BOT Investment Model

By, Roshan Lovely Shrestha  

BOT investment model is an efficient way to meet the need of cash-starved government, yet, it has many problems in implement. Investor always require governments’ guarantee in by warranty law files, such as; soil and logistics guarantee, foreign currency exchange guarantee, confined competition guarantee, management time guarantee, investment returns guarantee etc. Though governments’ support and guarantee is substantial to the success of BOT investment style, there are some law flaws and if there is not any system to harmonize such problems then it would lead to conflict. Therefore, there should be a proper law system for BOT investment style to make it more successful.

Key words: cash-starved government, BOT, government’s guarantee, law system

PPP/BOT and Government

PPP Background and Introduction

In1990 there was a sharp decline in the level of donor support for infrastructure projects in developing countries. Aggregate flows of aid for the infrastructure sector halved during the course of the decade. This shift away from infrastructure projects reflected the disappointment of donors with the performance of the infrastructure sector, which was often inefficient, poorly managed, socially and environmentally damaging, and lacking a clear and accountable process of governance to control corrupt practices. In contrast to the decline in official aid, private capital flows for infrastructure increased significantly during the 1990s, in response to the general trend towards privatization of infrastructure in developing countries.

"Public-private partnerships" (PPP) refer to contractual agreements formed between a public agency and private sector entity that allow for greater private sector participation in the delivery of infrastructure projects. Expanding the private sector role allows the public agencies to tap private sector technical, management and financial resources in new ways to achieve certain public agency objectives such as greater cost and schedule certainty, supplementing in-house staff, innovative technology applications, specialized expertise or access to private capital.

Some of the primary reasons for public agencies to enter into public-private partnerships include:

• Accelerating the implementation of high priority projects by packaging and procuring services in new ways;
• Turning to the private sector to provide specialized management capacity for large and complex programs;
• Enabling the delivery of new technology developed by private entities;
• Drawing on private sector expertise in accessing and organizing the widest range of private sector financial resources;
• Encouraging private entrepreneurial development, ownership, and operation of highways and/or related assets; and,
• Allowing for the reduction in the size of the public agency and the substitution of private sector resources and personnel

PPPs provide benefits by allocating the responsibilities to the party – either public or private – that is best positioned to control the activity that will produce the desired result. With PPPs, this is accomplished by specifying the roles, risks and rewards contractually, so as to provide incentives for maximum performance and the flexibility necessary to achieve the desired results.

* The primary benefits of using PPPs to deliver infrastructure projects include:

* Expedited completion compared to conventional project delivery methods;

Project cost savings;

* Improved quality and system performance from the use of innovative materials and management techniques;

* Substitution of private resources and personnel for constrained public resources; and,

* Access to new sources of private capital.

As PPPs have become more common, many governments have become eager to capitalize on the increased efficiency of the private sector and have found that private developers deliver greater value for money. PPPs are often used to meet such public objectives as:

• Accelerating implementation of high priority projects by compressing and overlapping services normally sequenced;
• Providing management resources for large or complex programs to insure quality, cost and schedule deadlines are met;
• Accessing advanced (and possibly proprietary) technologies not available through standard procurement approaches;
• Improving asset management and the scientific application of life-cycle cost practices;
• Achieving set levels of environmental or aesthetic quality; and,
• Accessing new sources of private capital (debt and equity), thereby eliminating the need to wait for future budget cycles to pay for needed infrastructure projects.

Some examples of PPPs are as follows:

• Maintenance and Operation Fee Service Contracts
• Program Management Fee Service Contracts
• Design-Build
• Build-Operate-Transfer (BOT) / Design Build Operate Maintain (DBOM)
• Design-Build-Finance-Operate-Transfer (DBFO)
• Build-Own-Operate (BOO)

For different types of PPP, responsibilities borne by two parties varies. The diagram below shows how the range of responsibilities shifts from the public sector to the private sector with different PPP options.

BOT and its growing potential

Public-Private Partnership (PPP) in infrastructure projects is getting popular among many developing countries and among all the PPP models, BOT (Build-Operate-Transfer) is the most common model.

BOT scheme can be described as a developing technique for infrastructure development by using private initiative and funding. In this model, a concession is granted to a concession holder (sponsor) who is required to build the relevant project facilities or infrastructure, operate them for a fixed period and at the end of the period transfer them back to the person who originally granted the concession. The concession will run for a finite period, which would ensure that any financial institutions lending to the sponsors are repaid and the shareholders receive a sufficient return on their initial investment. The scheme may have a definite lifespan within which the concession holder is allowed to operate the facilities, or the term may be variable, and would be determined once a target cumulative revenue has been received by the project company.

