Study on Private-Initiative Infrastructure Projects. in Developing Countries in FY2009. Project in Socialist Republic of Viet Nam SUMMARY.

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1 Study on Private-Initiative Infrastructure Projects in Developing Countries in FY2009 Study on the Expressway Operation and Management Project in Socialist Republic of Viet Nam SUMMARY March 2010 Infrastructure Development Institute-Japan Nippon Koei Co., Ltd. Central Nippon Expressway Company Limited

2 (1) Project Background and Necessity The project aims to study sections between Cau Gie - Ninh Binh and Ho Chi Minh - Dau Giay and to formulate them as concrete O&M projects including traffic control, and tentative O&M standards for the expressways in Vietnam. The project sections are nominated as priority sections by the Prime Minister Master Plan entitled Development plan of the National Expressway Network toward 2020 and Vision for post The development of the project sections, as a part of the North-South trunk road in Vietnam, expected to have a huge effect on investment environment improvement, sustainable export enhancement and job creation in Vietnam. (2) Principles for Decision on Project Component The North-South Expressway is projected to construct and provide a 2,300km expressway separate from the existing ordinary highway between Hanoi and Ho Chi Minh City. Construction of part of high-priority sections is being executed with a yen loan, ADB financing, and Vietnamese government funds. While the government of Vietnam will execute road construction along with frontage development based on BOT methodology, it is looking for ways to procure funds in a PPP. Under the current circumstances, adopting PPP for expressway construction when there are various means available entails considerable infrastructure construction investment risk. The uncertain application based on Vietnam s new BOT legislation is pointed out as an issue in promoting investment by other nations. On the other hand, no system is currently in place under which an entity around a Japanese expressway company can enter the market and undertake a project from construction to O&M. As a result, the intermediate conclusion for the time being, facilitating adoption of private funds for O&M and striving to transfer technology are practical, but for the long-term it will be important to utilize ODA funds to attract private sector funds and to take the form of phased expansion of participation and scale. Under above principles, we studied project formulation and feasibility study, including how to conceptualize these projects.

3 (3) Project Overview The project aims to study PPP schemes applicable to the sections between Cau Gie - Ninh Binh and Ho Chi Minh - Dau Giay and to formulate them as concrete O&M projects, as well as to help prepare tentative O&M standards for expressways in Vietnam. 1. Cau Gie - Ninh Binh Expressway O&M Project The construction project commenced in January 2006, but the completion has been considerably delayed and as of the present time, opening is scheduled for end For the project section, an integrated closed traffic control system linked to the sector between Hanoi and Cau Gie is scheduled to be installed. This section will be opened in It will be difficult to develop, prior to opening, PPP-related systems such as contract forms and payment mechanisms, and to set fees and contract periods corresponding to sharing of risk. Therefore, for the time being, the Private Contract Fee Service Scheme should be appropriate as an O&M project scheme for the section. 2. Ho Chi Minh-Dau Giay Expressway O&M Project A Yen credit for the construction project was pledged in March 2008, procurement of a consultant for detailed design was expeditiously realized, detailed design work commenced in July 2008, and design work was completed at the end of October Proposed projects are toll gates at three locations for the section and installation of one O&M station is scheduled. As the section is to be opened in 2014, there is enough time for private parties to take more risks than they can under the Private Contract Fee Service Scheme. Efficient management is expected by taking advantage of private know-how, and the concession method will be appropriate because the organizational outlook, materials and equipment and human resources development are clearly defined. The proposed O&M concession in the section is outlined below.

