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Published : August 08, 2010 | Author : anupamshukla
Category : Miscellaneous | Total Views : 3032 | Unrated

Anupam Shukla BBA LLB Symbiosis Law School

Private Participation in Infrastructural Development: Emerging Trends

Good quality infrastructure has been the main enabler of high level of economic growth in any developed as well as developing country. Despite becoming the second fastest growing and the fourth largest economy of the world, India continues to face large gaps in the demand and supply of essential social and economic infrastructure and services. India’s global competitiveness is greatly affected by the lack of infrastructure, which is critical for improving productivity across all sectors of the economy.[2] Upgradation in transport, power and urban infrastructure is critical in sustaining India’s economic growth, along with improved quality of life, increase in employment opportunities and a step towards eradication of poverty.

In order to overcome these difficulties, the Government of India (GOI) is committed to raising investments in infrastructure from its existing level of below 5% of GDP to almost 9%. However, there is a huge gap between the amount of investments required and the GOI’s ability to raise funds. GOI’s borrowing power is restricted under the Fiscal Responsibility and Budgetary Management Act. This restriction limits the ability of the Government to finance as much as infrastructural development is required. Given the large resource requirements and the budgetary and borrowing constraints, GOI has responded to the challenge by promoting the idea of private sector investments and participation in all infrastructure sectors. GOI has formulated various policies to attract major public sector investment in these infrastructure sectors.

Public Private Partnership (PPP) across all key infrastructure sectors including Highways, Port, Power and Telecoms is considered to be a major step in achieving infrastructural growth in India. It will be the primary means by which GOI will seek to overcome the “Infrastructure Deficit”. The Approach Paper to the Eleventh plan states that “One has to reach out the private sector, and private savings, and to the other mechanisms available in the market today to raise market funds”[3].

The Government of India has defined PPPs as:
“A partnership between a public sector entity (sponsoring authority) and a private sector entity (a legal entity in which 51% or more of equity is with the private partner/s) for the creation and/or management of infrastructure for public purpose for a specified period of time (concession period) on commercial terms and in which the private partner has been procured through and open transparent system”.[4]
Public Private Partnerships (PPP) broadly refer to long term, contractual partnerships between the public and private sector agencies, specifically targeted towards financing, designing, implementing, and operating infrastructure facilities and services that were traditionally provided by the public sector. These ventures are based on the expertise and the capacity of the project partners which allocates resources, risks and returns on a mutually agreed basis. This approach of developing and operating public utilities and infrastructure by the public sector under terms and conditions agreeable to both the government and the private sector is called PPP or P3 or Private Sector Participation (PSP). The fundamental qualities of a PPP project can be summarized under the following heads:

1. Cooperative and Contractual Relationship
PPP emerges from a government-led planning and prioritization process. It symbolizes long term cooperation between the government and the private sector where the government’s role gets redefined as a facilitator and enabler, while the private partner plays the role of a financier, builder and operator of the service and facility. Government remains actively involved throughout the project’ life cycle by being ultimately accountable to service quality, price certainty and cost-effectiveness of the partnership.

2. Risk Transfer:
Potential risks which are associated with the projects are identified and are transferred to the respective parties which are best equipped to handle those risks. Overall risk to the public sector can be reduced by transferring those associated with design, construction and operation to the private partner.

3. Ownership
PPPs have a flexible ownership where the public body retains the ownership of the project or the facility which is developed depending upon the viability and expected returns in the project. In some cases, the private body may be contracted only to construct facilities or supply equipment, leaving the public body as owners, operators and maintainers of the service. In other instances, the public body may purchase those services from the private entity rather than owning and operating those assets to make it more cost-effective.

4. Dissimilarities from private entities

PPPs are fundamentally different from an outright private contract or a public entity. PPPs involve private management of public service through a long term contract between a private entity and a public authority whereas privatization involves outright sale of a public service or facility to the private sector. PPPs introduce competition in public service areas unlike privatization, which transforms public monopoly into a private one.

