>>roads & bridges

Highway Toll Indexation

Does it need a relook?
By Indranil Bose and Shreyoshi Saha

T
he National Highway Development Prog-
ramme (NHDP) was introduced in 1998
and provided a new trajectory for road
development in India. In the initial phases of
the NHDP, public funding was the default
mode, till public-private partnerships (PPPs)
took centre stage with the approval of the
model concession agreement for PPPs in
2006. So far, the National Highways Authority
of India (NHAI) has successfully awarded more
than 250 PPP projects covering around 24,000
km of national highways in the country.
The NHAI toll policy of 2008 – National High-
ways Fee (Determination of Rates and Collec-
tion) Rules, 2008 – governs tolling on national
highways. The policy enables NHAI to collect
user fees from different categories of highway
users. The toll rates are indexed to the whole-
sale price index (WPI) inflation to account for
changes in prices and are revised annually. How-
ever, such a revision in toll rates is restricted to
only a 40 per cent increase in WPI plus a base
rate which is revised annually without com-
pounding. In 2015, the WPI inflation turned neg-
ative (-3 per cent) for the first time during 2006-
16 and triggered pessimism amongst highway
developers owing to declining growth in toll rev-
enues. Negative WPI resulted in declining toll
revenue collections for highway developers mak-
ing it difficult for them to manage project cash
flows and debt servicing requirements. There
was a growing belief among the developer fra-
the developers the right to claim compensation
for such losses. However, the logic of such rep-
resentations is debatable and needs to be
weighed on appropriate economic principles.
Undoubtedly, WPI indexation has many
challenges. It has been acknowledged by sev-
eral leading economists and the government
from time to time that such an index results in
the underestimation of inflation at the whole-
sale level mainly due to the non-inclusion of
the service sector, where services contribute
60 per cent to India’s GDP. The base year for
WPI estimation is 2004-05, making the index
non-reflective of changing times and con-
sumption patterns in India. The weightage of
certain commodities which form part of the
WPI such as crude oil and primary articles like
minerals, metals and agricultural commodities
(cotton) are highly susceptible to external com-
modity and oil price shocks.
Based on industry norms, the break-up of
operation and maintenance (O&M) costs for
highways is approximately 80 per cent for mate-
rial, machine and labour and the balance 20 per
cent cost is on account of employee salaries and
WPI and CPI movements in the last decade (2007-16) (%)
2009 – Subprime crisis and negative
pressure on demand and wholesale
prices with sticky retail prices
12
11
9
10
other administrative expenses. The primary
inputs forming part of the maintenance cost of
highways get affected by WPI inflation; however,
inputs like labour cost, employee salaries and
other administrative costs typically get affected
by consumer price index (CPI) inflation.
Inflationary trends
Supply-side pressures are better represented
through WPI inflation and demand-side pres-
sures through CPI inflation. Global demand fluc-
tuations have an instantaneous bearing on WPI
inflation unlike CPI inflation which tends to
remain sticky in the short term due to stickiness
in the revision of any contracts. So far, RBI’s
efforts have been towards containing WPI infla-
tion, as it was conventionally considered a better
indicator. In 2011, with the introduction of the
new CPI series, there has been a gradual shift in
RBI’s focus from WPI to CPI, which is more rep-
resentative of the Indian consumption basket.
WPI inflation, post the global financial melt-
down in 2008, declined drastically from 9 per
cent to 2 per cent in 2009; however, retail CPI
inflation remained sticky at higher levels from 8
2011 – Lagged meltdown effect and
expansionary monetary policy on retail prices
2015 – Softening global demand,
declining commodity prices, lower
inflation expectations, expansionary
10
10
9 monetary policy

ternity that a negative WPI inflation rate is pri- 8 8

6 6 7 2015 – New CPI series with base
marily on account of the change in the monetary 8 changed from 2010 to 2012

policy, as initiated by the Reserve Bank of India 2011 – Composite CPI with 4 4
5 5
(RBI) in consultation with the Ministry of Finance 2011 – Base change
in WPI inflation from
2010 as base moving from
disaggregated CPI indices
in early 2014. Many developers made a repre- 2
1993-94 to 2004-05 with different bases 1

sentation to the government that declining toll

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
revenues owing to the negative WPI is a clear
case of “change in law” as per the provisions of Source: RBI WPI inflation CPI inflation -3
the signed concession agreements, thus, giving