4 Table 1 Outline of O&M Concession between Ho Chi Minh and Dau Giay Project name Project outline Implemented by: Project cost/ finance Public assistance Project for maintenance and operation of Ho Chi Minh-Dau Giay section in the North-South Expressway (1) Business: Operation and maintenance including toll collection (2) Business type: O&M concession (3) Period: 20 years (1) Investor: Central Nippon Expressway Company, Nippon Koei Co., etc. (2) Vietnamese partners and form of cooperation: Expressway owner participation expected Investment necessary to O&M project: USD 23.4 million: USD 17.9 million (O&M Concession Acquisition (Long Term Lease) Cost for 20 years) USD 3.3 million (Buildings, facilities, vehicles, materials required for O&M services) USD 2.2 million (2 year training for staffs implementing O&M) Toll (passenger cars): USD/km (Level of toll of the BOT project pursuant to the provision of Circular 90 (twice as much as that for non BOT toll roads) SPC will receive 20% of the after-vat toll revenue Finance: USD 22.4 million; Equity: USD 4.5 million (20% of total project cost) Debt: USD 17.9 million (1) Financial assistance: VGF of USD 4.6 million; national and foreign funds (Japan, international banks, including ODA (bilateral and international organizations). (2) Non-financial assistance: Further discussion and clarification of conditions of the O&M concession. Note: Although USD 2.2 million for two year training for staffs implementing O&M is outlaid in the year of 2015 (the first operation year) and 2016 (the second operation year), not in the year of 2014 (the initial investment year). The value of USD 2.2 million appears not discounted to the 2014 value. All the values in the (3) Finance, however, are based on the net present value of future cash flow, discounted to the 2014 value. This is the reason why the value of (1) Investment necessary to D&M project: USD 23.4 million and (3) Finance : 22.4 million are not equal. (Source: Study Team) 3. Outline of the Preliminary Economic and Financial Feasibility Study Result a. Cau Gie - Ninh Binh Section a) Economic and financial feasibility of the project as a whole The construction cost of the proposed project is about 490 million dollars. As for EIRR for the section concerned, no calculation is available. However, as the estimate for the 63-km section between Ninh Binh and Thanh Hoa (63km south of the section) is 27.4 per cent 1, we estimate that the section concerned has an EIRR with a sufficient feasibility. 1 Viet Nam: Expressway Network Development Plan 2007, ADB.

5 b) Financial feasibility of the O&M project The FIRR for the section is calculated as 17.6% and financially feasible. The high FIRR is explained, however, by the relatively small amount of initial investment and higher percentage (20% of toll revenue) receivable for O&M cost. b. Ho Chi Minh-Dau Giay Sectiion a) Economic and financial feasibility of the project as a whole According to the ADB estimates, the amount of initial investment for this section is at about USD 666 million 2, EIRR at 15.5 percent, and FIRR at 4 percent. It estimates that the project is feasible both economically and financially. b) Financial feasibility of O&M project Calculated FIRR of the project is 3.4 percent. Though not below zero, the rate of return is much lower than investment opportunities equivalent risks to this project in Vietnam. As a purely private investment, the rate is not sufficient. The project becomes financially feasible only under public-private collaborations such as PPP between the government and private sector. 4. Study of Environmental and Social consideration As the scope of the project is not a construction project but solely an O&M project, anticipated socio-environmental impacts are very limited. The O&M, however, is within the scope of the construction project EIA. In this regards, the project should abide by environmental laws and regulations through specified in the construction EIA. (4) Project Implementation Schedule We examined project schedules for the two sections. For the O&M in the Ho Chi Minh - Dau Giay O&M section, the Concession Scheme is assumed. Based on existing survey reports and the results of consultation with VEC and other organizations, we summarized premises for schedule planning as shown in the below table. 2 The total initial construction investment of USD 666 million is estimated to be divided to USD 70.6 million in the year of 2008, million in the year of 2009, USD million in the year of 2010, USD million in the year of 2011 and USD 74.2 million in the year of Proposal Loan Socialist Republic of Viet Nam: Ho Minh City-Long Thanh-Dau Giay Expressway Construction Project 2008, ADB Appendix 12 p. 52

6 Table 2: Premises for schedule planning (Ho Chi Minh - Dau Giay) No. Category Premise 1 Construction work Construction work to be completed by end of Traffic control facility work Traffic control facility work to be completed by the end of Start of service The expressway service with traffic control will start in January O&M organization VEC will set up an O&M organization and this organization will provide O&M services during the period of liability defect against defect. 5 Defect liability period The period of liability defect against defect will be for two years. 6 7 Creation of SPC Contract negotiation If selected as a pilot project in March 2010, the procedure for creation of an SPC will be started. A detailed survey relating to the BOT law will be completed in about two years. In about one year of contract negotiation, the parties will reach an agreement on the terms of the O&M technical consignment service. The negotiation will be concluded by the end of Building organization on-site After conclusion of the contract, SPC will develop in Vietnam an organization to provide services. 9 Technical consignment During the period of warranty against defects, SPC will provide the O&M organization with O&M technical consignment service. 10 O&M concession The period of concession will be 20 years after the expiration of the period of warranty against defect. (Source: Study Team) (5) Project Implementation Feasibility Project finance is examined to the Ho Chi Minh - Dau Giay O&M section, as the concession scheme is assumed for the section. Under the current toll rate system (364 VND/km), the FIRR is calculated to 3.4 per cent and NPV is negative USD 4.58 million and we assumed this amount as viability gap. Possible methods of VGF include the following: - Grants - Low interest loans - Government guarantees We assume that VGF is principally made in the form of Grant, some mixture of these three tools, however, also to be considered. We assume that VGF is a funding after using existing supports such as export credit and has still deficit.

