. Third, the supposedly reduction in commute
time did not occur. Traffic bunched up at both ends of the Link causing
nightmarish grid lock. The blame rests, as usual, on the notorious Indian
corruption and political inefficiencies.”
Aside from the corruption and inefficiency, is it really a
“marvel” in an absolute engineering sense?
Let us take another bay bridge, the Hangzhou bay bridge in
China, for comparison. This bridge
connects the municipalities of Jiaxing and Ningbo in Zhejiang province, is 36
km long, cost
$1.7 billion, and took four years to complete! The longest span in the Bandra-Worli sea link
was 250 m, whereas the longest span in the Hangzhou Bay Bridge was 448 m. While the cost of the project seems to scale
with the distance (36 km v/s 5.6 km), the fact that the project was executed in
such a short time tells us what a true engineering marvel it is. This is not taking into account the fact that
building this long trans-oceanic bridge presented very difficult problems such
as choppy waters (25 feet tall waves) and typhoons in an earthquake-prone
region, the need to pre-construct large parts of the bridge and transport them
to the mid-oceanic location, and unexpected difficulties, such as the discovery
of poisonous methane gas on the sea bed below the bridge, that had to be solved
before the bridge could be opened.
Road
Construction Process in India in a Nutshell
What is the reason for this incredible inefficiency in the
roads sector? The reasons have to do
with how contracts are awarded and how they are executed. The first process in the construction
business is the awarding of tenders. The
government, more specifically the public works department of the government,
whose job it is to commission these bridges, roads, or other public works,
floats a tender for the construction work for which contracts are to be
awarded. The lowest tender that meets
the technical specifications is to be awarded the contract.
Rigging
Tenders
On the surface of this, this is a fairly clear
procedure. But in fact, the process is
rife with corruption. The number of
possibilities for corruption in the construction industry are too numerous to
recount here, but can be found elsewhere in exhaustive references. I will only mention a few principal
avenues. The corruption begins at the
stage when the tender is being drafted.
There are many companies that can execute the project, and all of them
can offer competitive bids. If you are
in charge of the ministry, and want to favour a certain company, and want to
make sure they get the contract, you cannot leave it to chance, can you? So what do you do? You draft the tender in such a way that only
one company will qualify. For instance,
you can say that the company should have executed at least 6 contracts in
Malaysia and Singapore, and three in Uttar Pradesh and two in Tamil Nadu, if
you know that only one company will fit those requirements (just using a
hypothetical example here). In return,
they will give you a kickback which is a percentage of the contract value. The immediate effect, of course, is that
quality takes a backseat to who can give the biggest bribe.
L1
Process: Lowest Bid Qualifies
The second way in which corruption and inefficiency enter
the construction industry is the government requirement of the lowest bid. This requirement often means that companies
will deliberately try to bid a very low amount to get the government contract. Often, these bids are impossible to execute
for the bid amount and so are completely unrealistic. In a bid to get the lowest bid approved and
overlook the fact that it is practically impossible to execute the project for
that cost, the decision-maker (typically a government minister) is bribed to
approve the winning tender and to say that the tender is sound and the project
can be executed for the specified amount.
Having won the contract, the
bidder is usually unable to execute it within budget and within time. So he negotiates an extension to the
project. If this is a bridge or a road,
the government cannot afford to cancel the contract when a half-made bridge or
road is under construction. There is the
possibility of a fine, which is again waived through bribery. Having promised the job for a much lower
amount, contractors typically cut corners by using substandard
materials or methods of construction that take less time and result
in a less reliable final product.
Add to this the fact that each construction project requires
a myriad different approvals and permits, and the process is infested with
corruption. The end result is shoddy
work which gets approved all the way from concept to final completion without
passing any proper standardized checks.
One further complication here is that often substandard quality is
introduced by contractors deliberately so that they will be asked to do repairs
or repeat the work, often at further cost to the taxpayer and benefit to the
politicians and contractors.
Examine this entire chain of events, and one thing stands
out. Every act of corruption is
predicated on the politician having power over decisions. Remove this control of the politician over
all these decisions, and you achieve two results simultaneously – you remove
corruption, and you guarantee quality.
So it is the politicians’ discretionary powers over matters of this kind
that are responsible for the lousy bridges, poor roads, buildings that
collapse, and so on.
Quality
Control
One may ask: how do you ensure quality in that case? There are two ways to ensure quality. The first is to have reliable third-party
auditors of the work. One can even have
two competing auditors hired to examine the quality of the tenders, the quality
of the progress on the work, and the quality of the final product. These auditors must necessarily be private
organizations, so that politicians have no power over them. It is conceivable that the private auditors
may also be bribed by unscrupulous contractors, and so it is necessary to
mandate complete transparency of all activity on the web that any citizen of
the country can examine. In case of any
illegality, the auditors can be taken to court.
And they have a reputation to worry about.
One may wonder if politicians can try to influence the
private auditors to approve a particular contractor they favour. But if the practice of withdrawing all
discretionary powers from politicians is strictly followed, then they will have
little to offer the auditors in return for any favors.
Indians have been conditioned since childhood to think that
the government is benevolent and private industry is evil, and so many Indians
might find my prescriptions strange. It
is very common to see Indians rant on the web about the “corrupt private
sector” as the reason for all that is wrong with India, when in fact exactly
the reverse is true. The private sector has simply adapted, and adapted extremely well, to the state-instituted corruption apparatus that they had no way of really escaping if they wanted to do business - and now corruption has become the standard accompaniment of doing business with the government.
The “Bribery
Fund”
Having worked in the private sector in India myself, I know
the realities of the situation. I myself
have always been a technical person (engineering), and in one of my jobs I had
to assist salespeople (a different company that partnered us) by accompanying them
to prospective clients, presenting the technical details of our product and
answering any technical questions the prospective client might have. Once I had done my bit of convincing the
client on the technical side, the sales representative would then take over and
talk with the potential client on pricing, etc., to seal the deal.
In this process I got to know a lot of salespeople and
interacted with them a lot, and learned a lot about the sales process in
India. One of the things I learned from
the salespeople is that in most Indian government organizations, no matter how
good your product is, you will NEVER effect a sale unless you bribe the
approving manager. One of the
salespeople said his company had a specific “bribery fund” for dealing with
Indian government organizations. I asked
him how much the bribe typically is, and he casually informed me it was between 2-5%
of the contract value. He told me most
regretfully that he wished he didn’t have to do it, but the government managers
make it very clear that the sale will not go through unless they get the bribe.
So, people who rail against Ratan Tata, Mukesh Ambani, and
the like, and accuse them of corruption, need to realize how evil and insidious
the Indian government corruption setup is, if it can force a man of such high
principle as Ratan Tata to allow his people to corrupt themselves. The corruption is not in Tata; it is in the
Indian government. And it is in the
Indian government because of the discretionary powers of politicians.
