The overall financial outlook of the NHAI remains promising, given the vast array of assets available to it for debt servicing, supplemented by ever-increasing budgetary allocations, though its ability to meet construction goals must be a touch more circumspect, given the continued slowdown in project awards and construction during the first three quarters of FY 2023-24, which has been attributed primarily to high input and land acquisition costs, as well as difficulties in the procurement of necessary right-of-way permissions, which trend is likely to persist in the FY 2024-25. It is notable, for instance, that MoRTH data indicates that the highway project awarded from April 2023 to November 2023 amounted to 2,815 kilometres, about half of the projects awarded for the same period in the preceding fiscal year, and that only 45% of the highway construction target for FY 2023-24 seems to have been met by December 2023.

Another step towards encouraging sufficient private investment is the proposed resurrection of the BOT model (i.e., where private participants take upon themselves financing, revenue and management risks, which may also include the government guaranteeing revenue by way of annuity payments, along with viability gap funding). While the NHAI had previously moved away from the BOT model to more concessionaire-friendly arrangements (such as the engineering, procurement, and construction (EPC) and hybrid annuity (HAM) models), this renewed emphasis on BOT seems to have emerged to reduce the burdens placed on the government body with each new project. Given the ballooning land and right-of-way acquisition-related expenses each new project entails, limiting government exposure in other aspects of these projects seems to be a well-founded idea, and one which would ideally reduce the necessity of external financing.

The question, then, becomes whether the banking system, which has borne the brunt of failing and delayed infrastructure projects in the past is, ready to embrace such projects again. It is, in that regard, pertinent to revisit the fault lines of the past, and address the corresponding risks, through sound public policy choices and requisite changes in the administrative regime that were faced in the earlier BOT regime.

The primary impetus behind switching away from BOT projects to other models seems to have been the spate of failures plaguing BOT model projects (with one study, for instance, noting that only a fourth of a sample of 120 BOT projects that defaulted between FY 2011-12 and FY 2022-23 managed a recovery, with assets of around Rs 42,000 crore becoming non-performing assets). While even the new BOT projects are envisaged to constitute only about 10% of all projects awarded in this sector, it is notable that funding requirements, which are typically met solely by toll revenue projections or annuities (calculated on the basis of price-indexed project costs) under the BOT model, have previously proven to result in reduced lender and private sector interest, because of how onerous financing requirements can become.

Such private entities have typically been expected to meet their oft-significant upfront expenditure requirements, as well as weather delays in right-of-way procurement, land acquisition, and the granting of suitable regulatory approvals, using the revenues from the operation of the roads, or by seeking market financing.

Market interest in even the newer EPC and HAM models seems to be limited, and attempts at monetising existing assets, by way of allowing private concessionaires to collect tolls on such roads, has not been met with the expected fanfare among private equity firms, and other expected investors.

The new variant of the BOT model, therefore, has an uphill task. Even expected improvements, such as a possible reduction in the incidence of contractual disputes, the streamlining of termination payouts, and relief for subsequent changes in laws, may require external inducements to create the necessary uptick in project implementation.

Selecting the most appropriate investors and sponsors for the projects is one of the key factors in the success of the project, with bringing in long-term investors to match the risk profile of such projects being an important policy task. Whetting market appetite for financing by increasing the emphasis on ESG and sustainability-based project implementation, increasing the accuracy of traffic growth revenue projections by investment in detailed project preparation, by accounting and ascertaining the scope of revenue for carbon-credits by adopting practices to achieve green ratings for the project, may help in ensuring the continued viability and bankability of projects in India’s highway sector and help in raising funds toward eco-friendly infrastructure can help private companies to raise money for their ESG (environment, social and governance) related debt.

Inclusion of securitised green bonds (i.e., bonds backed by environmentally responsible projects, with the primary repayment source being the project revenue flows) as the preferred financing method in BOT projects may prove to ease funding requirements on NHAI as well as the concessionaires. Such SGBs would provide a pricing reference for the private sector entities in India for their rupee-denominated borrowing for ESG-linked debt. The envisaged transformation of the global economy to achieve net-zero emissions by 2050 require $9.2 trillion in annual average spending on physical assets, which is $3.5 trillion more than what is being spent today, and represents a crucial market opportunity for availing funding while expanding infrastructure development capabilities.

The identification of highway projects as ‘green’ projects can be done with the help of the 2021 Green Bond Principles, which are voluntary in nature, or state-identified projects which can contribute to the sustainable development of the region. A recent study by the Central Road Research Institute (CRRI) and the Energy and Resources Institute (TERI) has stated that the estimated expansion of national highways and construction of greenfield expressways in the past nine years has the potential to avoid over 32 million tonnes of carbon dioxide emission annually.

As is evident from the experience of operators in hitherto more developed green bond markets abroad, green bonds trade at a premium in comparison to conventional bonds (popularly termed the ‘green premium’, or ‘greenium’). The bond proceeds can further be supplemented through funds received from the sale of carbon certificates generated through the projects being financed by the fund. This alternate source of revenue to the fund will translate into further lower cost of funds for the fund manager and can also be leveraged for servicing of interests and/or funding of new projects being undertaken by the fund.

Road projects financed through these bond proceeds will not only help in bringing down the cost of debt servicing for these projects but will serve a dual purpose by taking India forward in achieving ambitious COP26 commitments for reducing projected carbon emissions by 1 billion tonnes by 2030 and net-zero carbon emissions by 2070, making the highways sector ‘sustainable’, both financially and ecologically.

This article was originally published in Business Today on 30 January 2024 Co-written by: Jatin Aneja, Partner; Suranjan Shukla, Senior Associate. Click here for original article

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