CHAPTER 4 PUBLIC PRIVATE PARTNERSHIP FOR INFRASTRUCTURE PROJECTS

Transcription

1 CHAPTER 4 PUBLIC PRIVATE PARTNERSHIP FOR INFRASTRUCTURE PROJECTS 4.1 GENERAL Civil infrastructure is vital to the nation s economic growth. Infrastructure may be considered to be the skeleton on which the society is built. It includes highways, railways, ports, bridges, hydraulic structures, power plants, tunnels, municipal facilities like sanitation and water supply, and other facilities serving public needs. Adequate funding is required to construct and maintain the requisite infrastructure. The immediate need for such projects coupled with chronic budget shortages experienced by public agencies encouraged the use of innovative financing [1][2]. In many countries, particularly, developing countries shortage of public funds have led governments to invite private sector entities to enter into long term contractual agreements for financing, construction and operation of capital intensive infrastructure projects. To achieve meaningful growth, developing countries have to promote infrastructure development, which has a positive knock on effect in catalyzing continuous economic development, apart from meeting basic needs. However, in proceeding towards this goal, developing countries face various constraints, among which, lack of advanced technology and inadequate public financial resources are two major drawbacks. To overcome or alleviate these constraints, developing countries are encouraging local and foreign private sector involvement in the provision of infrastructure projects or services. Global trends of privatization and reduced governmental roles extend to developed countries as well. Build-operate-transfer (BOT) type schemes have therefore provided an increasingly popular vehicle to move towards infrastructure development. 58

2 Infrastructure projects are complex, capital intensive, having long gestation period and involves multiple risk to the project participants. In many countries shortage of public funds have forced the govt to enter into long term contractual agreement for financing construction and operation of infrastructure projects. A PPP can be defined to be the private sector construction and operation of infrastructure which would otherwise have been provided by the public sector. PPP structures are typically more complex than traditional public procurement projects. PPPs complexity is due to number of parties involved and the mechanism use to share the risk. PPP projects are characterized by non-recourse or limited-recourse financing where lenders are repaid from only the revenues generated by projects. The concessionaire is a special purpose vehicle in which the sponsoring entities are not responsible for the repayments of the loans. These projects have a capital cost during construction and a low operating cost afterwards which implies that the initial financing cost are very large compared to the total cost. Further, a mix of financial and contractual arrangements amongst the multiple parties including the commercial banks, project sponsorers, domestic and international financial institutions and government agencies makes it further complex. From the viewpoint of the public procurer, there is an obvious need to ensure that money has been spent economically, efficiently and effectively. The Government seeks to utilize private sector finance in the provision of public sector infrastructure and services and thereby achieve value for money. Value for money, defined as the effective use of public funds on capital project, can come from private sector innovation and skills in asset design, construction techniques and operational practices. It may also come from transferring key risks in design, construction delays, cost overruns and finance to private sector entities. However, in some cases the emphasis on risk transfer can be misleading as value for money requires equitable allocation of risk between the public and private sector. From the perspective of the project sponsors, PPP is essentially project financing, characterized by the formation of a highly-geared special purpose company for the 59

3 project vehicle and consequently a reliance on direct revenues to pay for operating costs and cover debt financing while giving the desired return to risk capital. This chapter presents the background of BOT projects and its variations. The current status of PPPs in India is described and the comparison is made with other countries. 4.2 BOT PROJECTS The term BOT is used mainly in the area of infrastructure projects financed by the private sector. The economic environment today is suitable enough for the private sector to invest in infrastructure projects for the following reasons : Government policy aiming to increase the private sector participation. Modification in legislation and laws that encourage investments. Decrease in inflation rates. Availability of cheap and experienced work force Background of BOT It was reported that Turgut Ozal, a former Prime Minister of Turkey, first coined the term BOT and used the BOT approach in Turkey in 1984 as a part of the Turkish Privatization Program. However, the philosophy and origins of BOT and BOO (Build Own Operate) schemes can be traced back to the privately financed French canals and bridges in the 17 th Century : the privately funded and operated trade related infrastructure for the transportation of people and raw materials following the industrial revolution; and the French concession contracts, for example to supply drinking water to Paris in the 18 th century; the Suez Canal; the Trans-Siberian railway; and the railways and power companies in the USA (which were mostly on a BOO basis, i.e. without the need to Transfer back the facility)[105]. 60