2 ❘ Indian Infrastructure ❘ March 2017


per cent to 11 per cent during the same period.
Gradually, in 2011, the lagged impact of the
global financial meltdown affected retail prices
as well, which declined from 12 per cent in 2010
to 8 per cent in 2011. This period also witnessed
a gradual correction in wholesale prices making
it the only year in the decade 2006-16, when
wholesale prices were higher than retail prices.
Post 2011, WPI inflation witnessed a con-
sistent decline from 9 per cent to negative 3
per cent in 2015, whereas CPI inflation de-
clined from 8 per cent to 5 per cent during the
same period, thus increasing the divergence
between the CPI and the WPI. Also, during this
period, the CPI base year was changed twice
with modifications in CPI composition. On the
other hand, barring basic changes, WPI infla-
tion did not witness such drastic changes in
composition during the period.
WPI and CPI inflation indices are correlated,
albeit with a lagged effect on each other. The
RBI-appointed Urjit Patel Committee’s report
highlighted (pp. 14 and 74, Annexure 1, Urjit
Patel Committee Report, 2014) the circular im-
pact of components of the WPI and CPI on each
other. Certain categories (like food and fuel) in
the WPI and CPI have commonalities and to that
extent affect each other. The food basket consti-
tutes a 26 per cent weightage in the WPI as
compared to 46 per cent in the CPI and the fuel
basket constitutes 16 per cent in the WPI as
compared to 7 per cent in the CPI, highlighting
that the 42 per cent weightage in the WPI and
53 per cent in the CPI will have a bearing on
each other. Non-food and non-fuel components
in both the indices have been empirically found
to have the least impact on each other. However,
despite the correlation between the WPI and the
CPI, there are a multitude of factors that have an
instantaneous bearing on the WPI, making it
rather vulnerable and may have a lagged and
diffused effect on the CPI.
Inflation causation
Although the WPI and CPI are correlated, sev-
eral factors have a greater impact on one index
as compared to the other. Some emanate from
the domestic market while others are a result
of global trade conditions. A number of these
Movement in crude oil and retail petrol price in India (Rs per litre)3
80.0
70.0
60.0
50.0 44.7 44.0
46.4
40.7
40.0
30.0
20.0
20.1
24.1
15.5 17.8
10.0
0.0
2005-06 2006-07 2007-08 2008-09
Retail price of petrol, India (Rs per litre)
Source: PPAC Statistics
factors led to declining WPI inflation in 2015.
WPI constitutes primary inputs like crude oil,
heavily traded commodities like agricultural
commodities (like wheat, cotton) and mineral-
based products (like copper) and manufactured
products using these inputs. Global price move-
ments in these commodities can send a price
shock to wholesale price inflation immediately.
The softening of global crude oil prices, mineral
prices (like copper), agricultural commodity
prices (like that of cotton) from 2014 onwards
has had an impact of decreasing the price of pri-
mary articles and manufactured products,
thereby resulting in WPI disinflation till 2016.
(Disinflation is declining inflation, which is still
positive. Deflation is negative inflation.)
Other factors such as global merchandise
trade flows (both import and export) reflect the
demand conditions in trading countries like the
US, the UK, the UAE, China and Canada. Soft-
ening trade flows get reflected in declining de-
mand witnessed in all these countries between
2013 and 2015 exerting negative pressure on
the global prices of tradable goods, thereby
impacting the WPI and CPI. These countries wit-
nessed a rapidly declining WPI as against the
CPI. On the other hand, inflationary expectations
of consumers have a significant contribution
towards keeping CPI inflation sticky unlike their
impact on the WPI, which is rather weak. It has
been observed that in 2015 the three-month-
ahead mean CPI inflationary expectations have
remained sticky at elevated levels at a time
roads & bridges<<
68.8 69.8 66.4
64.7 61.6 62.5
52.7
44.4
37.0
40.1
33.7 32.4
20.8
24.4
19.0 18.3
2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17
Wholesale price, Indian basket of Brent crude (Rs per litre)
when the WPI declined drastically, eventually
becoming negative. Factors like positive growth
in the reserve money supply and declining call
rate trends have shown a similar trend in CPI in-
flation, however, WPI inflation has declined dras-
tically indicating that several other factors have
a bearing on the WPI as compared to the CPI.
RBI’s nominal anchor
Typically, RBI uses tools like open market oper-
ations, foreign exchange sterilisation and policy
rates to control inflation. The WPI inflation rate
has conventionally been the reference inflation
rate for any indicative targeting by RBI, mainly
because the frequency of WPI inflation data as
compared to the CPI was higher whereas CPI
data had greater lag in its release, thus losing
relevance. Also, the WPI was more representa-
tive of the entire population as compared to the
CPI in the pre-2011 phase.
In 2014, a report was submitted by the
Urjit Patel Committee to revise and strengthen
the monetary policy framework. The report indi-
cated a move from a multiple indicator app-
roach to a single nominal anchor giving credi-
bility to RBI’s monetary policy with a focus on
price stability. It suggested that inflation target-
ing be adopted formally and retail inflation be
selected as the nominal anchor. Inflation tar-
geting reduces inflation volatility and the
impact of shocks and anchors inflation expec-
tations. Emerging economies face the chal-
lenge of vulnerability to high inflation threaten-
March 2017 ❘ Indian Infrastructure ❘ 3
>>roads & bridges