Item
Rate Contracts
Until recently, most of the contracts for road construction
had been done using item rate contracts (see this for an example). In item rate contracts, the expenditure on a
project is micromanaged by the nodal agency.
So, for example, to get paid for the amount spent on cement, sand, tar, or
a concrete mixer, the contractor must submit individual bills to the government
nodal agency for approval. The
motivation for such a process is cost containment; however, this process has
two major drawbacks: one, it leads to delays, as each expenditure must be
approved individually, and two, it leads to increased corruption, as the
government officer who has to sanction the expense can always demand a bribe in
order to pass a higher expenditure than what was actually incurred, thereby
causing both cost and time overruns.
An efficient alternative to item rate contracts is the lump-sum turnkey (LSTK)
contract, in which the contractor is given stewardship of the entire
project. In this mode, his individual
cost breakup is irrelevant to the nodal agency (e.g., NHAI or a state
government agency), which now only cares that the project is executed in
accordance with the specified quality standards and within the cost specified. While this process is also amenable to
corruption, it occurs, if it does, only once during the life of the project,
and there is no necessity to wait for approvals for each expense. Time overruns can, therefore, be greatly
reduced using the LSTK process rather than item rate contracts.
In addition, LSTK contracts allow private players to be
flexible about the way they allocate resources in order to be more efficient,
provided the final quality of the project is maintained. For example, the
contractor can spend more on material such as cement while optimizing costs on
labor, as long as the total cost and quality objectives are met.
Economic
Effects of Poor Roads
The poor condition of roads in India adversely affects the
economy in multiple ways: it increases the time to market for goods and thereby
raises costs for the end consumer; it does not allow vehicles to ply at the
optimum speed, thereby causing excessive fuel consumption for cars and
trucks;and creates a need
for greater packaging of goods to protect them from the bumps of the road. The
loss of efficiency due to the poor quality of roads is estimated to cost
the nation Rs. 87,500 crores annually, according to a report prepared by IIM
Calcutta for the Transport
Corporation of India. Of
this, Rs 4000
crores is lost simply due to delays due to traffic jams and waiting in
toll lines. The average speed of traffic
on the Mumbai-Delhi national highway is only 17 km/hr for trucks, and the average speed is estimated
at between 23 km/hr and 30
km/hr. This low speed is
extremely inefficient in fuel consumption of automotive engines, which
function most efficiently at a speed of between 45 mph (72 km/hr) and 65 mph
(102 km/hr).
Unfortunately, the quality of surface of Indian roads is too poor to be
able to drive traffic at such speeds, and much of India’s national highway
network is still only 2-laned, meaning that traffic density will force the
actual speed to be lower than what is technically possible given road
conditions.
The
Story of Highway Construction in India
Roads are a very important aspect of a country’s
infrastructure. Indian roads are
responsible for 80% of
passenger traffic and 63% of freight traffic in the country. Of the approximately 3.3 million km of roads
in the country, only about 2% of the total length is part of the highway
network; however they carry about
40% of all road traffic.
Since Independence, highway construction was never accorded
a priority until the late 1990s. At the
time of independence, in 1947, the total length of roads under the national
highway network was around 23,000 km. In the fifty years that followed, this
increased to only 34,298 km, an increase of just 11,300 km in 50 years, or just
226 km/year.
It was following the
economic shock of 1991, and the subsequent focus on economic liberalization,
that serious thought started to be given to increasing productivity and
efficiency in India, and infrastructure development was seen as a very
important enabler in improving the economic climate in India.
Additionally, increasing growth in the
country meant that the existing highways, which were designed
mostly for passenger traffic and medium density freight traffic, was inadequate
to carry the
larger, multi-axle and tandem trucks. The increasing prevalence of such trucks on
Indian highways has led to rapid deterioration
of the surface, necessitating substantial revamping of the
existing highways.
The first serious steps towards a coherent policy towards
improving highway infrastructure were taken by the NDA government of Atal
Bihari Vajpayee in 1998. This government
initiated a plan, known as the National Highway Development Project (NHDP), to
greatly expand the national highway system in India, with two key initiatives:
1.
The Golden
Quadrilateral (GQ) project, which aimed at 4-laning/6-laning of
the entire length of the national highway network that connected the cities of
Mumbai, Delhi, Kolkata, and Chennai.
2.
The North-South
and East-West Corridors (NS-EW corridors), which aimed at
4-laning/6-laning highways connecting Srinagar in the north to Kanyakumari in
the south and Porbandar in the west to Silchar in the east.
By the time the NDA government left office in 2004, 80% of
the work on the GQ project was complete (Ejaz et
al., 2012). Much less was
accomplished on the NS-EW corridors project; however, this project was
only approved in December 2003, just 6 months before the NDA
government lost in the elections and quit office.
The UPA government that followed the NDA government
understood the importance of the NHDP and continued the projects initiated by
the previous government; however, the pace of road-building was much slower. The GQ
project was finally completed in 2012 – taking 8 years to finish the
residual 20% of the project. As of
January 2014, only
5237 km of the 7142 km (73%) of the NS-EW project, that began towards the end
of the NDA government, have been completed. The NS-EW project is well behind schedule,
since it was initially scheduled
to be completed in 2009.
The highway network has grown from 34,298
km in 1997 to 70,934 km in 2012, but the growth in this period
has not been even. Figure 1 shows how
the network has grown in 5-year plan periods since 1997.
 |
| Figure 1. Growth of Indian National Highway Network Over Five-Year Plans |
It is clear that there has been a significant slowdown since
2002: the growth between 1997 and 2002 was 23,814 km, or 69%; the growth
between 2002 and 2007 was 9,008 km, or 16%; and the growth between 2007 and
2012 was 3,814 km, or 6%. It is a
decline not only in relative but also in absolute terms. The length of highway built between 2007 and
2012 amounts to just 763 km a year, or merely 2 km a day. This is just three times the rate of highway
construction in the dormant period between 1947 and 1997, and one-sixth the
pace of the 1997-2002 period. In
contrast, the
expected rate of highway building in order to achieve India’s goals is
considered to be 20 km/day. Some
of the reasons for the delays in the implementation of these plans will be
discussed herein.
The bottlenecks in the progress of highway
construction are due to two main reasons:
1. Financing, and
2. Delays in Project Awards, Land Acquisition, Dispute
Resolution, and Project Execution.
Both of these, in turn, can be related to
regulatory bottlenecks caused by faulty and regressive policies in the
country. I will discuss these in turn.