4 Despite such wide-ranging precedents, the perceived need for central planning and control of critical public infrastructure precluded private sector participation in most of such developments until the 1980s. The paradigm shift that mobilized the private sector more recently resulted from a combination of forces, such as the gross inadequacies of public funding capacities, particularly in comparison with the growing aspirations of burgeoning populations; the inefficiencies of government monopolies; the conspicuous availability of surplus private resources (financial, technical and managerial) ; and the formulation of creative non-recourse financing mechanisms whereby projects could be self-funding (i.e. not have recourse to other assets of the stake-holders). However, experiences indicate that although the idea of complete non-recourse is central to the BOT concept, some level of guarantee/support or a comfort letter is invariably sought in practice Definition of BOT BOT has more than one definition. Here are a few : A model that entails a concession company providing the finance, design construction, operation, and maintenance of a privatized infrastructure project for a fixed period, at the end of which the project is transferred free to the host government [106]. The granting of a concession by the government to a private promoter, known as the concessionaire, who is responsible for the financing, construction, operation, and maintenance of a facility over the concession period before finally transferring the fully operational facility to the government at no cost [107]. A model or structure that uses private investment to undertake the infrastructure development that has historically been the preserve of the public sector [108]. 61

5 A type of project financing whereby the government grants a concession to a private entity (project company) to build and operate a project, such as infrastructure of resource extraction, that would be operate by the government [109]. Essentially a form of project financing whereby a government awards a group of investors (hereafter referred to as Project Consortium ) a concession for the development, operation, management, and commercial exploitation of a particular project [110]. A contractual arrangement and a new legal concept to encourage private enterprises and entrepreneurs to help the government in its development effort [111] BOT Variations The emerging trend is to build infrastructure by privatizing them, at no cost to the state, using the procurement called Build-Operate-Transfer (BOT). A BOT project can be described as a project based on the granting of a concession by a client (usually a public or governmental agency) to a consortium or concessionaire (usually in the private sector) who is required to Build (including financing, design, managing project implementation, carrying out project procurement, as well as construction), Operate (including managing and operating the facility or plant, carrying out maintenance etc., delivering product/service, and receiving payments to repay the financing and investment costs and to make a margin of profit), and to Transfer the facility or plant in operational condition and at no cost to the client at the end of the concession period. While BOT in Turkey has been legitimized by a specific law based on the original BOT concept, diverse variations have evolved in many countries. These mainly differ in the 62

6 precise mechanisms of ownership, usage rights, and obligations. These variations include the following, with the terms indicating basic arrangements and/or essential emphasis: BOO = build-own-operate, BLT = build-lease-transfer, BOOM= build-own-operate-maintain, BOOT = build-own-operate-transfer, BOOTT = build-own-operate-train-transfer, BTO = build-transfer-operate, DBFO = design-build-finance-operate, DBO = design-build-operate, DBOM = design-build-operate-maintain, DOB = design-operate-transfer, ROO = rehabilitate-own-operate, and ROT = rehabilitate-operate-transfer. In the Philippines, the BOT law embodied in Republic Act 7718 of 1993 recognizes a range of procurement protocols from BLT, BOO, BOT, BT, and BTO to DOT, along with any other approved variants. BTO was preferred in the Caltrans project in California [10] primarily to reduce tort liabilities that may have overburdened private entities. Meanwhile, it has been observed that maintenance and life cycle costs may be optimized through DBO. This mechanism has therefore also been used in procuring utilities, for example, in the 120 mgd Tolt water treatment facility in Seattle. This also enables continued public ownership of the facility. DBOM has been used in North American transportation projects, whereas BOO has been employed for power production under the Public Utility Regulatory Policies Act in the U.S. and also for power projects in India and Sri Lanka and buildings such as prisons in Australia. 63

