CHALLENGES IN PRIVATE STRUCTURE INFRASTRUCTURE PROJECTS
Presentation at the SAFIR Programme in Sri Lanka
By S L Rao
1) Infrastructure in developing countries, as in most developed countries till a few
years ago, has been an area in which the major investment in generating and
providing the services was by governments. This was true in all areas: Electricity
(not as much in oil and gas production though governments played a crucial role
in giving support); Transport; Water and Sanitation; Railways; Road transport;
Airports and Telecommunications. It was only in the 1980’s as privatization and
less government swept economic policy, coinciding with the decline of the Soviet
Union, that the provision of infrastructure services by private parties began to be
seriously considered by some governments. The USA was a different case since
private provision of many infrastructure services like power, oil and gas, road and
rail transport and telecommunications, were in the private sector almost from the
outset.
2) The developing economies had been subject to Marxist ideologies and believed
that only government could be trusted to look after the interests of the most
vulnerable sections of society in the provision of these services. Scarcity of
resources, the lack of a thriving private sector and the superior ability of
government to raise the required large resources domestically and overseas, were
some reasons for government dominance of infrastructure investment. There was
a common feeling in these countries (among many even today) that opening
infrastructure to the private sector would hurt the interests of the many poor who
could not afford to pay for their full costs, and given the low levels of usage might
not get good quality service. Where the sector was already in government hands,
their disinvestments to private parties was felt to be giving away national assets
built by the State. In the case of new projects it was felt that at least some of
private parties who came forward were bogus ones who did not have expertise
and many times not even the finances, but were looking to raise it on the back of
such a project. Private investors were expected to exploit consumers, raise tariffs,
serve only prosperous customers, create private monopolies and prevent
competition.
3) Private investors also saw many risks in investing in infrastructure projects in
developing countries. There were payment risks, that they would not get paid for
their services or paid inadequately. There was always the fear of government
taking over the assets with little compensation. Public opinion seemed to
disfavour private investment in these areas and governments and political parties
were not very vocal in support. If private investment is to come about, there has to
be an enabling environment for it and a long-term commitment to infrastructure
development from government. This requires that governments are willing to take
unpopular actions like forcing higher tariffs, stopping services to these who do not
pay their bills, prosecuting thieves, etc.
4) What are some prerequisites if private investment is to enter into infrastructure
areas? There must be a strong, fair, objective, unbiased regulatory framework.
The institutional framework of consultants, lawyers, Courts, credit rating
agencies, merchant bankers, etc must also be well established. The markets must
be contestable so that anyone qualified to do so can enter as investor in the
infrastructure area. There must be a competition policy in place as well as a
specialist body to enforce competition so that the presence of competitors acts to
discipline investors. To prevent public monopolies being replaced by private
monopolies, contracts that have non-exclusivity periods and open entry to
segments of service delivery like T & D are desirable. Ways must be found to
generate reasonable rates of return for the investor. Management contracts could
reduce costs and lessen leakages in production and distribution. Efficiency gains
could enable cost recovery through the principle that the ‘consumer pays’. There
is enough survey evidence that if user charges are reasonable and affordable,
consumers often prefer efficient service delivery to receiving subsidized services
that might not even reach them. At least for a transition period, governments
should allocate funds to support service delivery to the poor. The private sector
and civil society must be empowered to enable speedier implementation of
reforms through effective representation and participation of private sector on
infrastructure regulatory boards and management institutions. Then again privatepublic interagency committees within government line Ministries might review
policy implementation at agreed times. Policy improvements are needed on three
fronts:
 Efficiency issues in the management and reform of the public sector
 Governance issues of institutional transparency, reliability and accountability
 Private sector unity of purpose and willingness in public-private partnerships.
Efforts to bring about these improvements must precede private entry into
infrastructure.
5) To understand the extent of private entry into infrastructure it would be useful to
see how many projects were cancelled. For this purpose we define cancellation of
projects in one of three ways: those in which the private investor has sold its
interest to the public sector; where it has physically abandoned the project; and
where the private company has ceased to provide services to all customers or has
halted construction on the project. .
