BOT Annuity method brings several advantages in the form of private capital, private sector efficiencies and transfer of risks. Yet, the model is not receiving enough attention until recently. Suresh Kumar says that in the government’s bid to achieve 50 per cent private participation in the current Plan, the Annuity model can achieve more projects at the same cost.The 12th Plan aims for increasing the total investment in infrastructure from 8 per cent of GDP in the base year to around 10 per cent of the GDP in the last year of the 12th Plan, the total investment estimated to be around Rs 45 lakh crore ($1 trillion) over the 12th Plan period. The share of private investment in this amount is expected to be around 50 per cent, significantly more than 30 per cent during the 11th Plan. Clearly, this quantum leap would require measures towards expanding, strengthening and increasing efficiency of the financing system which would meet the equity and debt needs of the private sector to enable it to bring the desirable level of investment in infrastructure. The Approach Paper to 12th Plan recognises this and outlines the steps required to enable this.Much of the private investment in infrastructure through public-private partnership (PPP) over the 11th Plan has been through projects wherein the private party recovers its construction and operations and maintenance (O&M) costs, and profit through the levy of user charges coupled with grants from the government wherever necessary, based on the viability of the project. This is the commonly alluded BOT-Toll model of delivery.However, not all the infrastructure projects or services are conducive to this model: In many cases, the user charges cannot be, or are not desirable to be, levied. The prime examples would be projects in following activities: • Rural or urban roads in areas where the tolling is not feasible or desirable; • Urban infrastructure including water, sewerage, and urban transport; • Education including building of schools; • Healthcare including building of hospitals; and • Rural infrastructure including agricultural Mandis (markets), storage facilities, etc.In all such cases, the choice is really between the traditional mode of procurement or a PPP arrangement that is structured in a way where the private investors recover their costs through a series of semi-annual payments made by the government over the concession period. This mode of delivery is called the BOT Annuity mode.The Finance Ministry data reveals that of the total investment through PPP over the 11th Plan period, only about 5 per cent came through the BOT Annuity mode. Also, a substantial share of projects—over 90 per cent—bid out on BOT Annuity have been in road and highways sector. The share of PPP in education and healthcare has been negligible. To reach anywhere closer to the targets for private investment in infrastructure during 12th Plan period, it would be incumbent upon the government to use the annuity model with equal initiative as the toll model in order to attract private investment in the more social of the sectors, such as education, healthcare, water, rural roads, agricultural infrastructure, etc.Issues against annuity modelThere are reasons that the BOT Annuity model has not been a model of choice for the policymakers. Indeed, the annuity model has been subjected to severe criticism vis-à-vis the more popular Toll model of procurement. The criticism has been largely on two grounds:(i) Non-transfer of risks: In case of BOT Toll projects, demand/market risk in addition to construction and maintenance risk is transferred to the concessionaire; whereas in the case of BOT Annuity Projects, only the construction and maintenance risk is transferred to the concessionaire, while the demand risk is retained by the government. Yet, annuity payments are assured through the government budgets. (ii) No mobilisation of additional resources: BOT Toll projects, based on user charges, lead to mobilisation of additional resources while BOT Annuity projects are to be funded through the government payment only which are deferred. Thus, these do not lead to generation of additional resources.The above criticism is valid, and there is no gain saying the fact that bankable projects that can be structured on BOT Toll basis should be done on BOT Toll basis. The argument here is not to somehow bring Toll projects under the Annuity model, but to take advantage of Annuity-based procurement when a project warrants one. The Annuity method brings advantages in the form of private capital, private sector efficiencies, transfer of risks, etc, which traditional method is not able to offer.BOT Annuity versus traditional procurementAs against the traditional method of procurement, BOT Annuity model has been subjected to criticism along the following dimensions:(i) Higher cost of financing: The cost of financing a project by conventional procurement will inevitably be lower than the cost of private finance; the government can borrow at a much lower rate than can a private sector entity. (ii) Inflexibility of future projects: Annuity contracts are longer term in nature, and so the annuities are committed for periods of 15-20 years. The flexibility of the government to direct the resources toward new projects is reduced