7 4.2.4 Participants in BOT Projects The implementation process of a BOT project involves many parties, including the government, promoter, construction contractor, operating firms, financiers and other parties. The main stakeholders in BOT projects are Government; promoter/concessionaire; lenders/financiers and the public. All of them have particular reasons to be involved in the project. I. Public Procurer/Government From his point of view, there is an obvious need to ensure that money has been spent economically, efficiently, and effectively. At its simplest, the Government seeks to utilize private sector finance in the provision of public sector infrastructure and services and thereby achieve value for money. Value for money, defined as the effective use of public funds on a capital project, can come from private sector innovation and skills in asset design, construction techniques and operational practices and also from transferring key risks in design, construction delays, cost overruns and finance and insurance to private sector entities for them to manage. II. Project sponsors/promoters From the perspective of the project sponsors, PPP (and PFI) is essentially project financing, characterized by the formation of a highly- geared special purpose company for the project vehicle and consequently a reliance on direct revenues to pay for operating costs and cover debt financing while giving the desired return on risk capital. III. Lenders / financial Institutions BOT-type projects usually use a nonrecourse or limited-recourse financing structure, where lenders look primarily to the revenue stream generated by the project for repayment and to the assets of the project as collateral for the loan. The 64

8 lenders have no recourse or only limited recourse to the general funds or assets of the project sponsors because the concessionaire is a special-purpose vehicle, in which project assets, project-related contracts, and project cash flows are segregated to a substantial degree from the sponsoring entities. This specialpurpose vehicle allows the investors to reduce substantially both their financial investments by using debts and, consequently, their exposure to project liability [14]. Typically, the providers of finance look to the cash flow of the project as the source of funds for repayments. Financial security against the project company usually has minimal assets and because the financing is without recourse to the sponsor companies. However, performance guarantees are often made available by the sponsor companies in favour of the lenders. Thus the key principle for large PPP projects is to achieve a financial structure with us little recourse as possible to the sponsors whilst at the same time providing sufficient credit support so that the lenders are satisfied with the credit risks. Figure 4.1 indicates a typical relationship between principal participants in BOT type procurement. Figure 4.1: Typical Relationships between Project Participants In BOT Type Procurement 65

9 4.2.5 BOT Project Financing Project financing involves the raising of funds to finance an economically feasible capital investment project by issuing securities that are designed to be serviced and redeemed exclusively out of project cash flow. BOT is fashionable worldwide, especially in developing countries to attract private capital to assist in developing public infrastructure [9]. The first BOT project officially implemented in modern times was in the mid 1980s as part of a move to privatize infrastructure projects and large power plants in Turkey. The BOT method was used as early as 1834 when the Egyptian government was financially supported by European capital to build the Suez Canal [10]. Financing has replaced the availability of technology and expertise as the main problem in infrastructure development around the world. After years of large cost overruns and numerous change orders on 100% publicly funded projects, many governments started seeking greater efficiency by centralizing the management and control of complex projects in the hands of private experts. Public deficits, resistance to taxes and a shift among development strategist toward private investment incentives have created opportunities for private companies and public agencies to cooperate in the form of BOT projects. Ideally, BOT projects put large, well-capitalized private firms at the services of governments with strong commitment to economic development, in the process of finding design and construction efficiencies, reducing the drain on the public purse, and distributing risks and rewards fairly. The success of BOT projects depends on the motivations of a market economy that benefit all parties i.e. government, end user, and sponsor [11]. A Public Works Financing database of worldwide projects between 1985 and 2004 shows that 1,121 PPP infrastructure projects (road, rail, airport, seaport, water and building) representing $450.9 billion worth of investment, were funded and completed with the majority of the projects being in Europe, Asia and the Far East as shown in Table 4.1 [3]. Several arrangements of PPPs have been utilized including the common build-operate- 66

10 transfer (BOT), and its variants such as build-transfer-operate (BTO), design-buildfinance-operate (DBFO), build-own-operate (BOO), design-build-operate-maintain (DBOM), and several others [6][1]. Also design-build (DB) is frequently considered a form of PPPs. These arrangements were used in varying degrees among countries worldwide. Table 4.2 shows the distribution of the PPP arrangements for $322.4 billion worth of road projects planned since 1985, with the BOT/BTO/concession projects being the most widely used. Table 4.3 shows the regional distribution of the different PPP arrangements used in road projects. Table 4.1. Regional Share of PPP Projects funded and completed between 1985 and 2004 [3] Table 4.2. Contractual Arrangements in planned PPP Road Projects between 1985 and 2004 [3] 67