Models: EPC, BOT-Toll, BOT-Annuity, and
VGF
Highways are not cheap. The 9044 km of
highways that were built in the eleventh five-year plan (2007-2012) cost the Indian government Rs. 1,03,814.17
crores, or (at $1 = Rs. 60) $17.3
billion. The government cannot afford to assume the entire cost of
highway building on its own. Left to finance the cost of highways on
its own, the pace of highway construction will necessarily be slow (as it was
in the period before 2000), especially for a developing country like
India. However, the gap in development that the country needs to
bridge is substantial, and cannot brook the large delays that will be necessary
if the government has to raise the money for development on its own. How
can this be addressed?
To answer this, it is necessary to understand
the different financial models that are used in the construction industry
for large projects. These are the Engineering, Procurement, and Construction (EPC) model and the Private-Public Partnership (PPP) models - the Build-Operate-Transfer (BOT) model and its variants such as BOT-Toll and BOT-Annuity, along with enabling models such as Viability Gap
Funding (VGF).
In the EPC route, a private contractor is asked to
design the highway, procure materials for construction, execute the
construction, and hand over the finished project to the nodal
agency. The payment for the entire project is agreed upon in advance
and paid to the contractor by the nodal agency in instalments. The
contractor is responsible for the quality of the project and is subject to
periodic verifications and checks. The financial consequences are
that the cost for the entire project has to be borne by the nodal agency, and
hence by the government. However, the owner (the nodal agency) is
protected from cost overruns because the cost is agreed in advance – the owner
is not responsible for changes in the cost of labor or materials. There
is an incentive for the contractor to finish the project within time and cost
to protect his own finances. There are also penalty clauses in case
the project is not delivered within the time specified in the
contract. However, if there is any change in the scope of the
project, the cost differential has to be borne by the owner. Once
the highway has been handed over to the owner, the contractor has no more
responsibility for it, except for performance guarantees; the regular
maintenance and upgradation of the highway are the responsibility of the owner.
In the BOT model, the private entity agrees to
build the highway, and then operate it for a fixed period of time as specified
in the contract. The payment for the building of the highway is not
made by the owner in advance or during the building of the highway. The
cost of building the highway is the responsibility of the private
contractor. They can raise the funds through debt – by borrowing
from banks – or through equity – by inviting financial partners or venture
capitalists. Once the highway is built, the manufacturing costs are
defrayed either by allowing the concessionaire (as the contractor is called,
because they sign a “concession agreement” with the government agency) to
charge toll fees from those using the highway for a fixed, pre-determined
amount of time – typically 20-30 years (known as the concession period) – this
is called the Build-Operate-Transfer-Toll model; or by the nodal agency paying
a predetermined annuity to the concessionaire for the same pre-determined 20-30
years, typically in six-month instalments – this is called the
Build-Operate-Transfer-Annuity model. In both BOT-Toll and
BOT-Annuity models, the responsibility for the maintenance of the highway for
the concession period (20-30 years) is that of the concessionaire. At
the end of the concession period, the concessionaire transfers to the owner
(the government) a well-maintained highway.
The owner incurs NO COST in the building of the
highway in the BOT-Toll model – the funds for building it are raised by the
concessionaire using equity or debt and recovered using the toll collected in
the concession period. There is no limit on how much toll can be
collected, though the tolling rates are fixed in advance in the contract, with
allowances for inflation-linked increases. The actual toll amount
collected depends on the number of vehicles using the highway, and there is no
limit on that. This is therefore a very attractive model for
cash-strapped countries like India which need to extensively improve their
highway infrastructure in a short period of time. It is also very
attractive for the concessionaire, because if the highway being built is highly
trafficked, the revenues from toll collection can lead to substantial profits.
It is because of this last-mentioned consideration
that not all highway projects are suitable for the BOT-toll
model. In particular, in many rural stretches, not many vehicles may
frequent the highway once it is built, and so toll collection may not be a very
good vehicle for cost recovery. In such cases, private companies may
be wary of incurring the upfront cost of building the highway and not
being able to recover the cost later. To address this
problem, two solutions have been adopted by the Indian government.
One is the use of BOT-Annuity contracts. In
these contracts, the concessionaire recovers the cost of the highway
construction not through tolls, but through regular annuity payments for the
next 20-30 years (the concession period). This model is thus safer
for the concessionaire, as they do not have to worry about the vagaries of toll
collection. However, in this case the entire financial burden shifts
back to the state, just as it does in the EPC model.
Thus a second, intermediate option has also been
used, that of using Viability Gap Funding (VGF). The financial viability of the project
is examined at the beginning, and the potential for revenue generation through
toll collection is assessed before the project is finalized, and if a shortfall
is anticipated, then the nodal agency is empowered to contribute 20% of the
project cost to bridge the gap between the actual cost and the estimated recovery. This
is known as viability gap funding (VGF). In addition, if even this
is found to be inadequate, the VGF model allows the state government of the
concerned state in which the highway is located to contribute up to 20% more of
the project cost so as to make the project more attractive to concessionaires
who might be interested in exploring the BOT-Toll option but are worried about
toll under-recovery.
There have also been some innovative funding
mechanisms explored, such as a hybrid PPP model involving both grant
funding from the state as well as annuity payments in a BOT-annuity scheme. This is motivated by the fact that
borrowing costs for the public sector are much lower (as in the case of low
interest rate loans from institutions like the World Bank and the Asian
Development Bank) than borrowing costs for the private sector (who have to
borrow at high, commercial rates). An example of a project using
such an approach is the Outer Ring Road project near Chennai, in which the
Tamil Nadu state borrows at lower cost and consequently pays lower annuities to
the private player after construction of the highway.
Bottlenecks in Financing
The Vajpayee government recognized that the Indian
government could not develop the necessary infrastructure on its own and
decided to involve private players in large measure in the construction of the
GQ and NS-EW projects. However, in this early phase of highway
development, the financing model followed was predominantly the EPC model,
which required the state to fund most of the expenditure needed for the
projects. In the early years of liberalization, between 1991 and
2004, only 86 projects were awarded using the PPP models among all
infrastructure projects with a total value of Rs. 34,000 crores (~ $5.7 billion
@ $1=Rs.60). Since 2006, the share of projects awarded under the PPP
model have greatly increased. As of 2012, the government had 758 PPP
projects across all infrastructure sectors costing Rs. 3,83,300 crores (~ $64
billion) in progress. (source here).
The tenth five-year plan (2002-2007) expenditure
(actual) on infrastructure amounted to Rs. 9,06,1,00 crores ($151 billion), of which 25% came from the
private sector. This increased to Rs. 20,54,200 crores ($342 billion) in the
eleventh five-year plan (2007-2012), of which the share of the private sector
was 36%. In the twelfth five-year
plan, the spending on infrastructure was estimated to be Rs.40,99,200 crores at 2006-7 prices, which, assuming an annual
inflation rate of 5%, translates to approximately Rs. 65,00,000 crores (~ $1
trillion) at 2014 prices,
of which the share of the private sector is estimated to be 48%.
