Friday, February 4, 2011

Off-loading construction risks in infrastructure

I have blogged earlier about the different models of infrastructure financing here, here, and here. Those posts also highlighted the importance of construction risks in developing countries and how such risks could be more effectively managed by governments. Post-construction, the assets could be contracted out (minus the construction risks) to private contractors.

The Bandra-Worli Sea Link (BWSL) was built at a cost of Rs 1800 Cr, several years behind schedule and at substantial cost over-runs. Once constructed, the Maharashtra Government (through the Mahrashtra State Road Development Corporation, MSRDC) have contracted out its maintenance and toll collection to Reliance Infrastructure for the next 40 years, starting from April 1, 2011.

In 32 months, starting from April 1, Reliance Infrastructure will construct the new 3.8 km sea-link between Worli and Haji Ali (WHSL), with connectors at Worli and Haji Ali. The contractor will recover the total cost of maintaining BWSL as well as construction and maintenance of WHSL for 40 years by charging toll from commuters.

Under the terms of the concession agreement, the contractor will make an upfront payment of Rs 1634 Cr and the toll rates will increase at the rate of 3% each year. The toll rates for BWSL, before and after completion of WHSL, have been fixed.

This model of contracting out the maintenance and toll-collection of BWSL in the immediate aftermath of its construction and recovering the public investment has important lessons for public policy in infrastructure. It aligns the incentives of all the stakeholders into a model that involves the most optimal distribution of risks.

It is all the more significant for countries like India where construction risks (delays and cost over-runs) are substantial and market forecasts are fraught with uncertainty. Shorn off these risks, these investments are likely to draw in capital at very attractive terms. The resultant lower cost of capital will have a substantial impact on the total cost and the financial viability of the project itself.

Further, it also addresses other concerns like traffic risk, a common challenge with road projects. Once the project (in this case, road) is commissioned and fully operational, it becomes possible for bidders to assess the traffic potential and its risks, and thereby make more informed bids. In case of the BWSL, the bidders can therefore bid with a much greater knowledge of the project's traffic outcome.

With construction risk off-loaded and traffic risk mitigated considerably, BWSL can attract financing capital at much lower cost. The MSRDC therefore would be able to capture much greater value from its concession agreement with the private operator.

1 comment:

sai prasad said...

In principle this looks gOod. Govt absorbs all the risk and the private sector brings money in. In this case we certainly need mid course corrections to ensure that there is no profiteering by the pvt sector and they gain only on a cost plus basis as they do not face any risk.