The sponsor is expected to finance the building of the infrastructure and undertakes the risk of constructing and operating the infrastructure facilities. A prerequisite for private financing is a need for the facility to be developed. It is only after market analysis justifies a need that private parties would be willing to financially participate as well as become involved in developing the facility.

A substantial part of the finance for the project company, aside from a basic equity commitment from the shareholders, is often provided by secondary parties such as banks, financial institutions and bond holders, on a limited recourse basis. In other words the repayment of the loans will be from the cash flow generated by the project and, and generally will not be guaranteed (at least not in full) by the shareholders of the project company. In some cases the government also provides part of the debt.

In comparison with other investment models, BOT model has following legal properties;

(1) Authority: According to the contract between government and franchise, franchise has the authority to operate the project for certain period of time and after that it should be hand in to government.

(2) Responsibility: According to the contract between government and franchise, investor has the obligation for designing, investment, construction, operation and maintenance of the project.

(3) Capital: The capital for the construction of the project can obtain from foreign investment or national investor or from the bank loans. Government will not provide any fund but can invest on the project.

(4) Participation: There will be the main participation of government and franchise by the contract. Beside this, with the contract such as loan contract, operation contract, construction contract, designing contract, between franchise and other parties there is involvement of bank, contractor and designer in this project.

The figure bellow illustrates the basic relationships in a typical BOT-type project.

The potential advantages of using the BOT approach for infrastructure development;

* Use of private sector financing to provide new sources of capital, which reduces public borrowing and direct spending and which may improve the host government's credit rating.

* Ability to accelerate the development of projects that would otherwise have to wait for, and compete for scarce sovereign resources.

* Use of private sector capital, initiative and know-how to reduce project construction costs, shorten schedules and improve operating efficiency.

* Allocation to the private sector of project risk and burden that would otherwise have to be borne by the public sector. The private sector is responsible for the operation, maintenance and output of the project for an extended period

* The involvement of private sponsors and experienced commercial lenders, which ensures an in-depth review and is an additional sign of project feasibility.

* Technology transfer, the training of local personnel and the development of national capital markets.

* In contrast to full privatization, government retention of strategic control over the project, which is transferred to the public at the end of the contract period.

* The opportunity to establish a private benchmark against which the efficiency of similar public sector projects can be measured and the associated opportunity to enhance public management of infrastructure facilities.

Globalization and Infrastructure needs

Investing in public infrastructure such as roads, bridges, ports, power plants, public utilities etc. is conventionally considered to be a necessary prerequisite for industrialization and economic growth, and has traditionally been the responsibility of governments, both in capitalist and socialist economies. Governments use tax revenue and/or loans from commercial banks or international finance institutions such as the World Bank to fund infrastructure investments. While the private sector is often sub-contracted to carry out construction work on infrastructure projects, governments have borne virtually all project costs and risks.

Given the current rapid industrialization in many developing countries, for a government to maintain adequate investments in infrastructure, which is very capital intensive, an enormous burden is placed on public finances. According to the World Bank, the developing countries now spend more than US$200 billion a year on infrastructure investment, of which more than 90 per cent is government-sponsored. This emphasis on infrastructure investment has been a major cause of burgeoning government budget deficits and foreign debt, and cutbacks to sectors, such as health, education and social welfare. This often happen in connection with structural adjustment and other austerity programs imposed by creditors such as the World Bank and International Monetary Fund.

The past decade has seen a new global economic trend emerge, actively supported by the World Bank group, which emphasizes privatization, economic deregulation and reducing governments’ role in virtually all sectors of the economy. Supporting new mechanisms which enable direct private sector investment in infrastructure projects is part of this trend, and BOT is one model currently being promoted by the World Bank group, ostensibly as a strategy for increasing efficiency, reducing the drain on state revenue and enhancing private sector development.

The thrust of the argument in favour of the BOT scheme therefore appears to be that enabling the private sector to invest directly in infrastructure projects reduces the drain on the public purse and as the private sector operates on a commercial basis, efficiency will also improve. It is a remarkably simple and seductive argument, and one, which can easily conjure up visions of free development – public infrastructure being created without having to invest public money. It can also be argued that by encouraging foreign investment, BOT can help to facilitate effective technology transfer between countries, and thus foster the growth of a strong local private sector. In the United Nations Commission on International Trade Law (UNCITRAL) notes on Build-Operate-Transfer Projects, UNCITRAL argues that: "Since direct funds from the public budget are not required, the Government of a country will thus experience reduced pressure of public borrowing, while allowing the transfer of industrial risks and also of new technologies to the private sector".