5. Finance
PPPs use a combination of public and private funds in order to finance the costs of infrastructure projects. The private sector raises capital funding for a project through equity and debt finance. These funds are raised either from the members of the public through user charges, or from the sale of the service to the public sector, or from a combination of the two.

PPP encourages private sector innovation by allowing the government to delegate responsibility to the private contractors for service design and construction. This enables the public body to identify the desired services, outcomes and outputs, while enabling the private party to innovate in search for the most appropriate solution to meet the requirements. PPPs are distinctly different from the traditional models of public procurement as they concentrate on delivering cost-effectiveness over the duration of the asset rather than achieving the lowest upfront costs associated with the infrastructure projects. Engaging in PPPs, private sector is provided with a wide range of business opportunities and can get involved in a broader spectrum of activities.

Variants Of Partnership Structure Under PPP
Certain elements like Design and Build, Finance, Ownership, Operation and Maintenance combine in various manners to provide a large number of partnership structures that can be opted depending upon the project to be undertaken by both the entities. Apart from these factors, the decision to choose a particular model is also affected by variants such as the nature of assets and facilities, the extent of participation of private sector, the level of Government’s control required and the ability of the consortium to provide the service needed.

The following are the different partnership structures that are associated with PPP:
A. Service Contracts:
Under a service contract, the government (public authority) hires a private company or entity by competitive bidding process to carry out one or more specified tasks or services for a period, typically 1 to 3 years. The public authority remains the primary provider of the infrastructure service and contracts out only portions of its operation to the private partner. The government pays the private partner a predetermined fee for the service, which may be based on a one-time fee, unit cost, or other basis. Hence, a contractor can increase its profit by reducing its operating costs, while meeting required service standards. These contracts provide a low risk option for expanding the role of the private sector which can be implemented in an efficient manner when service can be clearly defined in the contract, the level of demand is reasonably certain, and performance can be monitored easily. Repeated biddings involved in these projects maintain pressure on contractors to maintain low costs, while the low barriers to entry encourage participation in the competition. These contracts are unsuitable when the main objective of the project is to attract capital investment.

B. Management Contracts:

A management contract is an interim arrangement where the government contracts some or all of the management and operation of a public service to a private partner where the ultimate obligation for service provision remains in the public sector but the daily management control and authority is assigned to the private partner or contractor. The private contractor is paid a predetermined rate for labour and other anticipated operating costs in addition to a performance based payment. The government is responsible for setting the tariffs and acting as a provider of major capital investment for expanding the system whereas the private partner provides the funds for discrete activities specified in the contract and interact with the consumers. These contracts are normally of a duration between 2 to 5 years where the commercial risk is borne by the government. Private sector management leads to operational gains made without transferring the assets to the private sector and these contracts proved to be a relatively low cost affair compared to the more comprehensive contracts. However, the split between the obligation for service and management vested on the private partner and financing and expansion planning on the government is a complex affair which needs to be monitored properly in order to make this contract work in an efficient manner.

C. Lease Contracts:
Under a lease contract, the private partner is responsible for the service in its entirety and undertakes obligations relating to quality and service standards. Except for new and replacement investments, which remain the responsibility of the public authority, the operator provides the service at his expense and risk. The duration of the leasing contract is typically for 10 years and may be renewed for up to 20 years. Responsibility for service provision is transferred from the public sector to the private sector and the financial risk for operation and maintenance is borne entirely by the private sector operator. The operator is responsible for losses and for unpaid consumers' debts. Leases do not involve any sale of assets to the private sector. Under this arrangement, the initial establishment of the system is financed by the public authority and contracted to a private company for operation and maintenance. Part of the tariff is transferred to the public authority to service loans raised to finance extensions of the system. In India, lease contracts deal with operating container terminals at the seaport of Cochin which is usually of 8 years.[5] The key advantage of this option is that it provides incentives for the operator to achieve higher levels of efficiency and higher sales since the private partner’s profits depend on the utility’s sales and costs. The principal drawback is the risk of management reducing the level of maintenance on long-lived assets, particularly in the later years of the contract, in order to increase profits. The structuring of tariff levels is an important factor which needs to be considered since the contractor’s revenues are derived from the customer payments.