The expenditure on roads is projected to
increase from Rs. 4,53,100 crores (~ $76
billion) in the eleventh five-year plan to Rs. 10,79,300 crores (~ $180
billion) in the twelfth five-year plan.
The government cannot be expected to finance these
massive outlays on its own in such tight financial times, and hence the share
of the private sector has greatly risen in successive five-year
plans. Even factoring in the nearly 50% participation of the private
sector, it is not easy for the government to fund the remaining 50% of the
project costs on its own, even with the availability of cheap borrowing
resources, such as World Bank and Asian Development Bank loans, which are
granted on extremely easy terms – sometimes even interest-free for a long
period (these resources are not available to private players, who have to
borrow at significantly higher rates) – especially because, as the Deloitte report on Indian Infrastructure
(2014) states: “Central Government has
to contend with ... massive expansion on programmes aimed at social
entitlements.”
The aforementioned Deloitte report also contends
that, to put it bluntly, given existing resources and policies, the twelfth
five-year plan infrastructure goals are unrealistic, because there is a gap in
debt funding. The report analyzes the debt contribution of the
required funds for the infrastructure development as a total of 32,36,300
crores (~ $539 billion), of which the public sector component is Rs. 10,69,300
crores (~ $178 billion) and the private sector component is Rs. 21,67,000
crores (~ $361 billion). As against this, the total available debt
(comprised of loans from commercial banks, external commercial borrowings,
insurance funds, and infrastructure finance companies) is only Rs. 13,33,700
crores (~ $222 billion), leading to a debt gap of Rs. 19,02,500
crores (~ $317 billion). Not
only is this shortfall true of the twelfth five-year plan, it is also true of
past years. For example, in the roads sector, there was a shortfall
in funding of Rs. 1,30,100 crores ($21.7 billion) in 2011-12, and of Rs.
1,40,100 crores (~ $23.3 billion) in 2012-13 – a 23% shortfall in funding for the roads
sector.
In light of this funding crunch, the spending on
wasteful welfare schemes like MNREGA, which costs typically Rs. 50,000
crores a year, and therefore Rs. 2,50,000 crores (~
$41 billion) over a five-year plan; like the Food Security Bill (FSB), which is
estimated to cost Rs. 3,14,000 crores a year, and therefore Rs. 15,70,000 crores (~ $262
billion) over a five-year period; like the Right to Education, which is estimated to
cost Rs. 1.78 lakh crores (~ $30 billion) over a five-year period, need to be seriously re-examined.
Reasons for the Funding Crunch
Why is there a funding crunch in the debt
space? One of the main reasons is that the majority of loans are
obtained from Indian banks. These are subject to RBI regulations,
and face two main constraints:
1. Asset-liability mismatches
2. Sectoral exposure limits of banks
Asset-liability mismatches have to do with what are
known as the “tenor” of funds deposited in and loaned out by
banks. The tenor of assets is the amount of time that the asset can
remain in the bank – a shorter tenor asset can be withdrawn in a short time,
and a longer tenor asset is obligated to remain in the bank for a long
time. So, for example, many fixed deposits operated by banks
constrain the funds to remain in the bank for three
years. Individual savings accounts have extremely short tenors, because
the entire amount can be withdrawn without notice. In contrast,
infrastructure projects stretch over at least 5 years, often
longer. Hence there is a mismatch between the tenors of banks’
assets and the loans which can be granted to infrastructure. To
maintain adequate balance in the banks in case investors want to pull out their
money, banks must maintain adequate assets in different tenors. This
limits the amount available for infrastructure funding.
The RBI mandates that only a certain percentage of
a bank’s assets can be exposed in loans to any particular sector – be it roads,
transport sector, hospitals, and so on. The reason for this prudent
regulation is that if that sector fails, it will not catastrophically affect
the position of the bank and will not threaten the funds of its
investors. When the rush towards PPP started in 2006, banks had
adequate finances for the projects that were funded. However, in
just a few years time since then, most banks are today close to reaching
their sectoral limits and
will soon be incapable of granting more loans in the roads sector (and in most
other sectors as well, since all sectors of India’s economy are
expanding). Put another way, banks are out of money to lend.
In fact, this limit would have been reached much
earlier, had it not been for the fact that many projects in the eleventh
five-year plan period (2007-2012) not been delayed due to other reasons such as
delays in the award of contracts, and delays in land acquisition, both of which
will be visited later in this article. As the report in the
“Building India” series by McKinsey, on “Accelerating Infrastructure Projects,”
published in 2009 (downloadable here), says,
The core infrastructure sectors are on
course to a deficit of USD 150 billion to USD 190 billion in financing during
the Eleventh Plan period. This deficit is equal to around 35% of the
investment planned in core sectors over this period. However, the
shortage of funds has not been acutely felt during fiscal years 2008 and 2009
because the slow pace of tendering and uptake of projects has suppressed the
sector’s demand for capital.
In addition, certain avenues of long-term funding
are subject to regulations (again, prudential). These are pension
funds and insurance companies. To safeguard the interest of
pensioners and those paying insurance premiums, these funds face regulatory
restrictions in their investment in infrastructure, even though the tenor of
these assets matches infrastructural needs very well. The government
has tried to tap the bond market, by allowing tax exemptions under Section 80CCF
to the tune of Rs. 20,000 per year for long-term bonds, and the Deloitte report suggests that more can be
done in this direction.
Solutions to the Funding Problem
How can these problems be addressed?
Clearly, the Indian banking system is saturated and
cannot further fund infrastructure projects in India, or at least not much
further. If India has to achieve its ambitious goals elucidated in
the Twelfth Plan, much more needs to be done in providing avenues of finance to
the construction business.
Two ways present themselves quite
clearly. One is the entry of large foreign construction companies,
such as Bechtel, into the Indian construction space, which has simply not
happened for various reasons, most of them regulatory. A company
like Bechtel can more easily fund a venture with equity than a smaller Indian
company. Two, foreign institutional investors can pump in
much-needed funds to boost infrastructure development in India.
As the Ernst and Young report, “Accelerating
Public-Private Partnerships in India,” (2012) discusses, “Foreign direct investment (FDI)
of up to 100% is permitted in greenfield infrastructure projects under the
automatic route. In the case of existing projects, FDI under the
automatic route is permitted up to 74% and FIPB approval is required beyond
74%.” The report is also optimistic in its outlook on FDI, mentioning that
“Total FDI increased from US $5.03 billion in 2002-03 to US $27.02 billion. Over
the next two years, India could attract FDI worth US $80 billion.”
