High risk on the highway

High risk on the highway
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First Published: Tue, Apr 29 2008. 11 48 PM IST
Updated: Tue, Apr 29 2008. 11 48 PM IST
Even as the government is trying to protect consumers from spiralling commodity prices, it will soon face another challenge. Massive increases in key input costs — of steel, cement, etc. — are denting the profitability of private sector contractors in the much-needed physical infrastructure sector. And India plans to award as well as offer for bidding highway projects worth around Rs26,500 crore by end-June. Given that the preferred, indeed required, route is public-private partnership (PPP), how will it ensure adequate investor response with continuing high commodity price volatility?
Many of those building national highways have raised an alarm, saying that the order of cost escalation is much higher than they could have anticipated while bidding, and that they now find their margins under high pressure. They want contract norms modified to reduce such input cost burdens on their books.
Indeed, the construction business has been hit by a 35-40% rise in raw material costs over the past one year. But the fact is that it is the contractor who bears the business risk on this front and has bid — and won — on the basis of how well it felt it could manage and hedge such risks. A key problem, contractors say, is that the price escalation factor in contracts is linked to the outdated WPI which does not fully reflect actual input cost inflation. Still, there’s no case for renegotiating escalation clauses, as that would be unfair to those who lost the bid by being less “aggressive” in their business projections based on those very norms.
For future contracts, it is important to ensure that risks are shared optimally between the government and operators. It makes sense to revisit the model PPP concession agreement and see how best the terms can be modified to factor in the lesson learnt. Apart from realistic escalation clauses, another way out suggested by many is to allow for extension of concession periods so that the operator can be compensated for undue cost escalation by pocketing the toll revenue over a longer period than originally contracted. But this could encourage “gaming” bidders who bid low to win and hope to renegotiate. Such flexibility should be institutionalized, but only for unusual conditions that businesses can’t predict.
Can input cost risks be better addressed in PPP? Write to us at views@livemint.com
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First Published: Tue, Apr 29 2008. 11 48 PM IST