D. Concessions
A concession is a contract between the private sector operator (concessionaire) who is responsible for the full delivery of services in a specified area, including operation, maintenance, collection, management, and construction and rehabilitation of the system and the government who owns the assets during the concession period and is under an obligation to establish and ensure that the performance standards to be achieved by the concessionaire. In essence, the public sector’s role shifts from being the service provider to regulating the price and quality of service. The concessionaire collects the tariff from the system users established by the concession contract. In rare cases, the government may choose to provide financing support to help the concessionaire fund its capital expenditures. The concessionaire is responsible for any capital investments required to build, upgrade, or expand the system, and for financing those investments out of its resources and from the tariffs paid by the system users. The concessionaire is also responsible for working capital. A concession contract is typically valid for 25–30 years so that the operator has sufficient time to recover the capital invested and earn an appropriate return over the life of the concession. The public authority may contribute to the capital investment cost if necessary. This can be an investment “subsidy” (viability gap financing) to achieve commercial viability of the concession. Alternatively, the government can be compensated for its contribution by receiving a commensurate part of the tariff collected. Concession arrangement provides incentives to the operator to achieve improved levels of efficiency and effectiveness since gains in efficiency translate into increased profits and return to the concessionaire. The long term nature of the contract complicates the bidding process and contract design because it is difficult to anticipate events over a 25 year period. This drawback may be countered by allowing a periodic review of certain contract terms in the context of the evolving environment. Concession contracts provide limited competition since very few operators have the qualification for undertaking major infrastructure projects.

E. Joint Venture:
Joint ventures are alternatives to full privatization in which the infrastructure is co-owned and operated by the public sector and private operators by either forming a new company or assuming joint ownership of an existing company through a sale of shares to one or several private investors. Under the joint venture structure, both public and private partners have to be willing to invest in the company and share certain risks. The company should strive for good corporate governance in order to maintain independence from the government. This is important because the government is both part owner and regulator, and officials may be tempted to meddle in the company’s business to achieve political goals. On the other hand, the government can work to smooth political differences since it has an interest in the profitability and sustainability of the company. The joint venture structure is often accompanied by additional contracts (concessions or performance agreements) that specify the expectations of the company. It also takes some time to develop and allows the public and private partners considerable opportunity for dialogue and cooperation before the project is implemented. They signify the real partnership between the public and private sectors that match the advantages of the private sector with the social concerns and local knowledge of the public sector.

F. Build–Operate–Transfer and Similar Arrangements:

BOT and similar arrangements are a kind of specialized concession in which a private firm or consortium finances and develops a new infrastructure project or a major component of it according to performance standards set by the government. Under BOTs, the private partner provides the capital required to build the new facility. The private operator now owns the assets for a period set by contract which is sufficient to recover investment costs through user charges. At the end of the contract, the public sector assumes ownership with an option to assume operating responsibility, contract the operation responsibility to the developer, or award a new contract to a new partner. PPP initiatives in the road sector have largely been on the BOT basis. The policy framework for toll-based BOT projects was approved in 1997. In 2005, it was decided that all future projects under NHDP would be awarded only on BOT basis. Contracts based on BOT model are inherently considered superior to the traditional Engineering Procurement and Construction (EPC) contracts as BOT projects ensure higher quality of construction and maintenance of roads and completion of projects without cost and time overrun. There are many variations on the basic BOT structure including build–transfer–operate (BTO) where the transfer to the public owner takes place at the conclusion of construction rather than the end of the contract and build–own–operate (BOO) where the developer constructs and operates the facility without transferring ownership to the public sector. Under a Build-Own-Operate-Transfer (BOOT) contract, the private sector designs, builds and operates an asset where the asset is transferred after the conclusion of the operation contract. The questions of ownership and the timing of the transfer are generally determined by local law and financing conditions. With the design–build–finance–operate (DBFO) approach, the responsibilities for designing, building, financing, and operating are bundled together and transferred to private sector partners. The private sector develops and manages an asset with no obligation to transfer the ownership back to the government. BOT agreements significantly reduce the commercial risk borne by the private partner because there is only one customer i.e. the government.