11 Table 4.3. Regional Distribution of PPP arrangements for Road Projects between 1985 and 2004 [3] Renowned for inadequate infrastructure, the Indian industry has been crying for improvement. The government has committed $500 billion towards infrastructure development to be spent over the next five years. The funding for the projects is expected to come mostly from private partnerships. In cases, where there has been very little interest from private participants and where the return on investment is believed to be low, the government has provided for longer concession periods and the provision of Viability Gap Funding (VGF) where the government foots a considerable proportion of development cost. At the end of FY 08, 175 contracts covering a total length of 15,803 km have been awarded under the BOT programme with a total cost of over $17 billion. [112]. In a PPP finance-based approach, tapping private finance is a major objective to get the needed infrastructure built when insufficient government funds are available. For this objective, having robust demand is an important financial factor for a project to be successfully developed [113][71]. Projects are mainly funded through tolls in road projects. As shown in Fig. 4.2, the general financial structure of a project under such a scheme could have the private consortium setting and collecting the user tolls. BOT/ BTO/concessions and franchises in India and worldwide are examples of this finance- 68

12 based approach. In the PPP service-based approach, the major emphasis is the optimization of the time and cost efficiencies in service delivery through the utilization of private sector skills, innovations, integration, and collaboration in project design, construction, financing, operation, marketing, and management. Figure.4.2. Financial structure with private financing as driver [77] As shown in Fig. 4.3, the service-based scheme has the government compensating contractors from government funds (with or without user fees) over the contract/concession period where private finance is secured by these payments, not by the robustness of the demand [114]. Further, at the extreme, government may participate in lending to the private sector, as illustrated in Fig The United Kingdom was piloting this lending mechanism, called Credit Guarantee Finance, in order to further reduce the cost of finance; contractors were still required to provide necessary insurance guarantee for repayments [115][114]. 69

13 Figure 4.3 DBFO regular financial structure [114][77] Figure 4.4. Credit guarantee finance facility proposed for United Kingdom s PFI projects [114][77] 70

14 4.3 RISKS & RISK MANAGEMENT Much of the risk of a PPP project comes from the complexity of the arrangement itself in terms of documentation, financing, taxation, technical details, sub agreements etc involved in a major infrastructure venture, while the nature of the risk alters over the duration of the project. For example, the construction phase of the project will give rise to different risks from those during the operating phase. At least nine risks face any infrastructure project : 1. Technical risk, due to engineering and design failures. 2. Construction risk, because of faulty construction techniques and cost escalation and delays in construction. 3. Operating risk, due to higher operating cost and maintenance costs, 4. Revenue risk, e.g. due to traffic shortfall or failure to extract resources, the volatility of prices and demand for products and services sold. 5. Financial risks arising from inadequate hedging of revenue streams and financing costs. 6. Force majeure risk, involving war and other calamities and acts of God. 7. Regulatory/ Political risk, due to legal changes and unsupportive government policies. 8. Environmental risk, because of adverse environmental impacts and hazards. 9. Project default, due to failure of the project from a combination of any of the above. Successful project design requires expert analysis of all of them and the design of contractual arrangements prior to competitive tendering that allocate burdens appropriately. For this purpose the risk can be broadly categorized as global or elemental. Global risks are those risk that are normally allocated through the project agreement and typically include political, legal, commercial, and environmental risks are considered as 71

15 those associated with the construction, operation, finance and revenue generation components of the project. The major risks a project sponsor faces are political, financial, construction, operational, and market risks. Political risk comes from the potential occurrence of political events such as war, revolution, expropriation of assets, tax code revisions, currency devaluation, foreign exchange control problems (convertibility and availability), export restrictions, and any other government action that could influence the profitability of a project [116]. Political risk may be significant when considering projects in developing countries with unstable governments [99]. A change in government can affect government policy and project sponsorship. Financial risk relates to fluctuations in currency exchange rates, inflation, and cost of capital. Foreign exchange risk often is high in developing countries, especially those experiencing rapid inflation. The cost of capital risk may not be related to the country in which the project is to be constructed, but it will be a factor in the countries where project financing is obtained. Construction risk primarily relates to delays in completion and cost overruns. Construction delays may be caused by technical difficulties, by poor management, or by a combination of both. Since BOT investors rely on income from the completed project to recover their investment, any delay in completion will delay the generation of revenue. Cost overruns will impact the profitability of the project by increasing construction and financing costs. Operation risk relates to the cost of operating the completed facility. Actual operation and maintenance costs may exceed those anticipated during project planning. Unanticipated operation costs also will adversely impact the profitability of the project. 4.4 PPP S IN INDIA There is now over 10 years experience in India in the development and use of PPPs for delivering infrastructure services. Policies in favor of attracting private participation have met with varying degrees of success, but real progress has been made in some sectors, first in telecommunications, and now in ports and roads, and with individual projects in 72