to the extent of annuities committed.Case for BOT AnnuityAlthough the above criticism seems to be valid at face value, rejecting the Annuity model on these grounds could turn out to be myopic. The case for Annuity model needs to be considered on a holistic perspective, taking into account several benefits that these contracts offer over the traditional mode of procurement:(i) Better value for money: Given that the cost of private finance will be higher than the cost of government borrowings, the economic case for the Annuity model rests on achieving better value for money either through cost savings in the management of the project—including more efficient recognition of lifetime costs and risks—or through the delivery of a qualitatively superior product. Experience in the UK and several other countries has shown that despite higher cost of finance, projects done on Annuity have delivered value for money. Life cycle costing of a project including development cost, construction cost, cost relating to overrun and time delays, financing cost, etc, reveals this fact. The general assumption is that the government’s borrowing cost is less than that of the private sector, and therefore the project should be executed by the government. However, a value for money analysis shows that the savings in terms of finance cost is far less than cost relating to overrun and time delays when the government executes the project—not to mention the quality and efficiency in services brought in by the private player and more importantly, the risks offloaded from the government.We must also see this in light of the fact that significant cost overruns ensue because a significant proportion of the projects traditionally procured are delayed. A high proportion of these projects end up in court cases with contractors. According to the data released by Ministry of Statistics and Programme Implementation, about 40 per cent of the projects were facing delays ranging between a few months to as long as 17 years. Total cost overrun on 583 projects from diverse sectors is estimated to be around Rs 1 lakh crore.(ii) Transfer of risks: The higher cost of finance in case of Annuity projects reflects the risks carried by the private sector which otherwise would fall on the government. The private sector aims to make up for higher borrowing costs by taking on the construction and maintenance risks and also shields the government from any inflationary impact on account of these. In the traditional mode of procurement, these risks remain with the government and, invariably the costs escalate owing to frequent changes in specifications, and time overruns offset the gains that could have accrue to government on account of lower cost of borrowings.(iii) Time and budget: As compared to projects subjected to the traditional methods, projects on Annuity are more likely to be on time and on budget. This is because the efficiencies of private sector management are reputedly higher, and because additional due diligence is provided on behalf of the lenders, whose interests are aligned with the on-time and on-budget performance of the project. Since the annuity payments to the concessionaire do not start until after the completion of the project, they are bound to apply additional rigour in planning and execution so that more projects are on time and within the budget.(iv) Ring-fencing maintenance: Infrastructure assets created through traditional modes of procurement, in general, suffer from lack of maintenance. The contractors constructing the assets under the traditional method would have no further involvement with the asset. So there is no incentive to construct an asset that will require minimum maintenance. Therefore, the responsibility for maintenance of the asset falls on the public utility and in the absence of ring-fencing of maintenance, and during the budget cuts, it is the maintenance of the assets which suffers the most. On the other hand, assets created through BOT Annuity mode would, in a way, ring-fence the maintenance for the length of the concession period which could be anywhere between 15 and 25 years. If agreed upon before the project’s commencement, the concessionaire would be more motivated to construct the asset of a quality in such a way as to require minimum maintenance.Experience in other countriesThere have not been enough projects in India under BOT Annuity to enable collection of empirical evidence of the benefits. In the absence of data, the comparison of BOT Annuity model and the traditional model of procurement encourages assertions rather than analyses. In several real situations, however, the choice is often between a project bid out on Annuity or no project at all, thus making such a comparison only a theoretical exercise. In such situations, it would be useful to look at experience in other countries which have used this model extensively and look for broad indications and directions from their experience with this model.Internationally, the UK has been using a fair share of BOT Annuity model, popularly called the Private Finance Initiative (PFI), to award projects in sectors like education, healthcare and transport. From 1997 through 2009, about 800 PFI projects were undertaken, with a total capital value of 64 billion (about Rs 