PPPs arrangements comprise of a single contract drawn up between the public body and the private partner which covers all the elements involved in the project. The private partner could be a private company, a consortium or a non-governmental organization. Usually, in a PPP, private sector consortium comprises of contractors, maintenance companies, private investors and consulting firms. The consortium often forms a special company or “special purpose vehicle” (SPV). The SPV enters into a contract with the government and the subcontractors to build the facility and then maintain it. The SPV will sub-contract construction, operations and equipment supply to suitable service providers who may be the parent companies of the SPV and therefore, also equity investors in the project. Fund managers and financial institutions can also act as a source for the funds. Both the public body and the private sector consortium may decide to engage technical, legal and financial consultants to assist in structuring the tender or composing a viable PPP proposal. Financial advisors assist the public agencies in finding potential investors for a PPP project, clarifying the risk and responsibilities assumed by both public and private sectors, drafting payment mechanisms which offer optimum balance of risk, responsibility and reward to both partners, and review the tender proposals. General legal information on taxation, property, environmental, competition laws etc and drafting the tender documents and PPP contract are some of the services that the legal experts provide to both the parties. Technical advisors such as engineers, contractors, architects, surveyors provide expert opinion on evaluation of proposals and bids, conducting quality assurance tests during construction, assessment of technical risk and developing systems for monitoring performance.

Legal & Institutional Framework For PPPs
The GOI has launched several institutional initiatives for PPPs which are:
i. Committee on Infrastructure (COI):
This committee is chaired by the Prime Minister whose role is to formulate and implement policies which initiate structures that maximize the use of PPPs, oversee the progress of key infrastructure projects and promote the delivery of international-standard public services. The COI is supported by the Empowered Subcommittee, whose task is to review and approve policy papers and proposals for submission to the COI, as well as to follow up and oversee the implementation of its policies.

ii. Visibility Gap Fund (VGF):
The VGF is a special facility located with the Department of Economic Affairs (DEA) which supports state or central level PPP projects, although economically justifiable, are not commercially viable due to long gestation period or external economic factors with an upfront funding in the form of a capital grant up to 20 percent of the project cost. The sponsoring ministry or agency can provide an additional 20 percent of the total funding in certain circumstances. Roads, railways, airports, urban transport, infrastructure projects in SEZ are some of the sectors which are eligible for VGF support. The authority or government seeking for a grant should apply in a prescribed proforma to the PPP cell of the DEA. An Empowered Committee has been constituted for implementing the approval mechanism according to a given set of guidelines.

iii. India Infrastructure Finance Company Limited:
The IIFCL is an entirely government-owned company which provides long term finances for infrastructure projects that the banks are unable to support. It borrows money, guaranteed from GOI, from multilateral agencies and lends this to infrastructure projects, either directly or through the refinancing of long- term debt. The IIFCL is prepared to lend up to 20 percent of the total project cost. The lead bank would undertake all disbursement and recovery of capital. It monitors and evaluates the project’s compliance with agreed levels of performance for the purpose of disbursement of IIFCL funds. PPP project should adhere to certain criteria before it becomes eligible for IIFCL funding.

iv. India Infrastructure Project Development Fund:
The IIPDF has been established to provide the States and the Central ministries with financial support usually in the form of an interest free loan for the development of high quality PPP project. Costs involved in the development may include those of engaging consultants and transaction advisors .The loan covers up to 75 percent of the development expenses. The loan is then recovered from the successful bidder and if the bid fails, the loan is converted into a grant. When the sponsoring authority does not complete the bidding process, any money contributed would be returned to the IIPDF. The IIPDF is administered by the Empowered Institution whose function is to select development project for funding, and to establish terms and conditions under which finance will be provided and recovered. In examining applications for assistance, the Empowered Institution is supported by the PPP cell of the DEA.