6) Contrary to popular understanding the renegotiation or cancellation of private
infrastructure projects in developing countries has been quite small. Data from the
World Bank (PPI-Private Participation in Infrastructure Project Database) shows
that 48 projects were cancelled out of a total of 2500 such projects that reached
financial closure between 1990 to 2001. ‘Cancellation’ uses the criterion of
whether the private sector continued to be active in a project or not, rather than a
strict legal definition of exit from the project. Thus a project that has been
abandoned by a private party and later revived by another is regarded as having
been cancelled. But if the private party sold its interest to another without a
cessation of service or abandonment, it is not a cancellation. On this definition,
cancelled projects were only 1.9% with investment commitments of $24.2billion,
amounting to 3.2% of the total investment of $754billion. On average, projects
were cancelled four and a half years after financial closure. More than a third of
cancelled projects were from the Mexican toll road programme and without these,
the cancelled projects would be only 1.0% of projects that reached financial
closure in this period. The second highest rate of cancellation was of projects in
the water sector, followed by electricity projects in distribution and sale to final
consumers. The eight cancelled projects in telecom were only 1.2% in number
and 0.4% in investment value of projects in that sector. However it must be said
that the second half of the 1990’s saw a higher trend of cancelled projects.
7) Does private entry necessarily mean significant improvement? Let us take a look
at some experiences of private investment from a study of private electricity
distribution utilities in India. Such a study could also help in avoiding structural
and contractual inefficiencies in new private entries in infrastructure. Of the six
private utilities, CESC had 23.4 % T & D loss in 2000-01 and the trend has been
rising over the previous five years. Three other companies, despite serving urban
areas and many bulk consumers, also had high losses. While receivables of these
companies were at reasonable levels, manpower performance and cost showed
wide variation, from an average cost per man month of Rs10200 in Noida to Rs.
5700 in Surat. Employee cost per unit sold varies from Rs0.11 for Tata, a
predominantly generating company, to Rs. 0.05 for Noida and Rs. 0.21 for CESC.
Significant investments are made in distribution assets with utilities in Bombay
investing Rs. 2700million per year in distribution. Capital investment (Rs. per unit
sold) by CESC is Rs. 2.78, the highest among distribution licensees in total
investments and the current rate of investments. CESC investments are higher
than the combined investments for Bombay’s utilities. Yet power quality is worse
in Calcutta than in Bombay. Similarly the distribution costs also vary a lot and are
particularly high in Calcutta and Bombay. Finally the regulator also has been
tardy in Bombay in his readiness to hear tariff revision applications. Thus neither
the operations of the present private distribution licensees nor the regulatory
arrangements can be a model for the future. They must improve.
8) AES cancelled by walking out of the Orissa electricity distribution company
CESCO that they were running. There are many aspects to the story. But they
walked out while the other private investor BSES has stayed despite running three
circles to AES’s one. This does suggest that AES approached the management of
a former public utility in a somewhat aggressive fashion and in the process lost
sympathy and support. The Orissa privatization of distribution exercise can be
faulted on many grounds. It was based on poor information and it is surprising
that BSES and AES entered despite this. The state is the most backward and
poverty-stricken, with relatively inefficient governments, tariff uncertainty, high
level of losses, high collection risks, lack of paying capacity of many consumers,
problems of inherited staff, difficulties of imposing own management and
bringing in own employees (as happened to AES who did so and found
themselves unable to manage the enterprise), and poor information from the
Orissa government. Perhaps private entry should take place only in States where
governance is of good quality.
9) The privatization of electricity in Delhi and the proposals for it in Karnataka
illustrate the difficulties of private entry into distribution in a developing country.