448,000 crore). The share of PFI investment was particularly high in the soft infrastructure projects: Nearly 70 per cent of the new hospital schemes and almost 60 per cent of new school buildings were delivered through PFI.In June 2009, a review was made of PFI projects and the resultant off balance sheet debt they had accumulated, considering that the PFP deals were largely off balance sheets of public sector as per the practice followed by UK GAAP. The report of the Economic Affairs Committee (EAC) in 2010 recommended in favour of continuing with the PFI model, albeit with some safeguards.The benefits found by the EAC were:• On time and on budget finish, • Significant risk transfer, • Better maintenance, • Innovation, • Lesser workforce issues, • Better pricing (competition/ bidding).Annuity model for soft infraOf the projects bid out on BOT Annuity model in India, more than 90 per cent are from the roads and highways sector. Until 2009, the policy on how the mode of procurement would be adopted followed a waterfall approach, meaning that all the PPP Projects were first to be bid out on BOT Toll basis, and on failure, to be bid out on BOT Annuity basis and if this also failed, then these were to be taken under Engineering, Procurement and Construction (EPC) or the traditional mode of procurement. This meant that the process took several months, and also, since the preferred mode of bidding remained BOT Toll, only projects that seemed more executable on BOT Toll were taken up.The BK Chaturvedi Committee, constituted to resolve procedural impediments and financing needs of the road sector, recommended in late 2009 that all the three modes of delivery, BOT Toll, BOT Annuity and EPC should be carried out concurrently rather than sequentially. This meant that the roads below a certain threshold of traffic would not merit testing on BOT Toll and could be implemented directly on BOT Annuity basis instead of testing it first on BOT Toll basis. However, projects were compulsorily tested first on BOT Annuity basis before resorting to EPC. Projects would be awarded on EPC basis only in case bids received on Annuity were unacceptable (such as those leading to over 18 per cent IRR on equity, and over 21 per cent IRR on equity in cases of difficult projects).The Ministry of Finance’s Draft PPP Policy in 2011 says, “In sectors/projects not amenable for sizeable cost recovery through user charges owing to socio-political-affordability conside-rations, such as in rural, urban, health and education sectors, the government harnesses private sector efficiencies through contracts based on availability/performance payments. Implementing Annuity model will require necessary framework conditions such as payment guarantee mechanism by means of making available multi-year budgetary support, a dedicated fund, letter of credit etc. Government may consider setting up a separate window of assistance for encouraging annuity based PPP projects. A variant of this approach could be to make a larger upfront payment (say 40 per cent of project cost) during the construction period.”This is evidence of a shift in the policy towards BOT Annuity model considering the advantages and the useful role this model could play especially in sector like education, healthcare and water. In addition, a significant length of National Highways in the country is still single lane, and can be developed into two-lane highways using BOT Annuity.To further pave the way for a larger number of Annuity contracts, an Inter-ministerial Task Force, chaired by BK Chaturvedi, was set up in late 2010 to recommend some ceiling on the Annuity commitments which could be taken up under PPP, as these commitments pre-empt future annual budgets. The Task Force has recommended apportioning of the annuity payments across Plan and non-Plan outlays in the government budgets, and prescribed ceilings relating to maximum annuity commitments as a proportion of Annual Budgets of the concerned department or scheme:A closer scrutiny of these ceilings reveal a very cautious approach being adopted towards BOT Annuity projects in the name of ensuring greater flexibility in allocation of resources in future budgets. While use of BOT Annuity restricts the freedom to allocate budgetary resources for future projects, it also enables governments to take up around four to five times more number of projects than are possible under traditional procurements, with the same level of financial resources at its disposal, thus significantly enhancing the pace of infrastructure development.ConclusionThe 12th Plan amounting to $1 trillion would require significant expansion of the financial system to create avenues for raising equity and debt finance for private sector. Education, healthcare, urban and rural roads, water and rural infrastructure may not be subject to levy of user charges and thus the government will need creative solutions to attract private sector investment in these sectors. Encouraging the use of BOT Annuity model of procurement has the potential to spur private investment in these sectors and thereby fast-track the pace of infrastructure development.The author is Director – Strategic Initiatives at Feedback Infrastructure Services Pvt Ltd. With inputs from Abhishek Kapoor from the same organisation.