16 other sectors. There has been considerable innovation with different structures now being developed to attract private participation. But at the same time progress has been uneven: there are islands of progress, with some states having undertaken far more PPPs than others, and a much heavier use of PPPs in some sectors than others. And while there are a number of successful projects to the present date, there have also been a number of poorly conceptualized PPPs brought to the market that stood little chance of reaching financial closure. In terms of frameworks for PPPs, some states have made more attempts to develop this, including cross-cutting legislation and the development of cross-sectoral units that play a role in the identification and preparation of PPPs. Others however have worked within the bounds of their existing organizational structure. In the surveyed states and central agencies, there have been at least 86 PPP projects in our main sectors of focus where a contract has been awarded and projects are underway in the sense that they are either operational, have reached construction stage, or at least construction/implementation is imminent. Over 70% of these are in the roads sector. The other transport sectors have seen much fewer projects, with 8 ports (4 major and 4 minor ports), 2 airport and 2 rail projects underway. In the urban infrastructure sector, 11 PPP projects have been awarded, with 8 solid waste management, 2 water and sanitation and one bus terminal projects. Outside of the sectors of immediate interest and hence not included in the main text totals and charts, the survey found 6 PPP projects in e- governance and 2 in education. Though the coverage may not have been exhaustive for these last two sectors, it is clear that the potential use of PPPs in e-governance and health and education sectors remains largely untapped across India as a whole. 73

17 Figure 4.5. Number of awarded PPP s by sector (total = 86) Figure 4.6. Project cost of awarded PPPs by sector (total =Rs billion) There is now over 15years experience in India in the development and use of PPPs for delivering infrastructure services. Table 4.4 gives the state wise figures for the total number of project implemented. Figure 4.5 and 4.6 gives the sector wise value. 74

18 Table 4.4: Total number of projects state wise ( PPP India Database 2008 ) State-Wise Figures Total Number of Projects based on Value of Contracts State Total Number of Projects Based on 100 crore Between 100 to 250 crore Between 251 to 500 crore More than 500 crore Value of contacts Andaman and Nicobar Islands Andhra Pradesh Bihar Chhattisgarh Delhi Gujarat Haryana Jharkhand Karnataka Kerala Madhya Pradesh Maharashtra Orissa Pudducherry Punjab Rajasthan Sikkim Tamil Nadu Uttar Pradesh West Bengal Total FINANCING GAPS The planning commission of India has estimated the financing gaps in infrastructure up to the year and is given in table 4.5[6] 75

19 Table 4.5 overall financing gap in infrastructure up to (Rs billion) The investment requirements are enormous and are not likely to be met from the public sector alone. Attracting private capital in this critical sector is recognized as a key strategy to meet the resource deficit. Consequently, Public Private Partnership (PPPs) is being encouraged as the preferred mode for execution and operation of infrastructure projects. PPPs offer a number of advantages in terms of enhancing the ability to take a larger shelf of infrastructure investments, introducing specialized expertise and cost reducing technology as well as bring in efficiencies in operation and maintenance. The overall response to the call to promote PPP as the preferred mode for the implementation of infrastructure is encouraging. The progress is, however, slow and has been limited to a few sectors. Investment through the PPP mode needs to increase substantially in the states and across sectors Experience of other countries. India is far behind several other countries in private investment as a percentage of GDP. Table 4.6 shows India s performance vis a vis other countries in attracting private investment. 76

