VIEWPOINT

After spectrum, why not auction roads?

Posted on October 5, 2010 | Author: Srivatsa Krishna | View 679 | Comment : 15

We need to radically overhaul the existing, abused system of selecting concessionaries to build roads and the best way forward is to adopt bidding for present value of revenue.

artical Picture

India, advised prudently by Dot Econ, one of the world’s foremost auction theorists, conducted one of the most successful global auctions of spectrum which got the treasury $15 billion recently.

One of the questions that begs an answer is that if we can auction one kind of a limited national resource aka spectrum, why not another, namely roads?

If yes, how should such an auction be designed and what objectives should it seek to achieve?

India needs world-class highways and needs them quickly.

China has built 55,000 miles of highways in roughly half the time, about 11 years, that the US took to build its own similar network, whereas India can barely boast of about 12,000 km of world-class highways even 10 years after the start of the National Highways Development Programme (NHDP).

Private participation in highways is essential for three primary reasons.

First, to bring in capital, which the government is quite significantly short of.

Second, to bring in execution excellence by completing roads on time and within budget, which the government does not do very well. Third, to bring world-class quality in highway design and construction.
    
The puzzle is how to align the incentives of the developer to achieve these three objectives.

Developers in practice usually get into the bid at any cost, thereafter goldplate the costs and overinvoice to pull out about 15-20% upfront to recover their equity, then buy land around the proposed exits to be able to get windfall gains and finally renegotiate to get even further substantial gains, all at the expense of the taxpayer.

They also sometimes indulge in quality shading so as to be able to cut costs and increase the project IRR (internal rate of return).

In India, there is a permanent expectation on part of the concessionaire and the concensionee to renegotiate to give and take huge bribes at every step and thus the bids happen at unrealistic, artificially low tolls.
    
Thus, the taxpayer gets expensive, poor or uneven quality roads, and with fixedterm concessions where either the toll or the concession period is fixed, the gains from privatisation are easily squandered by opportunism and renegotiation.

Most private infrastructure concession contracts are renegotiated. Thus, the auction design has to be such that it prevents opportunism and renegotiation.
    
The often-adapted solution is one what is called a Demsetz auction where firms compete for the field rather than competing in the field through a process that mimics competition.

In other words, a government which wants to purchase a service or an asset such as a good quality road, they will bid and award it to the lowest bidder, which is the classic Demsetz auction or competing ‘for’ the field.

The other option is to award it to two agents and then allow them to compete ‘in’ the field’.

However, what this article proposes is a third method, which is in some ways a variant of this classical method.
    
The government is said to be contemplating a system based on a new index like the IRR and doing away with the annuity model altogether.

While the latter would be welcome, for the fiscal burden it imposes on the government is also a ‘cost’ to be added to that of the highways itself, the former is subject to debate.

It should frankly not be the government’s concern what IRR a developer gets. The concept of a cut-off IRR after which a project is considered unviable doesn’t take care of the key issues that hold up highways from coming up mentioned above.

Instead of making developers compete with one another in bringing down the IRR that gets actually selected, they should be made to bid on the basis of a present value of revenue (PVR) method based on the present value each bidder expects to earn from the project and this would minimise, if not eliminate, opportunistic renegotiation of the contract.

How it happens is as follows.
    
The authority would simply set a maximum toll and specify quality standards and monitoring specifications for toll equipment, not done at all today.

For instance, there are electronic logs available that show road availability and actual number of vehicles plying at any point in time in almost every new toll road in the world.

Thus, if a road is down for maintenance or if there’s accident on a road, the cameras time stamp it and stream it to logs which capture the downtime based on which penalty is imposed on the operator.
    
In response to the pre-announced toll schedule information instead of bidding on a toll as is usually the case, bidders will announce the present value of tolls for each package.

The concession would be won by the firm bidding for the least present value of toll revenue (and not the least IRR).

