Tuesday, March 29, 2011

Delhi-Noida toll bridge: loaded for private windfall profits

A case study commissioned by the Planning Commission shows the Delhi-Noida toll bridge PPP to be a manual on how to milk the public for private profits.

The Delhi-Noida toll bridge is one of the three bridges across the Yamuna river connecting Noida (in Uttar Pradesh) with Delhi and the only one that is tolled.
Popularly known as the DND Flyway, the bridge is 552.5 metres long and includes the approach roads on the Delhi and Noida ends. It has eight lanes with a capacity of around 222,000 vehicles per day.
The main advantage of using the bridge is the savings in time, distance and fuel consumption for travelers between South Delhi and Noida.
One of the earliest PPPs
The bridge, which opened to traffic in February 2001, was among the first few projects to have been developed as a PPP in India.
The project was structured as a Rs 408.2 crore, 30-year BOOT concession, which was financed through equity of Rs 122.4 crore and debt of Rs 285.8 crore. Debt financing consisted of term loans from various Indian banks and financial institutions totaling Rs 235.8 crore and the issue of deep discount bonds totaling Rs 50 crore by the Noida Toll Bridge Company Ltd or NTBCL (the concessionaire).
IL&FS, Noida authority (New Okhla Industrial Development Authority, an agency of the Uttar Pradesh government) and the Delhi Administration signed an MoU in April 1992, which recognized IL&FS as the developer of the project, notes Sheoli Pargal in a case study, commissioned by the Planning Commission and published in August 2007.
IL&FS incorporated NTBCL in April 1996. Concession agreement, signed in November 1997, grants NTBCL the right to collect user fees to recover (a) the total cost of the project, as well as (b) returns on the total cost of the project at a rate of 20 per cent per annum, over the concession period starting from the effective date.
The return on the total cost of the project is guaranteed in that the contract provides that the concession period will be extended by Noida in two-year increments beyond the 30 year initial concession period until such time as the total cost of the project and the returns thereon have been recovered by the concessionaire.
No cap on project cost
Pargal notes that the guaranteed return on the total cost of the project is the aggregate of (i) project cost, (ii) major maintenance expenses and (iii) shortfalls in the recovery of returns in a specific financial year. Project cost is defined as, collectively, (a) the cost of construction and (b) the other costs of commissioning.
“The project cost is defined ex post – once construction and commissioning have been completed – and the contract does not put a cap on project cost and total cost of the project.
This means the magnitude of the financial commitment being made by Noida, and, whether it is ‘reasonable,’ are not known up front.
Since the contract provides for returns on total project cost, the public interest in ensuring that only ‘appropriate’ expenditures are incurred would have been better served if the agreement had provided specifications and costs,” says Pargal.
She adds: As high costs would be borne by Noida and users, it would have been appropriate for Noida to have a say in approving the costs incurred by the concessionaire, especially the capital cost of Rs 408 crore and its components, to ensure that they were ‘reasonable’.
While auditors can certify that specified expenditures have occurred, they cannot opine upon whether these expenditures are ‘reasonable’.
Open-ended base for profits
The agreement does not provide a tight definition of what items are allowable as costs; so costs are effectively open ended. Given the public service nature of the project, the base upon which returns are guaranteed is unduly inflated by including the management fee in project cost and by including land costs, rather than having the government absorb these costs.
In fact by providing a return on the total cost of the project and not specifying exactly what is included under total cost, a perverse incentive is created for the concessionaire to (a) attribute whatever it can to the cost of the project and (b) over-engineer the project.
Such as increase in project cost would mean that toll levels and/or the concession period would need to be adjusted upwards to permit recovery of costs and returns; so users could end up paying unnecessarily high tolls and for a longer period than warranted, says Pargal.
The total cost of the project, which qualifies for an assured return of 20 percent per annum, includes shortfalls in the recovery of returns in previous financial years.
In other words, if the toll revenues of a given year do not generate such returns, the deficit is added to the total cost of project and the enhanced total cost of project forms the base for calculating the return of 20 percent in subsequent years.
“The inclusion of shortfalls in the recovery of returns in total cost of project not only substantially removes traffic risk from the concessionaire, but could be expected to result in very significant increases in the total amount due to the concessionaire.
Since any deficit in returns significantly increases the total cost of the project, this can create a vicious cycle in which shortfall in achievement of required returns and the compounding thereof results in a repeated need to lengthen the concession period and/or raise toll rates or grant development rights.”
In fact, actual revenues fell far short of projected revenues in the initial years of operation of the bridge, leading to significant losses which were added to total project cost. The first ever book profit was earned by NTBCL only in the year ended March 31, 2006.
There is no incentive to minimize costs since costs are completely passed through to consumers. O&M expenses are taken ‘off the top’ when determining the surplus available for appropriation to recover project cost and returns.
There is neither any norm-based estimate of what they should be nor any cap on what is allowable. For instance, they include “without limitation” attorneys’ fees associated with the settlement of pending or threatened suits/claims.
Profits without risks
Several of these eventualities have come to pass. The independent auditor has determined accrued return due to the company till March 31, 2006, amounting to Rs 953.40 crore, inclusive of project cost.