The same report also talks about Foreign
Institutional Investment (FII), which is important considering the capacity
constraints of the banking sector in India mentioned earlier: “The GoI is
reportedly in talks with the regulatory authorities to allow infrastructure
finance companies to issue bonds to foreign investors for the purpose of
raising infrastructure finance in the country. The GoI had earlier
raised the limit on FII investment in corporate bonds of duration of more than
five years issued by companies in this sector.”
Encouraging though these words may be, the reality
on the ground today is that foreign participation in the highways sector is
minimal. A look at the list of contracts awarded under the NHDP for its Phase III shows that most of the contractors are
Indian, and that foreign companies are mostly present as
consultants. The same pattern is seen in projects under Phase IV and Phase V. Clearly,
more needs to be done regarding the participation of international majors in
injecting much-needed equity and expertise into Indian road-building, and India
needs to loosen its regulatory framework if it wants to achieve its
infrastructure goals as per the Twelfth Five-Year plan.
Even under the existing regulatory framework, it is
clear that some foreign construction companies do bid for and are able to work
on projects – such as companies from Malaysia and the Persian
Gulf. So why are international companies wary of swimming in Indian
construction waters?
One answer perhaps is the long delays in project
approvals and land acquisition, which tie up funds for years with no
benefit. I will discuss this in what follows.
2. Delays in Project Awards and Land Acquisition
Although the PPP model began in earnest in India in
2006, it has been bogged down in delays of various kinds. Delays
have occurred both in project awards and in project execution.
In 2010-11, only 56% of the target length that was
to be awarded by NHAI was actually awarded; in 2011-12, the figure was 51% (as
quoted in the PWC report: The Road Ahead: Highways PPP in
India).
In addition, project execution has also faced
several delays. In 2009-10, the target for road construction under
NHDP was 3165 km; what was actually achieved was only 2693 km, or 85%; in
2010-11, the target was 2500 km, and what was actually achieved was only 1780
km, or 71% (source: PWC Report).
The same PWC report states that the minimum delay
in projects was 4 months and the maximum delay was 37 months, and the average
delay was 22 months. Additionally, an examination and analysis
of the NHAI website on the project implementation status of Phase I of
the NSEW project shows that the
minimum delay on the projects was 0 months, the maximum delay was 78 months (6
and a half years), and the average delay was 46 months (3 years and 10 months)
for all projects, including North-South and East-West sections. Of
these, the minimum delay in the North-South section projects was 0 months, the
maximum delay was 75 months, and the average delay was 30 months; the minimum
delay in the East-West section projects was 0 months, the maximum delay was 78
months, and the average delay was 54 months.
Causes of Delays
McKinsey, in their detailed report, “Building India: Accelerating Infrastructure
Projects,” have analyzed the causes of these
delays very carefully. Based on their findings, the following are
the main causes of delays in project delivery:
1. Tendering unviable projects: Projects that are
unviable because of excessive scope, poor or dated cost estimates, and tough
financial stipulations (such as the possibility of termination of concession if
traffic exceeds a threshold level),
2. Using item-rate contracts instead of LSTK
contracts,
3. Slow pre-tendering process, involving a multitude
of approvals, including cabinet/ministerial approvals,
4. Land acquisition delays,
5. Poor dispute resolution processes,
6. Poor performance management, including poor
transparency, lack of meaningful incentives for quality or timeliness, and
absence of clearly-defined consequences in case of poor performance or
delivery,
7. Poor availability of skilled and semi-skilled
manpower,
8. Weak risk-management skills,
9. Sub-par design and engineering skills, leading to
an absence of a value engineering mindset (Lean principles,
for instance), and
10. Lack of best-in-class procurement practices, such
as demand consolidation, preferred relationships through frame contracts, and
joint cost reduction.
The interested reader is directed to the
aforementioned report for details on all these points, but I would like to
focus on a few of these areas in a search for solutions. It will be
clear from a perusal of the list above that the identified lacunae come from
three sources:
1. Bad Contracting Practices (1,2,6)
2. Red Tape and Bureaucracy (3,4,5)
3. Engineering and Financial weaknesses (7,8,9,10).
Solutions to Delays in Project Delivery
Of these, bad contracting practices are the
province of the nodal agencies such as NHAI, and the McKinsey report details
some excellent suggestions on how these can be improved. In
particular, attention needs to be paid to selecting contractors on the basis of
BOTH cost and quality in preference to the current practice of selecting the
lowest tender. Part of the problem is also an unfamiliarity with the
international practices of commercial construction and the kinds of contracts
that will be attractive.
Engineering weaknesses can be addressed in a
variety of ways. The problem of shortage of skilled and semi-skilled
manpower can be addressed by the establishment of dedicated institutes for the
construction industry financed by the construction industry itself, with a view
to inculcating world-class skills and practices in the graduates of such
institutes, and with active participation from top construction companies and
civil engineering departments from all over the country.
The problems of poor engineering practices, absence
of Lean techniques, weak risk-management strategies, lack of a value
engineering mindset, and poor finance strategies, such as lack of best-in-class
procurement strategies, can all be addressed by tapping into the experience of world
leaders in the construction industry, for whom all these are standard best
practices to be followed in all projects. An examination of
the list of contractors who are working on projects under the aegis of
the NHDP Plan IV, for example,
(projects which are all in the implementation phase currently), shows that,
apart from two companies based in Oman, all the 38 projects are being executed
by Indian construction companies. Although the government has stated
that it allows 100% FDI in construction, this has not translated into much
demand from foreign companies. The move to allow 100% FDI in
construction is also a recent move and probably accounts for the low presence
of foreign construction majors in the Indian highway space.
Presence of foreign construction companies in the
Indian highway sector has two beneficial effects: the introduction of best
practices in the construction industry and their widespread adoption by the
Indian construction industry as a whole by osmosis; the higher levels of
capital that foreign construction majors possess, which will greatly alleviate
the financial crunch that the highway sector in particular, and the
infrastructure sector in general, is currently facing, because of reasons
already stated.
The issue of dispute resolution was addressed by
the BK Chaturvedi committee, which suggested that dispute resolution be handled in a two-tier
manner: Category A disputes, involving
amounts less than Rs. 10 crores or 5% of contract value, whichever is lesser,
to be handled by a committee consisting of a retired High Court Judge, a former
CAG, a vigilance commissioner, and a technical expert; and Category B disputes,
where the amount involved is between Rs. 10 crores and Rs. 100 crores, in which
case the recommendations of the existing arbitration tribunal should be
accepted. The result of this two-tier separation of the dispute
resolution process is expected to greatly speed up resolution of pending cases,
and the recommendations have been accepted by the ministerial panel.