What sets apart the PVR method is that the concession will come to an end when the present value of toll revenue is reached and more importantly, each firm’s bid reveals the revenue required to earn what can be called a ‘normal profit’ and thus reduces post-contract negotiations.

Under the PVR method, while the concessionaire will still bearing the risk, he will not have the incentive to renegotiate windfall gains at the expense of the taxpayer nor would he make losses, considering the long-run demand.
    
We would typically expect the least PVR chosen to be below the reserve IRR (can be 18% and 21% as per Chaturvedi Committee's report), just as in the 3G auctions, the price for bandwidth was sold was substantially about the reserve price fixed by the government.

What is also important is the discount rate used to calculate PVR, which should ideally be as close to the weighted average cost of capital and should be specified in the bid document itself.

Lastly, the concession period can be readjusted based on measured actual demand, allowing flexibility to the government to adapt to poor or good traffic.
    
The global experience in highway concessions reveals clearly that a fixed contract based on either a fixed toll or duration has only led to renegotiation where often the best-connected firm, and not the best firm, wins and opportunism is rampant at a huge cost to the taxpayer.

Evidence from the UK and China reveals that when developers compete for the field instead of competing in the field, then it mimics competition in a natural monopoly and aligns developers interest with that of the citizens and more importantly, reduces the onus on the government to be vigilant which it often is unable to perform diligently, either by accident or by design.
   

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Comments (15)

  • Yes, One must ensure the quality of road / contracts must be inclusive of maintainace. Same must be for other public services including transport, water supply, electricity etc should be given to private sector to be able to give quality to the massess.

    Posted by Vivek Ambalkar | 20 Oct, 2010

  • Yes we need to ensure that we are able to give quality. Not only roads but all public services including transport water electricity etc should be given to private sector to be able to give quality to the massess

    Posted by Krishna Pande,Director International Affairs at Teerthanker Mahaveer University|11 Oct, 2010

  • If we talk of Delhi as on 10/10/10 where one of the prestigious games are happening, Roads are in pathetic conditions.
    Can one imagine New Cars tyres asking for change in 30000 kms.This was maintaining the Roads???
    Here MCD /NDMC is sitting like a ...
    ...See More

    Posted by Par Banga , CEO at BWellnss | 10 Oct, 2010

  • All roads (means) to construction / repair of road are blocked in India as 99 % officials and political people are either corrupt of does not want to do a specified work for which they have been given responsibility. There is no system which can make a man do a job. Our people are cheats. They always want more for less or nothing spent. Hence I dont see auction of roads will improve the condition of roads. We are not honest to our company, our self and last but not the least to our country. We will want all the contracts but will not not want any expenses to be made. Good day

    Posted by ejaz ahmed | 10 Oct, 2010

  • The road networks built by government agencies or local bodies has now become a decorative item. Many of the roads do not lost for even one or two rainy seasons. As a Highway Engineer (post gradute Highway & Traffic engineering, IIT Kharagpur 1989), I see and know that quality control exercised is absolutely rubbish. Even quality control consultants from very good Institutes have no option but to except the bribe and keep mum.
    The qualities and test on the road stones , which is the most important ingradient of construction , is plainly neglected.
    If this give and take relation continues for long , India's Development is going to suffer a lot. I request those taker to please take but ask them to lay a very good quality road network.
    ...See More

    Posted by Anuj Kumar sharma | 07 Oct, 2010

  • Implementation is the key and India suffers from government delays in implementing. Important road projects like Vadodara – Bharuch section (NH 08) has even got one of the highest negative grants for development in which funds were given to the government by the concessionaire.
    Changing the format would take another 3 years as all the stake holders will have to be involved, educated and legal drafted agreement prepared.
    India should plan for 2030 and upgrade according rather than making single road double and double road four tracks. New technology, integration and flexibility should be given importance to add more value.



