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Economic Review - Private Participation in Infra Projects
Steps are being undertaken to increase private participation
Government support, an establishment of stable and efficient regulatory framework and credible mechanism for dispute resolutions are essential to attract private participation in infrastructure. The government is taking steps across sectors to facilitate private investment. For e.g., the model concession agreement (MCA) is being put in place in sectors like roads and ports. The MCA framework addresses issues that are crucial for limited recourse financing, force majeure and termination. Furthermore, there are provisions such as increase and decrease in the concession period that help reduce traffic risk and improve viability of a project. For large infrastructure projects like electricity generation and transmission, projects are being awarded to the private sector through the special purpose vehicle (SPV) route. Here, the SPV or shell company is responsible for obtaining mandatory clearances and approvals before the projects are bid. The SPV addresses issues such as land acquisitions, availability of the right of way, environmental clearances, fuel linkages and power purchase agreements. These issues help reduce execution risk and potential delays once the project is available for bidding.
Private sector investment is now established in roads, ports, electricity generation, telecom and airports. However, private player participation in sectors like water supply and sanitation, and railways are yet to see an uptick, in our view. We discuss private participation in greater detail under various sectors that follow in the report. Activity at the state level picking up The PPP model, which was initiated by the Central government, is gradually percolating to the state level. States have set up PPP cells that are involved in identifying and facilitating private participation in infrastructure. So far, 22 states have set up PPP cells. States have kept up the pace with the Centre in awards, however with little progress.
Construction companies are in the forefront of private participation. Construction companies are in the forefront when it comes to bid for BOT projects, particularly in less complex projects like roads. These projects are typically housed in a SPV. The SPV is usually part of a subsidiary that houses all BOT projects. Winning bids for BOT projects also ensure order inflows from these projects to the parent company. This has been one of the incentives for construction companies to actively pursue BOT opportunities, in our view. Furthermore, construction companies are well placed in assessing construction and execution risks. Because construction companies do not share construction margins with third parties, the project costs are reduced to that extent. For e.g., if we were to assume 6% construction margins, the net construction costs would come down by 6% for the BOT project. If we were to assume 16% equity IRR for the BOT project combined with savings in construction, the IRR would increase to 18%.