7 Because actual cash flow does not reach the level of return expected by potential investors, the project will be difficultly financed. However, if we get 4.58 million seen above, feasibility of the project is large as a whole. (6) Advantages of Japanese enterprises in the implementation of the project Japanese expressway companies have long experience in the operation and management of expressways while establishing and improving standards and manuals. Among others, Japanese expressway companies have competitive advantages in O&M technologies and know-how in the following fields: Operation and maintenance technologies, including asset management technologies such as inspection, diagnosis, database development Quality control technologies and systems ITS technologies related to ETC, traffic control, information service Initial reaction to a disaster or an accident, coordination and decision-making systems, emergency rehabilitation and restoration measures. Environmentally friendly planning and design know-how and construction workmanship Service provision in service areas and parking areas It is essential to localize these Japanese technologies and know-how into Vietnam and transfer them to Viet Nam through a PPP for the project. (7) Schedule for Project Realization and Preventing Risks 1. Schedule for Project Realization The O&M concession project for the Ho Chi Minh Dau Giay section has been proposed as part of the PPP joint study between the MPI (the Ministry of Planning and Investment in Viet Nam) and the METI (in Japan) scheme. A presentation of the proposal was given on December 21, 2009 in Vietnam. Currently, the proposal is being studied by assessment consultants and a PPP task force of MPI. They will decide whether they will adopt it as a pilot project or not in March 2010.

8 Meanwhile, at MOT/VEC, the implementing authorities for expressway projects, preparations are being made for the creation of an O&M organization. For smooth promotion of the project, it will be indispensable for us to ensure that information is appropriately shared and necessary adjustments between MPI and MOT/VEC are made for project implementation. As a legal restraint, there is Decree 108 that goes into effect on January 15, It is hoped that, now that Decree 78 has been abolished, a circular under Decree 108 will be drafted and implemented as early as possible. Additional detailed analysis is necessary, especially detailed study in financial feasibility. VEC has begun studying the PPP project scheme. Taking into account the results of their study, further discussion with VEC will be necessary to examine the terms of contract in more detail. It is also necessary to discuss which party, i.e. the expressway owner or the O&M contractor bares what kind of risk items, such as traffic volume, O&M cost increase, tariff change, inflation and foreign exchange and in case the O&M contractor bares some of these risks, contingency cost should be added. The specific schedule for project realization is as shown in the bellow figure. Fig. 1 Project schedule (Ho Chi Minh - Dau Giay section) [Paid ODA] Expressway construction work [SPC] Office construction work/ Purchase of equipment and vehicles (for operation, maintenance, and management) Operation, maintenance, and management by the project owner ( = Period for warranty against defect for the finally complete [METI STUDY ON PRIVATE-INITIATIVE INFRASTRUCTURE] [MLIT PPP STUDY MEETING] Solicit Investers with Interest [METI STUDY ON PRIVATE-INITIATIVE INFRASTRUCTURE] [Survey by METI STUDY ON PRIVATE-INITIATIVE INFRASTRUCTURE etc.] Investment procedure under the BOT law License In Service Establishment of project SPC Establishment Contract negotiation Agreement Building implementation system [SPC] Defining LOS, training of the project owner s staff Operation, maintenance, and management concession (20 years) Project Period Preparation Note: Although establishment of a SPC is not a required condition in general, all financial decisions such as investor s share and financial planning should be made for project approval. (Source: Study Team)

9 2. Potential Risks against Project Implementation The main risks preventing this project from realization are uncertainty in traffic volume, operation cost increase, unexpected tariff change and exchange rare risks. As foreign exchange risk is particularly phenomenal in Vietnam, public tools such as export credit should be studied. In addition, there exist institutional or policy risks, such as whether tariff increase corresponding to operation cost increase by inflation is really made or not, although this is regulatory guaranteed. Not only tariff escalation reflecting to inflation, there exist various institutional risks in Vietnam, as regulations concerning PPP and expressway tariff are now under development. Under above circumstances, risk sharing should be clearly defined in the concession contract. Furthermore, it is a challenge to be studied that risks impossible to be borne privately should be taken care publicly through government guarantee.

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