According to the report, using the LVPR wil transfer the traffic risk from the operator to the user of the facility. Unlike other sectors like telecom and power, the road operator cannot influence traffic to use his facility. Private sector investors, especially companies such as Renong Corporation have been keen on the government giving a traffic guarantee. Experts too have often called for allocating risk to the agency that can manage that risk.

Currently however, the bidding process is based on capital subsidy asked for by the operator from the government. The tenor of the concession agreement is also fixed at 20 years. In fact, for the Jaipur-Kishanganjsection, where the model concession agreement in being negotiated, the government is saying the volume of traffic justifies six-laning, while the bidders are still unconvinced.

Also, if they do not exercise the option of sixlaning after seven years, the tenor of their four-laning project automatically gets reduced to nine years. Left holding the traffic risk, private operators have refused to accept these conditions. The IDFC report, which has looked at feasible options has highlighted some of the drawbacks of a fixed tenor system. One of the major problems is that it creates unacceptable risk for the concession holder, if traffic projections do not materialise (except in the case of the Atlanta Constructions promoted Udaipur bypass, traffic projection have proved to be over-optimistic, and resistance to toll and been underestimated).

The high risk associated with traffic projections also implies high risk premium, which IDFC estimates to be almost 30 per cent of the investment cost. For lenders theimplication is that the high risk forces promoters to ask for government debt guarantees or minimum toll guarantee. In such cases there is no incentive for lender to monitor projects well.

IDFC has recommended an LPVR auction, as they feel that this would link duration of the concession to demand for the facility. Under the LPVR, the bidder with the least LPVR gets the concession, which ends when current present value equals the amount bid. This method essentially ensures that the private contractor does not lose if there is long term demand for the facility, but it is not realised during the concession period.

The operator therefore gets to keep the facility until such time that he recovers his investment. If traffic is more than projected, he hands over the road earlier, and if less, he gets to keep the facility till he makes his money.

One of the biggest advantages is that with the concession period being flexible, the tolls can be kept low, benefiting users, and reducing protest risk and tollresistance. IDFC's report has however warned that the ministry and the National Highway's Authority of India (NHAI), would have to develop two capabilities before adopting the LPVR.

Since the method aims at minimising construction cost, there could be a tendency on part of the operator to lower quality standards. Credible mechanisms to monitor this would have to be put in place. Also the lenght of the concession period is determined by cash flows. The operator could therefore under-report revenue earnings. The regulator would need to put in place a random audit mechanism.

The IDFC report has recommended the LPVR method for bidding as the government is not in a position to give traffic guarantees. In fact earlier offers by the Malaysian government and Renong Corporation to construct highways had to be abandoned as the ministry was unable to give a traffic guarantee. The finance ministry has also refused to consider government guarantees for traffic in the past.

Sensible Suggestions

Given thelimited options faced by the government and the road operators in financing road construction the suggestion by the IDFC does make sense. The conventional financing structure does put a strain on the operator in terms of inflexibility in duration of the concession.

The suggested structure will enable potential operators to structure the project, including pricing and the extent of leverage, keeping various factors such as their cost of funds in mind. However, what is unlikely to change is the traffic risk which cannot shift from the road operator.