Both governments decided that they could not by themselves revive the sector and
that private entry was the only answer. Orissa has put off private investors who
need a transition plan with well-defined sharing of risks and responsibilities
between government, private investors and consumers. The main elements of such
a transition plan are:
 Multi-year tariffs to enable licensees to plan efficiency improvements
and investments and providing for
1. Pass-through of power purchase costs, not merely fuel price adjustments
2. Phased reduction and ultimate elimination of cross-subsidies
3. Tariffs based on standard costs and efficiency parameters and actual
technologies in use
 Licensees commit to a binding multi-year programme to achieve
the standard costs and efficiency parameters
 Need for subsidy during the transition period to bridge the gap
between targets and actual1. With the cash deficit being financed by government.
2. From the Regulator, a tariff plan
3. From the Distcom an efficiency improvement plan
4. Subsidy commitment from government
5. Together to ensure break-even for the licensees
6. And a binding agreement among Government, Distcom and
Regulator with the Regulator enforcing the commitments.
 Clearly the government and the SEB need to take a
number of fundamental risk-mitigating actions prior
to attempting privatization. These include:
1. Close to 100% metering, billing and
collections.
2. Disconnection of illegal connections
3. Less one-sided terms with employees
4. Progressive reduction of cross-subsidies
5. Transfer of irrigation load to a separate
organization.
Private entry cannot take place without
considerable prior hard and difficult decisions
being implemented.
10) The essential problems of the Enron-Dhabhol project were its extremely high
and apparently heavily padded capital costs, the suspicions about the backhanders
paid on the project, the high levels of public distrust and the inability of
consumers to pay the resultant tariffs. The Godbole Report came to some
conclusions. Meanwhile the plant is still lying shut. Enron has been thoroughly
discredited. Demand growth has been much slower in Maharashtra. The
resumption of the project with the same foreign parties as before is very unlikely.
It may restart under a state-owned enterprise.
11) Reasons for Cancellation of private projects in Electricity: In developing
countries, electricity has become a right that many expect to be cheap and easily
available. Dominance of government ownership has led to overstaffing, gross
inefficiencies, tolerance of theft and collusion in theft, poor commercial and
accounting practices, poor investment in maintenance and modernization, and
rising deficits. Distribution and supply are the worst affected. Private investors are
reluctant to take over hitherto state-run distribution unless they get guarantees on
safeguards against risks as well as for adequate return. The governments are
unwilling and unable to take the actions required to clean up the system in order
to make the investment attractive for private investors.
12) Coimbatore By-pass and Bridge: This is an example where the role of
government in a public-private partnership was questionable. An additional bridge
to make the old two-lane into four-lane and a 27.77 km bypass were to be built on
a BOT basis. The cost was to be recovered through tolls on both bypass and
bridge. The contractors were allowed to charge tolls for twenty years on the
bridge and for thirty on the bypass. While traffic risk was with the contractors the
risk due to non-payment of tolls was with the government. Multiple users (state
and private buses, taxis, trucks) did not want to pay for each trip and others did
not want to pay for each trip when there had been no toll on the old bridge. The
contractors were agreeable to concessional tolls for state and private buses with
the financial loss to be made up by government. Police support to collect tolls was
ineffective. After four years the contractors had lost Rs. 126 million. The usage of
the bridge is heavy and has been a great convenience to users but there was
unwillingness to pay tolls. Only one bidder, lack of preparation of public opinion,
weak government commitment was some reasons for the unhappiness of all
parties.
13) Mini Buses in Tamil Nadu was to supplement state and private bus transport in
un-served rural areas. The project design was adapted to suit the demands of
operators to allow some overlap with served areas. The bus size, design, distance
traversed, number of trips, tariffs, etc were specified. While the public is happy
the operators are not making sufficient profit. Partly this is due to competition.
Minibus owners overcrowd the buses to make up and because the distances are
limited, customers do not protest. Maintenance and fuel costs are high in relation
to tariffs because of the poor quality of roads while inadequate fares depress the
profitability.
