• MAY 10, 2006

Public Private Partnerships (PPPs): Moving Ahead

Public private partnerships (PPPs) have a long history. The intellectual foundation for privatisation was lead by Milton Friedman. PPPs is basically a medium to long-term relationship between the public (read government) and the private sectors involving the sharing of risks and rewards of a venture and the utilisation of multi-sectoral skills, expertise and finance to deliver desired policy outcomes that are in the public interest.

The history of PPPs in the infrastructure sector dates back to the 1970's with the U.S deregulation of airlines, gas, rail and telecommunication followed by similar developments in the UK in the late 1980s and early 1990s. During 1985-90, there was increased interest in the BOT (Build, Operate, Transfer) option of privatisation. Infrastructure needs are now greater than ever before, both for emerging and developing countries. During the last few decades, infrastructure development world over has progressed due to restructuring and privatisation of utilities for cost effective service delivery, leading to the path of PPPs.

PPPs: An instrument for development and growth

India has been pro-active in introducing private sector participation and restructuring of utilities for enhancing competition, efficiencies and service delivery. Infrastructure services, which traditionally have been the domain of government institutions, was characterised by a monopolistic regime, huge subsidy burden, and consequent unaffordable cost, all of which is slowly coming to end. Demand for infrastructure and the consequent requirement of financing the same is so large that no amount of resource mobilisation within the public sector can meet this challenge. In such a backdrop, PPPs provide an attractive alternative to bring about long-term private investments bundled with their inherent efficiencies. As such, the government is looking at public private partnerships (PPPs) for future growth, that would lead to a paradigm shift in favour of PPPs in the infrastructure sector.

The potential of the infrastructure sector to attract private sector investments is directly proportional to the revenues that can be generated from the project as well as the risks attached to the same. Considering this and to encourage the private sector to invest in infrastructure via the PPP route, the government has announced several incentives. Some of these include:

  • Government would bear the cost of project feasibility study, shifting of utilities, environment clearance, cutting of trees, etc.

  • Foreign Direct Investment up to 100 % in road sector

  • Provision of capital subsidy upto 40% of the project cost to make projects viable. The quantum of subsidy to be decided on a case-to-case basis

  • 100% tax exemption in any 10 consecutive years out of 20 years after commissioning of the project

  • Duty free import of high capacity and modern road construction equipments

  • Easier external commercial borrowing (ECB) norms

  • Right to retain Toll, which are indexed to the wholesale price index

PPPs consists of different models, which are discussed in brief below:

Civil Works Contract: A traditional way of involving the private sector was to contract and bid out the construction process on the basis of defined designs and specifications. In this process, the government/road agency appoints an Engineering, Procurement and Construction (EPC) Contractor who is awarded the construction contract. In such an arrangement, on completion of construction, the Government would maintain the project and the role of the private player ceases to exist from hereon. Build-Operate-Transfer (BOT) Direct Tolling: In this model, a concession is awarded to a private entity (the concessionaire) to build, operate and collect toll on a road for a specified period of time (usually 15-20 years), at the end of which the road is transferred back to the government free-of-charge. The investment in the road is recovered directly through user fees by way of tolls.

Build-Operate-Transfer (BOT) Shadow Tolling: This model is somewhat similar to BOT direct tolling. In this case, the money is recovered directly from the government through shadow tolls. The authority granting the concession repays the concessionaire's investment through public funding based on the number of vehicles observed to be using the road within a certain specified period or a similar indicator. This method of financing is often used by the government to provide security to the concessionaire when there is high traffic risk, more specifically when there is a risk that users are likely to divert to alternate roads to avoid paying tolls.

Annuity: The annuity model comprises of a composite contract, combining the construction of civil works and their maintenance for a subsequent period of around 15 years. In this approach, the contractor receives a fixed semi-annual payment over the life of the contract instead of receiving a payment for the civil works as they are completed over the period of construction.

Depending upon the project requirement in the infrastructure sector, the appropriate PPPs model is selected. Some of the recent projects, which have been built/being built on BOT basis include Delhi Noida Bridge, 160 kms Taj Expressway proposed to link Agra and Greater Noida and the Paradip port in Orissa. In India, the presence of PPPs is mostly seen in the road segment. Other segments such as ports, railways, civil aviation does not have much of PPP participation as yet. However, these are on the rise.

To conclude, PPPs provide a good solution to enhancing efficiencies in the infrastructure sector. Government of India is offering several projects in the infrastructure sector on BOT basis, which offer net equity of 18% to 25% to the construction companies. Considering that the PPP model is relatively new for India, albeit having already tasted some success, PPPs have a big role to play as India's infrastructure development story unfolds.

Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA, Canada or the European Union countries, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

Equitymaster Agora Research Private Limited (Research Analyst)
103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407