Evaluation of policy parameters, uncertainties and risks in build, operate and transfer (BOT) projects for transport infrastructure development

Abstract

There is a growing recognition that inadequate transport infrastructure in any country is an impediment to its industrial and economic progress. Governments worldwide are increasingly attempting to involve the private sector in the financing, designing, and operation of major infrastructure projects. In this context, the Build, Operate and Transfer (BOT) concept and its variants are becoming the popular mode of privatization of transport infrastructure development. The main parties involved in a BOT project are the project sponsor (government), the project promoter (concessionaire), the financiers (lenders of debt and investors of equity), the contractors, and the users of the facility. In recent years, the Government of India has introduced several initiatives to involve the private sector in transport development projects through the BOT concept. However, since the BOT concept is new in India, there is very little prior information or experience with such projects. The government should ensure that a project selected for implementation under the BOT scheme is sound when subjected to an economic analysis, and that the project is bankable, with adequate potential returns for the investors. For the successful implementation of BOT projects, it is essential that both the government and the project promoters are aware of the risks and returns of such projects. Despite all the developmental efforts made so far, there is still considerable lack of clarity on many policy parameters and on the evaluation of risks associated with BOT projects in the Indian context. This thesis aims to develop a methodological framework to analyze some of these effects quantitatively. A review of literature indicates that the conventional financial analysis, as currently practiced in transport projects, uses deterministic estimates of important parameters, involving implicit assumptions of certainty. In reality, however, many critical variables of a transport infrastructure project-such as the duration of construction, construction cost, operation cost, maintenance cost, mode mix, traffic volume, and toll revenue-are not amenable to precise prediction, and the financial performance cannot be assessed accurately. For a meaningful financial analysis of BOT projects, the effects of risk and uncertainty should be consciously considered. Hence, there is an urgent need for scientific investigation of the evaluation criteria of policy parameters and risks associated with BOT transport infrastructure projects in the Indian environment. A comprehensive simulation model is developed in this thesis to evaluate the policy parameters and the risks in BOT projects for transport infrastructure development. Risk analysis is performed using Monte Carlo simulation technique along with the Hertz model for analyzing risk in capital investments. The unique modeling flexibilities inherent in computer simulation techniques afford an opportunity to represent through the model the various complex interrelationships of the BOT process to enable better insights into the quality of decision-making. The basic inputs to the model are of three types: (a) Policy Parameters – such as the construction period, concession period, and permitted toll rates for different modes of vehicles, which are decided at the time of contract negotiations between the government and the BOT project promoter. (b) Macroeconomic Parameters – such as interest rate on long-term debt, discount rate to be used in financial analysis, the annual inflation rate during the concession period, and the estimated annual growth rates for various modes of vehicular traffic. (c) Stochastic Input Variables – related to construction cost, operation cost, maintenance cost, and traffic volume. These stochastic variables are generally uncertain, and to facilitate analysis of risk characteristics, probability distributions of these variables are used as input to the model. The output typically gives the probability distributions of the financial performance measures such as the Net Present Value (NPV) and the Internal Rate of Return (IRR). The experiment on the model is continued for a large number of replications to ensure that the results achieve a steady state and are reliable. The model permits flexibility in the specification and analysis of different toll structures, the mode of tax assessment and tax holiday policies, the options on debt service, and the consideration of toll elasticity. Four case studies of actual BOT projects under consideration in India are examined in the thesis to demonstrate the adaptability and usefulness of the developed simulation model. The model has been used to perform sensitivity analysis and scenario analysis to derive conclusions that lead to a better understanding of the impacts of changes in various policy parameters on the financial performance of the overall system. Based on the analysis of the case studies and a study of the various aspects of BOT projects for transport infrastructure development in the Indian context, several observations have been made. A few of these are briefly listed below: (a) The simulation model developed in this thesis facilitates evaluation of any BOT project proposal for financial feasibility and highlights the risks and returns under the chosen set of policy parameters. (b) The decision criteria for evaluating the financial viability of a BOT project should include the cash flow criterion (liquidity) across the concession period, in addition to the threshold values of NPV and IRR. The project promoters should ensure liquidity at the end of each year of the concession period. To this end, they should negotiate with the financiers a suitable debt service schedule that avoids cash flow problems, particularly in the early part of the concession period, as demonstrated in some of the case studies. (c) The risk profiles for the financial indicators NPV and IRR obtained from the simulation model enable the project promoter to evaluate risk with information on the probability of these falling below a desired value. (d) The concession period should be restricted to that required to recover the costs with an acceptable toll structure, ensuring a relatively high probability of obtaining an agreed value of IRR. This period can be determined using the simulation model developed in this thesis. The project promoter of a BOT project cannot afford the risk of time overrun during construction, as is commonly found in public sector projects. A time overrun of even one year adversely affects the cash flows, leading to a liquidity crunch in the early part of the concession period. (f) The toll rate structure should be designed such that the toll rates are acceptable to users, while also ensuring the financial viability of the project for the chosen concession period and the estimated traffic volume. Different options for toll rates can be examined easily using the simulation model, as demonstrated in the case studies. (g) The adoption of an appropriate value for the discount rate in financial analysis is critical for evaluating the Net Present Value (NPV) of the BOT project during its initial selection for implementation. (h) The simulation model permits the study of the effects of various corporate taxation policies for government consideration, including concessional uniform tax rates, partial tax holidays, and complete exemptions. (i) Data on toll elasticity for the Indian environment is not currently available. Consideration of toll-traffic elasticity is likely to affect the computation of revenue realizable. The extent of traffic volume and revenue changes due to changes in toll structure will depend on the characteristics of the project and can best be studied using the simulation model. To the best knowledge of the author, no comprehensive analytic research study has been carried out on the evaluation of transport infrastructure leasing projects in the Indian context. The methodology presented in this thesis is exploratory in nature, possibly the first of its kind in the Indian environment. The findings of this study are expected to benefit policymakers and entrepreneurs in evaluating the probable risks and returns of proposed BOT projects. The study is also expected to stimulate further research in this developing field.