The Problem of Land Acquisition in
India
That leaves us with red tape and bureaucracy,
probably the biggest cause of project delays in the Indian infrastructure
industry in general and highways in particular, because of the large areas that
highways cover. Highway-building inevitably requires displacing people from the
places where they live or farm; or, alternatively, destroying forest regions;
or requiring people to vacate slums so they can be destroyed and space created
for highways, and rehabilitating them. Villagers may have to part
with fertile land in order to make way for highways and need to be compensated
with equitable land elsewhere so they can continue in their hereditary
occupations.
Worldwide, the standard is that more than 80% of
the land is acquired by the government before a private organization is asked
to work on the project, and the remaining 20% is acquired during the
project. In India, often projects are awarded with just 30% of the
land having been acquired, which then leads to problems as people refuse to
leave the land or construction is blocked by agitations. In
2009, it was reported that more than 150 of 187 projects were behind
schedule, mainly because of problems with land acquisition. Mr.
Kamal Nath, Union Minister for Roads, Transport, and Highways, has been reported to say, “the land acquisition problem is the major factor
behind project delays as multiple authorities are involved.” Several
highway projects in the east, in Bengal and Assam, were held up because of agitations against them in 2012. In the same
year, the much-heralded Yamuna Expressway was finally inaugurated
after a long history of agitations by villagers against the project, on issues such as alleged inadequate
compensation for the land acquired by the government, access to the highway for the villagers
with service roads, foot overbridges and underbridges to enable local residents
to cross the highway, and the high cost of the toll charged. In August 2012, the Union minister of
state for road transport and highways, Tushar Chaudhury, said “Fifty-eight ongoing national highways
projects are delayed for want of land acquisition, inter-alia, including
shifting of utilities, environmental clearance, etc.” In August
2013, the NHAI said it was scrapping highways worth
Rs. 4000 crores and amounting to about 420 km because of difficulties in land
acquisition. The highways were to be
located in Goa and Kerala. In addition to these, more than 30
projects were in difficulty and were being delayed due to difficulties in land
acquisition.
In the past, the government’s approach to land
acquisition has been ham-handed, driven by an archaic and insensitive land acquisition
act - a legacy of British rule,
which allowed central and state governments to indiscriminately use the power
of eminent domain to
dispossess people, with unclear guidelines on what kind of compensation was
adequate. Further, the act allowed the state to bypass the normal
procedures that it itself prescribed for land acquisition in the event of an
“urgency” without ever defining clearly what comprised an “urgency,” with the
result that almost every land acquisition was carried out under the guise of an
“urgency,” thereby completely bypassing the normal procedure of consultative
democracy and grievance redressal. The 1894 Act did not specify
proper resettlement procedures either. The net effect of all this
was that most land acquisition was caught in endless litigation, causing huge
delays in land acquisition for all major infrastructure
projects. These delays are one of the main reasons why foreign
investors and construction companies hesitate to enter India’s construction
arena – for fear that funds might remain locked up for years because of delays
in getting approvals and delays due to litigations on land acquisitions.
The 2013 Land Acquisition,
Rehabilitation, and Resettlement Act
To alleviate these difficulties, the UPA-2
government came up with a new land acquisition bill, the The Right to Fair Compensation and
Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013, hereinafter referred to as the
LARR. The idea of the LARR was that because most of the litigation
in infrastructure cases concerned inadequate compensation and resettlement
provisions, this legislation would remedy the situation adequately and prevent
future bottlenecks due to litigation. Unfortunately, it appears that
the remedy is worse than the illness.
1. For compensation, the highest estimate of the
market value of the land will be multiplied by a factor of 4 in rural areas and
by a factor of 2 in urban areas.
2. For rehabilitation, the following allowances will
be given:
a. A subsistence allowance of Rs. 36,000 for the first
year,
b. One of the following, at the choice of the affected
party:
i. A job for a family member
ii. A one-time, upfront, lump-sum payment of Rs.
5,00,000
iii. A monthly annuity, totalling Rs. 24,000 for the
year, for the next 20 years (inflation-linked)
c. An additional, upfront, resettlement allowance of
Rs. 50,000
d. An additional, upfront, transportation allowance of
Rs. 50,000
e. A new home of not less than 50 square meters if a
home is lost in a rural area
f. For SC/ST families, additional grants of
i. 2.5 acres per affected family
ii. Additional assistance of Rs. 50,000
iii. Free land for community and social gatherings
g. 25 additional community services at the expense of
the land acquirer to displaced families, such as schools, health centres,
roads, safe drinking water, child support services, places of worship, burial
and cremation grounds, post offices, fair price shops, and storage facilities.
3. For consent, the new law requires the consent of at least 80% of all
affected families in the case of private projects and 70% of all affected families in the case
of public-private partnerships. Interestingly, consent is NOT
REQUIRED when the land is acquired directly for public purpose by the
government.
4. For due process, the new law requires, in turn, the
following steps to be followed:
a. When land is proposed to be acquired, a Social
Impact Assessment (SIA) is to be completed within 6 months, in consultation
with the Gram Panchayat, Gram Sabha, Municipality or Municipal Corporation, as
appropriate, and after conducting public hearings in the affected area to
ascertain the views of the local populace. The SIA authority is also
to prepare a Social Impact Management Plan to discuss ameliorative measures to
deal with the social impact that has been ascertained.
b. The SIA will be reviewed by a multi-disciplinary
expert committee consisting of two non-official social
scientists; two representatives of the local panchayat, gram sabha,
municipality, or municipal corporation, as the case may be; two experts on
rehabilitation; and a technical expert in the subject related to the
project. This expert committee is to rule within two months whether
the project should proceed or not, on the basis of the SIA report.
c. Within 12 months of the report of the expert committee,
the District Collector will issue a preliminary notification on the proposed
acquisition, arrange for widespread dissemination of the notice, invite
comments and criticisms, and arrange for hearings to discuss proposed concerns
by citizenry. The period of 12 months can be extended on the
discretion of the Collector if, in his/her view, the circumstances warrant the
delay.
d. Within 12 months of the preliminary notification,
all important concerns will be addressed, and a final declaration on land
acquisition will be issued. This, too, can be extended on the
discretion of the government.
In addition, 26 substantive amendments to the LARR were
passed after the passage of the bill. Notable
among these are a retrospective clause for providing benefits to claimants on
projects that were already complete; a requirement for the government to
deposit money in lieu of agricultural land in case they are unable to find
equivalent agricultural land to give to affected parties; a waiver on stamp
duty and income tax on any compensation received; and a provision to share 40%
of the proceeds in case that land acquired was not used for the purpose claimed
but resold to a third party (as opposed to 20% in the original draft of the
bill).
Implications of the 2013 Land
Acquisition Act
The LARR was generally seen to be a setback for highway
construction in India.
There are many reasons why this is so. While the earlier land
acquisition act of 1894 was definitely arbitrary and draconian, and was skewed
in favour of the government, the new LARR swung the pendulum all the way to the
other side in favour of the landowners. Here are some of the main
criticisms of the LARR:
1. Excessive compensation for
landowners. As the Wikipedia page on the LARR explains, using a conversion rate of 45
rupees to the dollar, if 1000 acres are to be acquired, at a rural rate of Rs.