Institutional Structure:
The institutional structure with Central government for appraising and approving PPP projects is made up of the following elements:
Ø Public Private Partnership Appraisal Committee (PPPAC), which is chaired by the Secretary of the DEA and also includes the Secretaries of the Planning Commission, the Department of Expenditure, the Department of Expenditure, the Department of Legal Affairs and the department sponsoring the project.

Ø DEA PPP Cell, which acts as the secretariat to the PPPAC and has the responsibility for dealing with VGF proposals and appraising PPP proposals in the central sector

Ø The Ministry of Finance, which has the task of examining the financial terms of concession agreements, making decision about extending guarantees, as well as assessing the risks associated with investment.

Ø A PPP Appraisal Unit (PPPAU), established under the auspices of the Planning Commission, which prepares appraisal notes for the PPPAC in order to provide specific suggestions for improvements in the concession terms.

Ø The Ministry of Law and Justice and the Department of Legal Affairs are also represented on the PPPAC, and ensure that all concession agreements are carefully scrutinized from a legal perspective.

Sectoral Regulations
Till date, there has not been any specific legislation to oversee PPP projects. But, sector specific legislations do exist in addition to central sector regulatory agencies in order to restructure industries. Some of the examples are as follows:

Ø National Highways Authority of India (NHAI):

This is the governmental body charged with implementing the National Highway Development Programme. The NHAI has developed and modified standard concession agreements, and developed innovative approaches to extending government approach to PPPs.

Ø Telecom Regulatory Authority of India (TRAI):

It is a regulatory agency which promotes the evolution of Indian telecom market from a Government owned monopoly to a multi-operator, multi-service, competitive market by implementing rules, regulations and directives.

Ø Ram Vikas Nigam Limited:

It is a special purpose vehicle which has been set up in the railway sector to develop and implement PPPs and mobilize resources.

Ø Central Regulatory Electricity Commission:

It is a regulatory authority which oversees the affairs in the power sector under the auspices of the Ministry of Power. In addition to it, each state has its own Electricity Regulatory Commission.

Ø Model Concession Agreement (MCA):

It is a regulatory framework which has been developed to identify the best practices in upgrading and maintaining highways and ports. These frameworks covers issues which are key to a successful PPP project, such as risk mitigation and allocation, symmetry of obligations between parties etc.

The current trend in the infrastructural development has highlighted the facilitating role played by the Government for increasing private participation in various sectors. Government has permitted 100% FDI under the automatic route for all road development projects. 100% tax exemption has been provided for 5 years and 30% relief for next 5 years, which may be availed of in 20 years. Reckoned against an investment level of Rs. 8,71,445 crore (USD 217.86 billion) anticipated to be achieved in the Tenth Plan period, the expected infrastructure investment in the Eleventh Plan based on sector-specific projections, would amount to Rs. 20,56,150 crore (USD 514.04 billion), which is 2.36 times the amount anticipated to be achieved during the Tenth Plan.[6]

In conclusion the need for massive infrastructural development is being managed by a sound collaborative effort from both the public and private spheres through this mutually viable partnership. Considering the adequacy of this form of arrangement vis a vis the economic scenario of India, Public Private Partnerships seems to be an effective solution.
[1] Tarun Patniak and Anupam Shukla, Vth Year BBA LLB, Symbiosis Law School Pune
[2] Department of Economic Affairs (DEA) Ministry of Finance, Government of India & Asian Development Bank (ADB)
[3] Planning Commission, June 2006, ‘”An Approach to the Eleventh Five Year Plan”
[4] Department of Economic Affairs, Ministry of Finance, Government of India, 2007a
[5] World Bank. 2006. Private Participation in Infrastructure database.
[6] Projections of Investment in Infrastructure, The Secretariat for the Committee on Infrastructure, Planning Commission, GoI

Authors contact info - articles The  author can be reached at: anupamshukla@legalserviceindia.com

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