20 Table 4.6 India s Performance vis a vis that of other countries in attracting Private Investment Country Since 1990 Since 2001 Malaysia 3.5% 2.9% Nigeria 1.2% 2.5% Czech Republic 2.1% 2.4% Hungary 2.5% 1.9% Brazil 1.9% 1.9% Chile 2.3% 1.8% Colombia 1.5% 1.4% Thailand 1.4% 1.4% Turkey 1.0% 1.1% India 0.7% 1.0% Argentina 2.0% 0.7% Mexico 0.9% 0.7% Indonesia 1.1% 0.7% China 0.4% 0.2% Private investment in infrastructure as a percentage of GDP, averaged over period If investment in infrastructure is to increase to 7-8% of GDP, the amount contributed from the private sector has to rise from the average of 1% to the range of 2% of GDP or more. These investments have to rise outside the telecommunication sector which has attracted most of the private sector investment in India. The PPPs can help meet the infrastructure gap in India, but are not a panacea. They are often complex transactions and the risk should be properly allocated to the public and private sector. The key barriers and constraints that have contributed to project delays and discouraged private investors are to be recognized and practical ways should be found out 77

21 to mitigate these constraints and policy reforms to facilitate private investment in infrastructure in India Foreign player vs domestic players Private sector targeted towards financing, designing, implementing, and operating infrastructure facilities and services that were traditionally provided by the public sector have been a success story so far with the Government of India leading the process of promoting Public Private Partnerships (PPPs) in India. Domestic players participation in PPP projects Review of successful projects indicates that they have clear boundaries and measurable performance for the private party, sufficiently large scale of operations, competitive market for provisioning of the services, significant service delivery, and ability for the private sector to control factors for which it is responsible. On aggregate level the domestic players have dominated the PPP projects both in terms of numbers and investment. Out of a sample of 300 projects 278 projects with investment of Rs crore, the road sector has dominated investment by domestic players with aggregate investment of Rs. 51,398 crore. The port sector with total domestic player investment of Rs crore comes second and airports at Rs. 19,111 crore. The energy space that includes hydro based power plants is dominated by domestic private players Rs. 17,802 crore as shown in figure

22 Figure 4.7 Sector wise Domestic player investment in PPP projects Leading among big domestic players is Larsen & Toubro with a total investment of, both in existing and under construction projects, totaling Rs crore mostly in road projects. It is followed with GMR Infrastructure with a total investment of Rs crore. In case of small road projects on BOT basis Sadbhav Engineering Limited with investment in 11 projects with total investment of crore leads the domestic scene. The Delhi based DS Constructions Limited is second, with total investment of Rs. 320 crore. Mumbai based MSK Projects (India) Limited is third in terms of investment, with 15 projects and total Investment of Rs crore. Among these three players they shared 30 projects out of 300 sample projects as shown in table

23 Table 4.7 Domestic Players in PPP projects Foreign player Participation in PPP projects As per available records, foreign multinationals have equity participation only in 22 PPP projects in the sample of 300, where contracts have already been awarded and projects are underway. Malaysian companies are leading investors in public private partnership (PPP) projects in India, involving nearly six major infrastructure ventures. Followed by the United Kingdom with four projects, Mauritius (three), two each for France, Germany, United Arab Emirates and the Philippines, and one each for the United States and Switzerland. Figure 4.8 shows the foreign versus domestic number of in PPP projects in India. Foreign equity participation of 27 foreign companies in PPP projects was only at Rs 1, crore which is meager 1 per cent of the total project investment. Prominent PPP projects where foreign companies have an equity stake include modernisation of Mumbai and Delhi international airports, Delhi-Noida toll bridge, Pipavav port, Bangalore international airports and JNPT container terminal etc. Table 4.8 shows the foreign versus domestic investment in PPP projects in India along with sector wise break up of foreign investment in PPP projects. 80

24 Mauritius-based ACSA Global (Airports Company South Africa), for example, has Rs 160 crore equity stake in modernization of Mumbai international airport project. Apollo Enterprises from UK has equity stakes of Rs 48 crore and Rs 11 crore in Lucknow- Sitapur road project and Raipur Durg expressway respectively. Figure 4.8 Foreign versus domestic number of in PPP projects in India Table 4.8 foreign versus domestic investment in PPP projects in India an sector wise breakup of foreign investor participation in PPP projects 81

25 4.6 CONCLUSIONS PPP projects are targeting towards financing, designing, implementing and operating infrastructure facilities and services that were traditionally provided by the public sector. The government of India is leading the process of promoting PPP projects in India to create a success story. However, the overall financing gaps in infrastructure are quite high as per the estimates of planning commission of India. The investment needs for infrastructure is enormous. India faces a very large financing gap which needs to be bridged by domestic as well as foreign and private sector investment. 82