2,25,000 per acre (USD 5000), the total costs of land acquisition would be
a. Land ownership costs of Rs. 90 crore (USD 20
million),
b. Land owner entitlements of Rs. 6.3 crores (USD 1.4
million) + 100 replacement homes,
c. Livelihood loser entitlements of Rs. 365 crores
(USD 70 million) + 1000 replacement homes,
d. Leading to an effective average cost of land of Rs.
41 lakhs/acre (USD 91,400/acre) plus replacement homes and additional services
such as schools, health centres, etc., as specified in point 2(g) of the
previous section. Even assuming a much lower base price of
pre-acquisition land – at Rs. 22,500/acre (USD 500/acre), the average cost of
land works out to Rs. 33,03,000/acre (USD 73,400/acre).
e. This can be compared with prices of farmland
elsewhere in the world. For example, US farmland varies between USD
480/acre and USD 4,690/acre, with an average value of USD 2140/acre. The
average cost of farmland in Europe was USD 2,430/acre.
2. Long timelines for land acquisition. As
can be seen from the previous section, the land acquisition process mandates,
at a minimum, a 6-month timeline for the SIA, a 2-month timeline for the expert
committee report on the SIA, a one-year period for the preliminary
notification, and a one-year period for the final declaration – a total of 2
years and 8 months. However, it should be noted that both the period
of the initial notification and the period of the final declaration can be
extended by the government at its own discretion if the circumstances warrant
them. In particular, this means that if there is a lot of concern
among the displaced people, the discussion on the proposed project could easily
extend to multiple years on both time windows, leading to disastrous time and
cost overruns on highway projects.
3. Delays in Project Delivery. The requirement of 80% of all affected parties for
private projects and 70% of all affected parties for public-private
partnerships, without allowing the exercise of eminent domain to expedite the
process, could further greatly delay projects.
4. Uncertainty due to Retroactive Provisions. Further, the land acquisition bill, on the
discretion of the government, would also apply in some projects retroactively,
thus further creating uncertainty and inflating costs.
It should be noted that, as passed in 2013, the
LARR does not apply to the highway sector; but that is
only a temporary phase. To underline this, in January 2014, Jairam Ramesh, the Union
Minister for Rural Development, wrote to several ministries, including the
Ministry for Road Transport and Highways, to remind them about the need to
change their laws to be compliant with the LARR. In the case of the Ministry for Road
Transport and Highways, that law is the National Highways Act, 1956. So, although the LARR does not
currently refer to the highways sector, that is no cause for comfort, because
in a short while the highway sector has to fall under the umbrella of the
LARR. Further, in an interview, Mr. Ramesh dispelled any
hope that a new NDA government would roll back the LARR. As Mr. Ramesh said, “Almost all political parties
have consensus on the land acquisition bill because it is going to help the
farmer. Parties including BJP, SP, BSP and of course Congress have praised the
bill and accepted the need of amendments for an effective implementation of the
act.”
The LARR is set to further intimidate construction
majors from taking up highway construction projects in India, and is giving the
jitters to construction companies that are already involved in projects under
implementation. For example, the Delhi-Jaipur expressway is anticipated to
cost three times what was estimated because
of the impact of the LARR.
The higher costs of land acquisition under the LARR
will mean that the financial viability of projects, which were already in
question even with the much more liberal land acquisition laws, will now be
much worse. As has already been discussed in this report, BOT projects
often do not find takers because the ROI on those projects may not be adequate
– builders may not be able to recover the cost of construction and their
expected profit with the total toll amount they can expect to
collect. With much higher project costs due to the LARR, the toll
amount that operators will have to fix on the highways they build may rise
significantly, and this may mean that the public may not find it worth paying
so much to travel on those highways. An example of a highway that is
already at the point where the average Indian will hesitate to pay high tolls
is the Yamuna expressway, which is currently charging a toll of Rs.
2.10/km for cars and jeeps on the 165 km highway – which means that a car or jeep travelling
the entire stretch would have to pay about Rs. 350. For a multi-axle
truck, the rates are much higher, at Rs. 10.10/km, which means that for a
round-trip, a heavy truck will have to pay Rs. 2,560. These are high
costs for Indian motorists. If a project like this is hit by
inflated costs due to the LARR that raise the actual cost to 3 times their
present cost, motorists will simply not use them, which means the projects will
be financially unviable.
In an atmosphere where much-needed highway projects
are already not finding bidders because of viability concerns, which is causing
contractors already to opt for annuity-based projects instead of BOT-based
projects, the LARR is a spanner in the works that threatens to completely halt
the progress of highway construction in India. The only viable
option in India for bridging the huge gap in highway infrastructure is the BOT
model of PPP; but if land acquisition costs are so high, tolling may well be
impossible, and we will have to settle for a much slower rate of highway
construction that is determined more by budgetary limits of the state, where
contractors are willing to work only on EPC or Annuity-based mode with generous
annuities and high levels of VGF, so that there is no risk to them
financially. This could be crippling for the growth of the highway
sector and could very well make the goals of the twelfth plan impossible to achieve.
It may be well worth discussing some impacts of the
existing inefficiencies in the infrastructure sector on the economy without
factoring in the impact of the LARR. The McKinsey report mentioned
previously has done exactly this analysis. The analysis is not
limited to the highway sector alone, but considers all infrastructure in the
country, including ports, airports, irrigation, power, railways, storage, gas,
and telecom. This report, written in 2009 (before the introduction
of the LARR), estimates that if the then-current inefficiency trends were to
continue, India could suffer a GDP loss of USD 200 billion in FY 2017, which
would be a loss of 1.1% in GDP growth rate. In addition, the
McKinsey report estimates that India’s economy could lose up to USD 160 billion
in 2017, by forgoing the industrial productivity impact of
infrastructure. These are serious loss estimates, and don’t even
include the debilitating impact of the LARR.
Concluding Thoughts
The story of roads and highways in India is a
chequered one. For 50 years since independence, Indian road
construction was stuck in the wheels of a socialist machine that promoted
corruption, inefficiency, and substandard roads. This led to
standard corruption processes such as using a lowest cost bid to select
contractors for projects but rigging the system so that a low initial cost was
proposed and projects were delayed forever, leading to cost and time
overruns. The players were well-entrenched and saw no reason to
change the system.
All that changed with the perceived need to rapidly
develop the country’s highway network in the mid-1990s in order to achieve
higher GDP growth rates, and India finally started taking baby steps towards a
free market structure in the roads and highways sector. The NDA
government, which kick-started the Golden Quadrilateral and NSEW projects,
realized that it could not accomplish these goals by just public funding and
execution, and that it needed to involve the private industry in order to make
this happen.
