This option is costlier to finance, difficult to negotiate and longer gestation period to realize the project


By Muhammad Bashir Chaudhry
Sep 02 - 08, 2002

In view of resource constraints, the provincial governments are reportedly considering financing options such as Build, Own and Transfer (BOT) or Build, Own and Operate (BOO) for construction of new highways or up-gradation of the existing highways. Physical infrastructure projects such as bypasses, bridges, expressways, link roads, dual carriageways, etc are some other projects in this sector. The financiers would recoup their investment with profit through toll tax from the users of project facilities for concession period to 30 years. The City, District or Town Governments may undertake such projects within their respective municipal limits. Projects in other areas are the responsibility of the provincial governments. The National Highways Authority (NHA) implements certain expressways or motorways on overall country basis.

The provincial or district governments apparently consider BOT or BOO financing appropriate for a badly needed infrastructure project for financing of which there are no funds. They may have a point. However, they should also realize the complexities of BOT / BOO financing and burden of toll tax to which the users will be subjected for a long time. This option is costlier to finance, difficult to negotiate and longer gestation period to realize the project. This paper mentions alternate financing options and suggests important points to the government for consideration in case of BOT or BOO.

The governments of Sindh and the NWFP have recently availed loans from the World Bank. The government of Sindh is already familiar with the utilization process of ADB loans, as it has been recently availing ADB funds largely for repair of important roads. Therefore, the provincial governments might like to explore credits from the World Bank or ADB for financing construction of important highways or other important physical infrastructure projects. Funding from these institutions would be cheaper. Once the highways are ready, toll tax rights may be auctioned off in a transparent manner on yearly basis. Through this approach, the users of the highways are expected pay reasonable toll tax. However, there is one catch. The World Bank's Country Assistance Strategy lists the reformatory steps required to be taken by the provinces before additional funding is processed. The provincial governments may consider carrying out the reforms in the overall governance in order to be eligible for additional loans from these institutions.

Municipal banks are the ideal place to raise finances for implementation of physical infrastructure projects within the limits of the District governments. Until we have a proper Municipal Bank, the commercial banks and DFIs can fill the financing gap. No doubt, the banks would want to see the feasibility of the project and other allied matters in some details. This may not be to the liking of the district or provincial governments but there is a positive side to it as well. The government will become aware of its shortcomings in particular areas and take measure for improvement. This will facilitate the fund raising process for all time to come. The banks are expected to advance construction credits, provided the projected cash flow shows adequate debt servicing capability and the governments stands behind the project for collection of reasonable toll tax.

Provincial government bonds or municipal bonds are another options for mobilizing funds for financing infrastructure development projects. The provincial governments and the governments of Cities like Karachi or Lahore are expected to take the lead in the issuance of such debt securities. Financial advisory services companies could assist the governments in this regard. The issuers of medium and long-term debt securities are required to get themselves rated by rating agencies such as PACRA and JCR-VIS in Pakistan. These securities shall also require to be listed on the Stock Exchanges. The provincial or the district governments may approach the federal government to allow income tax exemption on the securities; with a view to make them attractive to the investors and to mobilize funds at relatively less cost. This financing route is new so the formalities may initially appear daunting but it has big potential and is worth trying. The financing trail so blazed by the provincial or City governments would pave the way for the district governments to also tap this vast reservoir of funds.

The persons or parties who are offering the government to construct certain highways under BOT / BOO arrangements, are looking for a highly profitable opportunity. They will be spending the money upfront, one to two years before the toll tax collection would start. In order to bind the government to the agreed arrangements, they would require execution of a number of inter-related agreements and would seek a number of guarantees and concessions. Their efforts would be to pass the government even those risks that purely belong to them. In order to arrive at arrangements that are reasonable to both parties, it would be a long time before the lawyers and advisors complete the negotiations. This process is relatively lengthy and it costs money all the time. In most cases, the persons making the proposals are promoters and their efforts are to conclude agreements heavily tilted in their favour. Being private parties they can hire the best people that is usually not the case with the government. After the agreements are signed, they might sell their major interest to the investors and the bankers, who would be willing due to attractive agreements. The investors and bankers also attempt to improve the position further to their advantage before actual execution is started.

It would require a lot of planning on the part of the provincial or district governments as well as timely compliance with the conditions specified in the set of legal documents covering BOT / BOO financing transaction. The way our government departments are presently organized and working, more problems are anticipated for them during project implementation. It is apprehended that disagreement with the counter parties may develop, as the concerned departments may not fulfil their part of the contract on timely basis.