The directors estimated that the concession period will be in excess of 70 years, as a result of the shortfalls in the recovery by the company of the total project cost and the returns to date.
Finally, the concessionaire has requested the grant of development rights under the concession agreement and has received ‘in principle’ approval for the same. Subsequently, DND Flyway Ltd, a subsidiary of NTBCL, has acquired 30.5 acres of land for development from its parent.
The level of return, at 20 percent per annum on the total cost of the project, cannot be assessed as appropriate without knowing whether such returns are the norm.
In the absence of benchmarks or data on comparable projects in the sector and country at the time, the return can be judged to have been justified only if it was the outcome of competitive bidding for the contract. However, the concession for the Delhi-Noida toll bridge project was not awarded competitively.
High returns are also considered a reward for high risk. In this concession agreement, however, the guarantee of return means that the concessionaire does not bear any significant commercial risk.
Big returns on equity
In addition, since the base upon which returns are paid is the total cost of the project, i.e., equity holders are effectively earning substantially more than 20 per cent per annum given the rate of interest on debt is less than 20 per cent per annum.
In effect, the margin between the average interest rate payable on the company’s term loans (14.7 per cent per annum) and the assured return of 20 per cent would accrue as an additional return to equity holders, who would receive about 32 per cent per annum on their equity holding.
In fact, returns to equity are likely to be higher than described above on two accounts.
First, carrying forward the annual deficit in returns and payment of compounded returns on this deficit means that while the debt burden on the concessionaire would only be compounded by the rate of interest, a major share of the compounding of returns would be allocated to equity, resulting in an extraordinary rise in the return on equity.
Second, debt has been restructured to reduce the average interest rate payable. This implies a sharp rise in the return on equity as there is no mechanism in the concession agreement for the conceding authority or the users to claw back these gains.
Onerous obligations for public partner
The criteria for deciding that development rights need to be granted, the value of the development rights to be granted (and the principles underlying such valuation), as well as the duration for which they would be granted are not known.
The concession agreement also does not state how the development income generated would be monitored in the absence of an escrow account, by whom it would be monitored and what role, if any, the independent auditor would play in this.
In the event Noida authority decides to repudiate the agreement, it would be obliged to pay the concessionaire an amount equal to the total project cost and returns thereon outstanding till the termination date.
Since the accrued return due to concessionaire was as high as Rs 953.4 crore in March 2006, it would be very difficult for Noida to terminate the contract.
In the case of termination following a concessionaire event of default, Noida is obligated to compensate the concessionaire for the debt and debt service outstanding.
No distinction has been made in terms of compensation between a concessionaire event of default that occurs prior to operationalisation of the bridge and the one that occurs after the operationalisation. In both cases Noida authority pays off the total debt outstanding.
‘Let me award the project to myself’
IL&FS, a project sponsor, was fully involved in (a) conceptualizing the project and (b) as a member of the steering committee that decided that the project should be implemented by a corporate entity promoted by itself.
This involvement of the project sponsor in designing the structure and setting the technical specifications of the project would be considered a clear conflict of interest under public-sector contracting norms, says Pargal.
IL&FS was also counted among the lenders to the concessionaire and in that capacity would have had a voice in the selection of the independent auditor and independent engineer, sole say in the selection of the one-member project oversight board in case of no agreement upon this between Noida and the concessionaire, and, likewise, sole say in determining the chairman of the three-member fee review committee.
The potential tie-breaking role of IL&FS (as a lender) in the these selection processes could result in both the project oversight board and the free review committee being perceived as weighted in favour of the interest of the private partner.
The concession agreement does not spell out the penalty payments or sanctions for not adhering to performance specifications/standards. Pargal cites several other provisions loaded in favour of the private partner.
Pargal concludes that the Delhi-Noida toll bridge project illustrates “the pitfalls of not following the good practices in contract design and the process of awarding the contract.”
The net profit of the Noida Toll Bridge Company rose 45.04 percent to Rs 10.07 crore in the April-June 2010 quarter from Rs 6.95 crore in the corresponding quarter of the previous year, according to media reports of July 2010.
“It is one of the most lucrative public-private partnerships this country has seen,” Ashish Chugh, an investment analyst, was quoted as saying by Moneycontrol.com.
Chugh added: “As on March 31, 2009 this company had receivables of about Rs 1486 crore from Noida Authority, which is a shortfall in 20 percent guaranteed profits and as on 31 March, 2010 that figure would have jumped to about Rs 1,700 crore. So you have a company that is available at enterprise value of Rs 780 crore where the value of the asset if build today maybe much more than the current enterprise value of the company and along with that they have got receivables, which are good which will come to them over a period of time of about Rs 1,700 crore.”
(This article is primarily based on a detailed case study on Noida toll bridge project done by Sheoli Pargal on behalf of the Planning Commission. The full case study can be accessed on government website: http://infrastructure.gov.in/pdf/NOIDA.pdf)

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