Developing countries are having huge need infrastructure, which if not met will continue to affect their economic growth. Furthermore, it is quite clear that governments are no longer able to meet all these needs. At present, the BOT scheme provides one of the better options to solve this problem. Enhanced mobilities and instantaneous communications have enabled rapid movements of both physical and financial resources to areas where they are needed, or could reap more benefits. For example, excess construction capacities or surplus funds from one region could easily flow into another to redress shortages and meet sudden needs. The phenomenal demands to upgrade basic infrastructure in most developing countries can thus be fed by BOT-type arrangements that facilitate mutually beneficial flows. The megascale of such demands is boosted by tremendous pressures for both new infrastructure and infrastructure renewal in developed countries themselves.

Private financing of public infrastructure can be a great help for cash-starved governments. The efficient maintenance and operation of assets such as power stations and roads by the private sector provided an added advantage, while also allowing for the recovery of the investment over a longer period. The transfer of the asset back to the government at the end of a specified period in the BOT concept accommodated a variety of perceived needs.

Risk Distribution

An important facet of BOT is the radical realignment of risks between project participants. Construction project risks may be broadly classified into: “Project risks” comprising development, design, construction, operation, finance and revenue generation risks; and “Global risks” comprising political, legal, commercial and environmental risks. The shifting to the franchisee of many such risks previously borne by owners may accommodate enhanced rewards or, in the alternative, incorporate some minimal safeguards of minimal returns. The model shift in project financing for BOT-types projects was also crucial in that it envisaged “non recourse” funding, where lenders would treat the cash flows of the project as the only source from which loans would be repaid and the project assets as the only available collateral.

The risks like political risks are the most difficult to handle in comparison with financial risks, while technical risks are the easiest to handle. This problem was experienced in BOT projects conducted in South-Asia region and South-east Asia region.

Government Involvement

To encourage private sector participation in BOT programs, government must prepare attractive projects and provide stable political and economic environment. They must enact clear laws and regulations; develop strong domestic capital markets to borrow local long-term dept and float the project on local stock markets; ensure easy and speedy processing of the project, fair sharing of risks between government and private sectors and provide realistic incentives, adequate returns and protection of the investment.

The private sector BOT program allows governments to reallocate scarce resources. If BOT projects are conducted in a fully transparent manner and are properly structured, these will promote open competition, provide the lowest possible project cost, and transfer most risks to the private sector. The private sector's role is vital in providing wider access to capital markets, better management skills and access to latest technology, and implementing a project much faster than the public sector.

Although BOT being very popular these days and having a high success rate, but for the country which doesn’t have perfect law system, the success rate of BOT project is low. As the infrastructure projects need large investment and long time period, the risks for investor is also comparatively more. Thus investor always requires government support and guarantees. Therefore, the degree of government support and guarantee is one of the important factors in the assessment of BOT projects. In other word, government support and guarantee is an important prerequisite for the success of BOT projects.

It is true that BOT can play a big role for the development of infrastructure, but it doesn’t implies all the infrastructure projects should go under BOT-type procurement. Moreover, if a project is thought to be potentially appropriate for BOT-type procurement, then it should be consider which one is the most appropriate vehicle from the many versions, such as BOT, BOOT (build-own-operate-transfer) and BOO (build-own-operate). Ogunlana (1997) had analyzed BOT projects failures and came to the point that all infrastructure projects are not amenable to privatization. He identifies eight characteristics that indicate suitability for BOT-type procurement:

• A stable political system
• A predictable and proven legal system
• Government support for a project that is also clearly in the public interest
• Long term demand
• Limited competition
• Reasonable profits
• Good cash flows
• Predictable risk scenarios

Beside this there are also some other evaluation methods for suitability of a project for BOT, like Ashley’s Project scoring table (PST). All these methods show that there should be strong support and co-ordination from government level for the success of BOT projects.

Conclusion

From above, it can be said that for the overall success factor of BOT-type projects, the following point should be considered:

• Careful evaluation of the suitability of a project for BOT-type procurement appears critical at the outset, for example, with stable political and legal regimes and suitable socio-economic conditions with the project being clearly in the public interest, capable of sustaining steady cash flows, and being provided with adequate safeguards against the various risk factors
• A reasonable but not excessive rate of return is needed, again with any useful safeguards to achieve the desired balance
• A proactive, stable and reasonable (including non-corrupt) sponsor (e.g. government/public sector body) is needed
• A financially strong, technically competent and managerially outstanding consortium is required as a franchisee, who should hopefully be attracted by the foregoing conditions.

Even on infrastructure projects deemed suitable for BOT-type procurement, deep SWOT (strengths, weakness, opportunities and threats) analyses may be needed from time to time in advance of critical decision such as the precise type of BOT (or PPP) to be adopted and the franchisee selection.

(Author is a student, doing Masters in Engineering Management and Science at Hohai University , Nanjing , China . He is now associated as a Technical Engineer in Firestone Building Products in China .)