ing output and employment. Hence, the price

stability target makes it imperative to make Movement in global cotton futures price ($)
inflation targeting the goal of monetary policy Today 85

so as to anchor inflation expectations. 80

5 day
Along with the 2011 CPI modifications and
the Urjit Patel Committee recommendations, 1 month 75

the CPI-combined (CPI-C) series (a series of CPI 1 year 70

that factors in both urban and rural compo-
65
nents) is the preferred choice, reflective of the 3 year

latest consumer expenditure survey (2004-05 60

5 year
National Sample Survey Organisation) and the
cost of living and influences inflation expecta- July October January April July October January April July October January
2014 2014 2015 2015 2015 2015 2016 2016 2016 2016 2017
tions. The committee suggested the adoption
High 77.03 10 day average vol 18,800 Year-to-date
of the CPI-C target at 4 per cent with a band of Low 76.58 52 week high 78.45 % change 8.20

+/- 2 per cent considering the vulnerability of
the Indian economy to external shocks and
large weight of food in the CPI and to avoid a
deflation bias. Considering the current elevat-
ed CPI inflation, hardened inflation expecta-
tions, supply constraints and weak output per-
formance, the transition path to the target was
calibrated to bring down inflation to 8 per cent
by 2015 and 6 per cent by 2016 before for-
mally adopting the target of 4 per cent.
Comparable emerging market experience
World development indicator (WDI) data
revealed that in the year 2015, globally, there
had been a general softening of WPIs across
most emerging and developed economies. This
is mainly owing to the declining global tradable
commodity and oil prices post 2012 and muted
global demand conditions.
Global wholesale price index inflation trends (%)
0.15
0.10
0.05
0.00
-0.05
-0.10
2008 2009 2010 2011
Source: World Development Indicators
Volume 1,500 52 week low 55.77
In light of the factors affecting the WPI and
the typical operations and maintenance cost
break-up for a highway developer, it can be
ascertained that a mere claim of a change in
the monetary policy may not be a sufficient
reason to demand compensation for negative
WPI inflation. There are several factors which
have a bearing on the WPI and alienating any
probable impact of the adoption of the nominal
anchor and the impact because of the correla-
tion between the WPI and CPI may be chal-
lenging. Also, the operations and maintenance
cost structure reflects components which are
affected both by the WPI and CPI, hence, the
need to move towards a more composite toll
indexation method from the current one.
It is understood that as toll revenues gener-
India United Kingdom
South Africa Malaysia
2012 2013 2014
1 yr % change 31.13 Source: CNBC
ate cash flows primarily to meet highway oper-
ations and maintenance costs and debt servic-
ing costs, a hybrid formulation for the toll infla-
tion index is better suited to factor in retail price
changes that get affected by CPI inflation. This is
mainly because the cost of living is factored into
the CPI and hence if components like labour,
employee and administrative costs getting
affected by CPI inflation are not accounted for
suitably, it will result in the underestimation of
the toll growth rate in comparison with growth in
operations and maintenance expenses. The toll
indexation should also factor in the variability
index to account for fluctuations in market inter-
est rates that will impact debt servicing costs.
Emerging market experience with toll
indexation
According to a World Bank report, toll rate
indexation is usually carried out with the CPI
United States
with adjustments done once or twice a year. In
China
Brazil some of the emerging market economies like
Indonesia, highway tolls are indexed to retail
prices with a toll rate growth price regulation
cap of 25 per cent. On the other hand, in the
Philippines, in order to make investments in
highways attractive for investors, the Presi-
dential Decree 1894 mandates a formula tak-
ing into account local and foreign interest
rates, the CPI, currency values, and a construc-
2015 tion materials price index. ◗
(The article does not reflect the views of any
organisation, only those of the authors.)

4 ❘ Indian Infrastructure ❘ March 2017