However, the early modes of highway funding were
primarily done using the EPC mode, and it was only after a few years of
government spending that the bureaucrats in the ministry for road transport and
highways seem to have realized that using government funds exclusively for
funding highway projects was not sustainable in order to achieve the kinds of
growth in highway length that they were hoping for.
This triggered a move towards BOT-Toll and
BOT-Annuity projects, and the formation of the BK Chaturvedi committee, which
recommended the “waterfall mode” of financing – try to tender projects with
BOT-Toll first, then try BOT-Annuity if BOT-Toll had no takers, and finally use
EPC if neither approach had takers – which is the standard for highway tendering
today in India.
The journey taken by the Indian government towards
the free market since 1998 is significant and needs to be
appreciated. The initial model of highway construction was a highly
state-dominated one: where the funding, design and construction was overseen by
state PWD departments, with item-rate contracts parcelled off to individual
contractors, where the prices for each line item purchase had to be verified
and approved by the government. This gave way during the first two
phases of the NHDP to an EPC LSTK model, with much less participation from the
state and much more control in private hands. In this model, the
state let go of control of the design and construction space, but still
retained control of funding and operations. This yielded, in turn
(and driven by financial realities) to a model that surrendered both finances
and operational control to private entities in return for a finished highway to
be transferred to the government at the end of a concession period – the
BOT-Toll approach – which is now the preferred route for highway construction
in India, with BOT-Annuity being used as a fallback option. The
resulting benefit and the achievements in this sector because of the gradual
move to the market is there for all to see – a doubling in the length of
national highways between 1997 and 2012 relative to the total highway length in
1997.
The increasing participation of the private sector
can also be seen in the fact that the tenth five-year plan only had 25% private
participation, which increased to 36% in the eleventh five-year plan and 48% in
projected private participation in the twelfth five-year plan.
However, Indian highway construction has hit
several severe bottlenecks, and even the admittedly slow rates of the last five
years cannot be sustained for much longer if these bottlenecks are not
immediately addressed.
The first is a severe funding crunch that is due to
domestic banks reaching sectoral exposure limits and facing asset-liability
mismatches. To alleviate this problem, the Indian government needs
to go further on the road of free enterprise and remove restrictions on
participation by foreign banks and non-banking financial corporations so that
the cash crunch in the Indian construction industry can be overcome.
The second is the problem of delays in highway
construction, which are due to delays in project tendering and awarding, delays
in land acquisition, dispute resolution, and delays in
construction. The government of the day needs to streamline the process
of tender awarding by reducing the number of approvals needed. In
particular, ministerial approvals are open-ended and often end up holding up
the project for months. These can be expedited by creating automatic
routes of project approval where ministerial intervention is not required as
long as pre-set expectations are met by bidders.
Delays in project execution due to engineering
shortcomings can be eliminated by making the Indian construction industry adopt
best-in-class practices, such as lean manufacturing and adopting a value
engineering mindset. One of the best ways to make local industry
adopt international norms is to actively encourage participation in the Indian
infrastructure experience by world-leading construction companies. Their
very presence in Indian projects, and the resulting movement of people between
them and local players will ensure that these ideas are widely adopted in
India, purely from the standpoint of Indian industry being able to compete with
foreign majors. This also applies to best-in-class procurement
techniques, group contracts, supply-chain management, and so on.
Dispute resolution can be resolved by fast-track
processes, such as have been suggested by the Chaturvedi committee.
By far, the greatest danger to the present highway
expansion program is the recently-passed legislation on land acquisition, the
LARR. This legislation has the potential to completely derail the
Indian growth train by making land acquisition costs prohibitively high and by
causing huge delays in land acquisition owing to clauses such as the need for a
project to be approved by 70-80% of the affected parties. I am not
suggesting here that the voice of the affected parties should not be
heard. They should, but the process needs to be fair to both
parties.
The LARR is a highly one-sided legislation that has
been passed purely on populist and not on practical
grounds. Unfortunately, 2013 being the year before a major election,
no party really had the courage to oppose the bill on principles of sound
economics, lest it be seen as an “anti-people” party. It takes a
really bold political leader to understand and explain that true “anti-people”
policies are those that make infrastructure creation impossibly expensive and
complicated, and result in everything being more expensive for the “common man”
– from loss of goods and perishables due to poor road conditions and long times
to market; to more expensive products because of greater transportation costs
because fast highways are not available. This legislation should be
amended as soon as possible in favour of a more equitable and balanced
legislation that does not compromise the legitimate interests of the affected
farmers, slum-dwellers, and other parties affected by highways, but at the same
time does not create new roadblocks that interfere with the speed of highway
building, which is a critical component in national development.
India also needs to transfer its learnings from the
highway sector to improve its road-building processes at the village, town, and
city levels. The main lesson learned has been that the state should
move from the role of an all-in-one payer-and-builder to that of only a payer
and, if possible, not even that. What this means is that more
intra-town and intra-city projects should be handled on LSTK basis and handled
on an EPC basis rather than have the PWD design and construct these
roads. The role of the state should be in formulating the correct
vision for the path forward, in setting the right standards to which roads and
highways need to be built, and in setting up transparent oversight bodies to
oversee the work and make things clear to the paying public. The
rest should be outsourced. This is the model that has worked for
India in its highway sector and is the model that has worked in many other
sectors as well, both in India and abroad.
There needs to be greater devolution of powers, to
deal with instances such as the one I mentioned early in this article, about
the pothole near the apartment complex I lived in Pune. Powers need to devolve
from the state to the municipality to the citizen. In this case, if
local citizens feel that a road is inadequate, they must be empowered to get a
contractor themselves and repair things on their own. And, in return,
the state should not tax the citizens in advance for repairs that may or may
not be performed. Finances for road repairs should be sanctioned by
citizens periodically on a per-case basis, and tax revenues that are charged
should be justified before being levied. That is the essence of true
democracy.
Finally, the serious financial crunch that the
Indian highway sector finds itself in should give pause to Indian government
planners who have been on a welfare binge recently and make them realize that they
don’t have unlimited funds to dole out freebies to buy votes. The
huge cost of social programs is hitting India where it hurts it most – in
deficient infrastructure that is holding back the progress of the country. Deficient infrastructure and lack of progress do not discriminate in their impact between the rich and the poor - they affect all sections of people.
Other Articles in The Free-Market Series
Hospitals (coming soon)
Power Generation and Electric Supply (coming soon)
Water Supply (coming soon)
Telecommunications (coming soon)
Railways (coming soon)
Public Transport (coming soon)
Defence (coming soon)
Agriculture and Food Sufficiency (coming soon)
Education (coming soon)
Conclusion (coming soon)