14) Privatizing transport in Britain: This was an initiative of the Thatcher and
Major governments and appears to have led to all round dissatisfaction, with poor
timeliness, deterioration in safety, and poor overall performance. It raises
questions about any wholesale privatization of public transport.
15) Reasons for Cancellation of Private Projects in Transport: The inability of
governments to give the support that they had committed to the project-for
example, in collecting tolls-is an important reason. The forecasted number of
users is poorly estimated, consequent lower use of the tolled facilities, leading to
revenue shortfalls. Users had alternative toll free facilities that they could use. In
some cases tolls were imposed on the improved facilities when there were none
charged on the earlier unimproved one. The tolls were set too high and did not
make allowance for frequent and multiple users. Governments by accepting traffic
risks made the private investor lazy. Investors did not do their own homework
independently to check the traffic forecasts. Governments also failed to build
public opinion in favour of such projects and the tolls that would have to be paid.
16) The Project for Water-supply & Sewerage in Pune suffered from similar
deficiencies and was cancelled. Pune had high levels of unaccounted water,
intermittent supply, low pressure, limited sewage treatment, rising river pollution
and need to extend services to include an addition 0.8 million inhabitants. The
project was to remedy deficiencies and meet future demand. Three different
contracts for construction, operations and management, billing and collections
management were to be awarded to one contractor. Financing was to be internal
and external with Pune Municipal Corporation guaranteeing one-third of the cost
from public funds and two-thirds to come from private funds to be arranged by
contractor. PMC would create a special fund from octroi collections. Substantial
tariff increases were proposed. The project was cancelled because of loss of
political support despite being consistent with state policy on public-private
partnerships for infrastructure development, close consultations at all government
levels, and broad cross-party support.
17) The Tirupur Water supply Project has reached financial closure and is to
commence with first phase completion in 2005. It was initiated by local industry
in a town that manufactures knitted products for export. Tirupur knitwear
accounts for a substantial part of India’s garment exports. There is insufficient
water for domestic use and for the industry, and there are pollution and attendant
problems. The focus of the project was on plugging the 25% leakage of water.
There was local equity participation. It has received wide funding support and is
expected to make good progress.
18) Reasons for Cancellation of Water Supply & sewage Projects:
This is a sector in which tariffs have been much below costs and collections also have
been very poor. Viability of new investments in this sector would depend greatly on
plugging leakages of water and collections. Many times this is not enough and tariffs
also may have to rise. Some of this might be done in advance of the entry of the
private investor. But the capital investments required must be carefully evaluated for
their impact on tariffs and the prospect of their being accepted by users. Public and
political opinion must be mobilized in advance behind the project. Much prior work
by the State is needed before private entry.
19) Telecom projects from which private investors have withdrawn are different from
other infrastructure projects. The reasons for withdrawal have to do with high
license fees in relation to the revenues, governments trying to impose artificial
market structures (as in India), and inadequate demand.
20 and 21) SOME LESSONS:
Private entry is not a magic wand that will resolve complex ills in an infrastructure
area. It needs an enabling environment if it is to be effective. The owner, government,
has to do a number of things in advance. It must create a commercial culture in the
area. It must introduce professionalism in management. It must become demanding in
terms of work and efficiency. It must provide rewards and punishments for
performance. It must develop efficiency standards and try to reach them.
To attract the maximum interest the project should be properly packaged; the balance
sheet and accounting history should be clear, the assets must be listed and valued, the
Detailed Project Proposal must be professionally prepared so that difficult issues are
resolved in advance, and the risks must be well defined.
The government must define its social objectives, estimate their costs over a specified
time frame and provide for them, making the funds available to the enterprise in time.
It must give law and order and other support to the contractor to ensure that the
contractor gets his dues and is able to function as per the contract.
It must enable independent, transparent and objective regulation of licensing, tariffs
and other decision-making.
It must have transparent procedures for selecting the project investor/s, have clearly
laid down procedures for information, reporting, performance, etc.
Private entry must not coincide with tariff shocks. Tariff rises will have to be phased
and subsidy amounts estimated and provided.