BOO, BOT and their variations are more suitable for larger infrastructure projects by the sponsors (or governments) that are well organized and equipped to negotiate the concession and other agreements with the private investors. The provincial and the district governments might consider trying BOT / BOO source of funding if they are fully equipped with the experienced manpower and are clear on the policy options. It is prudent that the government negotiates such funding from position of strength. Before actually going for BOT type financing, the government may consider important aspects as suggested below:

1. Special teams comprising experienced specialists in law, financing and engineering may be constituted. Before actually inviting proposals for financing infrastructure projects, the provincial or the district government and all the team members must thoroughly study the BOO / BOT financing techniques. The team members may be exposed to formal training as well as made familiar with the existing projects that were financed on BOT / BOO basis in the country. If possible, project documents and agreements may be studied and discussed. Particular attention might be given to project parameters, capital cost, financing, loans and other securities, financial incentives and concessions, sharing of the risks, guarantees, the pre-conditions for various actions or disbursements, the tariff and its basis, etc.

2. The government has to carefully decide the projects for BOT / BOO financing. General public has to pay the toll tax for a long time. How will the public react to the level of the toll and what are the socio-economic and political fallouts? It will not be bad idea to invite public objections to the project and its financing on BOT /BOO basis and the levy of toll tax on the users. BOT / BOO financiers may seek numerous details about the concerned government and its finances. They may also seek other concessions and guarantees to be provided to the various local and foreign banks. The government has to decide if it will be willing to disclose those details.

3. The government must be clear as to the functions, responsibilities and risks of each party and not to allow discriminatory concessions or assume risks that belong to the financiers. The government has to be extra careful in the negotiation of credit and other agreements and should not agree on terms or concessions that it cannot deliver within the specified time. The ownership of the project should stay with the government. The financiers to have the concession to collect the toll tax from the users for the concession period that may not be excessive. The financiers may usually not be allowed to commercialize the facilities incidental to the project.

4. Capital cost of the infrastructure project is a critical. The government should give careful attention to project parameters, costing of various elements and the time frame for execution and completion. Project alignment, acquisition of additional land and displacement of population are also important issues and must to be provided for carefully. If all this work has been done in-house, it would be advisable to have it vetted from reputed and experienced consultants. In many cases, it is preferable to engage outside consultants for the entire job, their selection to be through open and transparent tendering.

5. There should be upper limits to each capital cost item and it may be made known to all counter parties that cost will be properly audited be the external auditors as well as by the government commercial auditors. Preliminary and pre-production items generally go beyond budget due to various reasons. It will be prudent if these costs are capped or fixed as a ratio of total project cost say at 2 %. In case there are over-runs due to changes in government duties or actions, provision may have to be made to finance such overruns, and eventually reflect in the toll tax.

6. The toll tax to be collected from the users of the facility will largely be determined on the basis of the capital cost, gestation period, anticipated return on investment based on the perceived risks, concession period and expected life of the project, anticipated inflation, operating cost of the toll collection, income tax level or exemption, projected number of users of the facility, type of vehicles and a host of other factors. Determination of reasonable toll and its whole-hearted acceptance by the users is important.

7. Large infrastructure projects, their capital cost and the financing arrangements generally require federal government approval. Major deviations and cost increases also require approvals. Therefore, to proceed properly it is advisable to prepare technical aspects of the project and the cost estimates very carefully. Before expression of interest for the BOT / BOO execution and financing are invited, the provincial or the district government should be clear on prescribed requirements as well as the best practices for execution of large infrastructure projects.

8. Some times land or part of the land needed for the infrastructure project is not already owned or possessed by the government. Acquiring of land may be costly and time consuming particularly if the location is in densely populated areas or with high market value. Land acquisition has big potential for pilferage of funds or payment of unfair compensation. Differences over compensation may lead to court cases and the project could be delayed until the matter is resolved Such possibilities may be factored in the determining time for handing over project for execution and the overall completion of the project.

9. Time is critical for all activities to be met by the counter parties. Private sector may possibly perform better as to the government authorities. Delay may cause cost over-runs and the benefits from the project may not be available as soon as is envisaged. The private financiers may ask for compensation if the delay is attributed to the government. The government may make arrangements to avoid such situations. Regular monitoring, of compliance with the contract terms and the physical progress with agreed milestones, would be a big help.