    Posted by Surendra Sharma,Shipping and logistics at Consultant|07 Oct, 2010

  • The auctioning off of primary roads has been practiced in Europe for the past 30+ years.
    Dublin, Ireland has auctioned off some bridges and primary roads circling Dublin.
    France has auctioned off 4 major auto routes over the past 40+ years. In France these are competitive bids over seen by the French Government. The bidding vendors must meet the French Gov'ts RFI, RFP Transporation Business Model. These private sector French bids are Thirty (30) Year bids, with a 30 year renewable contract, based upon the peformance of the Independent Corp bidder meeting the French Gov'ts Contractural SLA's, KPI's, Scheduled Highway, HW, SW Mainteance, Upgrades, meeting pre-determined demographic generated Toll Collections, ROI's, ROA's Targets, insuring positive cash flows to the 4 Auto ...See More

    Posted by GERARD LA,PRES/CEO at Wexford Systems,LLC.|06 Oct, 2010

  • good roads are really the basic need for the sucess of the grwoth of any country.Unfortunately ,even after so many years of indepence ,road conditions are subject of concern.Except few states ,all states connecting roads are not upto the world class .Even on the national highways ,big pot holes are observed.The suggestion for outsoucing the construction of highways will be in interest of our nation.it will certainly fasten our growth .

    Posted by Bijay Shanker Tiwari | 06 Oct, 2010

  • This idea is worth to be given a try. CWG mess is refresh in our minds. But I am not sure that we we cab deliver quality construction highways. First we lack advance planning which should be atleast for 50 years ahead . Second We do not have accountability system. Third our present system is encouraging under hand dealings which leads to corruption. For that matter check any govt ofiice contract awarding system. Our just have a pep talk with bidding contactors who will give first hand information.Out rightly he keeps 40% of amount for offering to dealing officers and in remaining 60% he has to earn his living as well and some of his own amount get blocked for few months for which he tries to earn interest as well. so hardly 35-40 % contract money is used for actual work.
    2 G ...See More

    Posted by SK Raina | 06 Oct, 2010

  • Auction of bandwidth is not comparable with awarding the Highway project. A consumer would always have the option to select the best price, quality of service available out of the service provided by multiple bandwidth owners creating a competitive environment and built in checks on quality and price by the consumers’ choice.
    However the same mechanism cannot be extended to Highways which creates monopolies and only check on price and quality is thru government control and monitoring using an authoritative control creating a potential for free market for authority (corruption). Gross mismanagement of expressways in terms of the loss of public time to enforce artificial excludability by a private monopolist in an otherwise non excludable public good club good) for private profit ...See More

    Posted by RAJIV KHANNA,DIRECTOR at HELLMANN WORLWIDE LOGISTICS|05 Oct, 2010

  • Welcome, This is the need of the time. It will definately give private contractors to do the best without compromising the quality and avoid corruption.People will get hassel free well maintained road.

    Posted by Probir Kumar Roy Chowdhury | 05 Oct, 2010

  • Wonderfu what a great thought & an innovative idea. This will give wonderful opportunity for private players in govenment authority area & help strengthened R&D of private players and not just remain contractors.

    Posted by NIRANJAN | 05 Oct, 2010

  • You go by anyway
    the politicians will take there bribe from contractor anyway,With the name of politicians others also getting their part of bribe.Those who will not pay bribes are getting notices and penalties for approvals and completion and delay's ,until they will not pay bribe.

    Posted by Mahendrasing | 05 Oct, 2010

  • I truly am in the favor of the above. I wish the law makers and those in the exexution capacity should understand this and for once, keep the interest of the country and its citizens before then their personal interests. I believe, inviting privare players on a BOT method can also be an option.

    Posted by Sameer Goyal | 05 Oct, 2010

  • There is widespread agreement that most developing
    countries urgently need massive highway
    construction programs. Traditionally, highways
    ...See More

    Posted by kumar.subramanian. chandran,senior sales manager at First Flight Couriers Limited|05 Oct, 2010

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