Ever since India doubled its proposed infrastructure spending under the Twelfth Five Year Plan from US$500 billion to US$1 trillion, it has been clear that large-scale Chinese participation would be required for India to realise its aggressive infrastructure goals.
Despite this, the experience of Chinese engineering, procurement and construction (EPC) contractors in India has been far from rosy. Since most government construction contracts and large private contracts are awarded through a tendering process, the Chinese companies have had to pitch battle against deeply entrenched competitors that are familiar with the bewildering red tape that India’s bureaucracy is known for. In addition to this, most tenders in certain industries have historically evolved to favour a certain contractor, or those from a certain country. The murky lobbying process prevalent in India has thrown up certain shocking outcomes in terms of expensive and outdated technologies being preferred to more modern and efficient ones. All this has made it rather difficult for Chinese EPC contractors to gain a foothold in the Indian market.
However, a latest step taken by the Indian government to encourage private and foreign participation in national highway projects this year might be the panacea that Chinese EPC contractors have been waiting for.
On 21 June 2013, the Cabinet Committee on Economic Affairs (CCEA) approved a proposal to facilitate the unhindered substitution of a concessionaire in ongoing and completed national highway projects, after obtaining the consent of lenders and the National Highway Authority of India (NHAI). This scheme has been called the substitution of concessionaire in ongoing and completed national highway projects.
Under the scheme, the consortium members of existing concessionaires will be permitted to divest their entire equity stake in: i) projects that have achieved the appointed date (financial closure); and ii) projects to be bid out in future, as per the prescribed mechanism.
The decision has been prompted by the flagging interest among potential bidders to participate in highway projects on a public-private partnership (PPP) basis, and the difficulties that have been faced by such projects in achieving financial closure. The substitution of the concessionaire will have to be effected by the lenders after obtaining the consent of the NHAI. Additionally, the lead substituting entity will have to maintain a minimum equity stake of 51% in the concessionaire, post substitution.
The mechanism for substitution of the concessionaire, as specified by the CCEA is as follows:
- The concessionaire has to make a written representation to the lender’s representative, with a copy to the NHAI, requesting the lender’s representative to seek the NHAI’s consent for its substitution;
- The lender’s representative is then required to analyse the representation. If the lender’s representative is of the opinion that the substitution would be in the interest of the project, it shall make a relevant representation to the NHAI;
- Upon receipt of such representation, the NHAI will evaluate the credentials of the substituting entity and inform the lender’s representative and the concessionaire of its decision along with its reasons;
- Following communication of the NHAI’s decision, the lender’s representative, in consultation with the concessionaire, would invite, negotiate and procure offers through private negotiations, public auction or tenders, for effecting the takeover and transfer of the project highway along with the concession to the substituting entity. Such substitution should only be effected on the assumption of the aggregate liabilities and obligations of the concessionaire under both the concession agreement executed between the concessionaire and the NHAI, and the lender’s representative, under the financing agreements.
It is expected that the NHAI will issue a formal classificatory policy in relation to this substitution proposal. Prior to this decision, road developers, due to an inability to infuse equity, could not either raise fresh capital or recycle their development capital into new projects. The CCEA’s nod to the substitution proposal can certainly be seen go a step towards reviving investor interest in the highways sector.
Under this scheme, Chinese EPC contractors will be able to invest in road projects and then also participate as EPC contractors, thus earning two revenue streams – one as a return on their investment for the duration of the concession, and another as the contractor for undertaking EPC work.
For example, a road project of US$100 million might be financed with US$30 million equity and US$70 million debt. Let us assume an Indian company has come up with funds for the equity portion in order to obtain financial closure, and a Chinese company is interested in undertaking the EPC work for the project, which otherwise might have been undertaken by the Indian company or its associate companies. Under this scheme, the Chinese company will be able to purchase a 10-20% equity stake in the project from the Indian company to ease the Indian company’s financial burden.
This will mean an investment in the region of US$3-6 million for the Chinese company, and for the Indian company it will mean ability to invest these funds in another project. In return, let us assume the Indian company will agree to award 50% of the EPC work in the project to the Chinese company. Since the EPC value in a project of this size will be in the region of US$70 million, this will mean an EPC contract of around US$35 million for the Chinese company. The best aspect of this EPC contract will be that the Chinese company will not have to participate in any tender process, and can obtain the contract purely through private negotiations.
In other words, the Chinese company will have made an investment of US$3-6 million in the project, in order to obtain a contract of US$35 million. There are many ways to further optimise this process. For example, the Chinese company’s investment can be routed into a parent or holding company that is undertaking multiple projects through independent special purpose vehicles. In such a scenario, the Chinese company might be able to extract a much better investment-to-EPC ratio.
Santosh Pai and Raunak are partners at D H Law Associates. D H Law Associates is the only full-service Indian law firm with an active China practice since 2010
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