The Hindu Business Line : Greenfield airport projects — Time for private-public partnerships to take off

Private participation in public infrastructure presupposes an environment different from that when governments exclusively owned and operated the facility. The need for private investors to achieve stipulated levels of financial performance translates into developing systems to identify and manage risks inherent in these projects.

WHEN the delay-plagued Bangalore greenfield airport project finally took off in June, it was a welcome start to public-private-partnership (PPP) initiative in the country.

The success of this project is crucial to greater involvement of private investors and lenders in infrastructure development.

There are strong growth prospects for airport privatisation given the steady air transport expansion, the need for adequate return on social investments and the dwindling government finances. Similar models have been proposed to develop Mumbai and Delhi airports.

Though private participation in airport development and operation is an accepted concept world over and `airport privatisation' is now part of the industry vocabulary, it would be premature to dub the concept a `success'.

According to the World Bank, during the 1990s, private sponsors in 22 developing countries were involved in 89 airport projects, with investment adding up to $5.4 billion. Private participation in airports has attracted less investment than privately-sponsored projects in other transport segments.

Airport assets are viewed as strategic for national security, and, therefore, outright privatisation of airports is often met with political resistance.

It is noteworthy that greenfield airport projects, such as the Bangalore International Airport, account for just 10 per cent of global investment in private airport facilities.

A greenfield project is one where a private entity or a public-private joint venture builds and operates a new facility, entering into Build-Own-Transfer (BOT) or Build-Own-Operate (BOO) contracts for this purpose.

Other typical airport project types include `Operations and management contracts' covering leases; `Operations and management contracts with major capital expenditure' by private investors contributing 70 per cent of all private investment; and `Divestitures' (20 per cent) where a private entity holds equity stake in the state-owned airport, with or without management responsibilities. It is against this global backdrop that financial closure has been reached in the greenfield airport project for Bangalore.

At financial closure, the debt component of the project, including the local government's interest-free loan, stands at a whopping 77 per cent. Of this, Rs 7360 crore (52 per cent) will be financed by ICICI Bank.

As is characteristic of such project financing, the 23 per cent equity component is shared by multiple contributors — Siemens (40 per cent), Unique Zurich and Larsen and Toubro with 17 per cent apiece, and the local and Central governments investing 13 per cent each.

Private participation in public infrastructure pre-supposes an environment different from that was when governments exclusively owned and operated the facility.

While many government- controlled airports may not have recovered their operating costs, the use of private capital dictates that a reasonable return on investment is generated.

The need for private investors to achieve stipulated levels of financial performance translates into developing systems to identify and manage risks inherent in these projects.

Greenfield airport privatisation projects carry risks for all parties involved. The private investors consortium, entering into the concession agreement with the host government faces construction and completion risks. Thereafter, operational and market risks could impact the expected cash flows.

The host government runs the risk of project sponsors being unable to generate sufficient returns to carry the project through the concession period, or having to make substantial capital investment for upgradation after the concession period.

The project company's highly leveraged capital structure implies that any development impairing expected cash flows or project assets would directly hit the debt service capacity of the project and the lenders' bottomline.

Past experience with airport privatisations in various countries suggests that risks have generally been underestimated, especially in terms of capital costs for project construction, and forecasts of revenues from operations. Some of the `practices' noticed in earlier privatisation projects are alarming:

Private bidders prepare optimistic forecasts, leading to an over-estimation of revenue, or under-estimation of capital costs.

Natural features of the terrain jeopardise aircraft safety — in the Wellington airport privatisation, significant risk arose from the runway area extending on to narrow land, surrounded by sea.

Violation of international safety standards — the bidders' profit motive could cause airport designers to adopt a minimalist approach to reduce capital cost.

Most problems arise due to design incompatiablitywith the needs of the airport beyond the concession period.

Site expandability problems were noticed in airport privatisations in Europe and New Zealand.

Changes in aircraft mix and airline alliances altered risk dimensions for a privatised airport in Canada.

Over-estimated airport traffic and revenue due to oversimplified assumptions was seen in Manila's Terminal 3. All charges and rates were forecasted to increase by 10 per cent over the 25-year concession period, which growth could hardly be sustained in the economy.

One dominant partner influences the bids. If this partner is also a developer, attempts to minimise costs using substandard material may ensue, as was the case in Toronto.

Government policy changes and environmental impact were risk factors in many projects.

In the absence of government's detailed development plans, bidders determined the project's form and scale that met the profit objective of the private investor, but conflicted with traffic needs or government's plans, as in the case of the Manila airport. The onus is, therefore, largely on the government in privatising substantial and sensitive infrastructure such as airports.

Contracts work best when risks are identifiable, outcomes verifiable and contracts enforceable. Since risks would be allocated to various parties through contracts, it is imperative that the government institutes a sound legal framework to ensure proper risk management.

Insurance is a powerful risk mitigating mechanism in large projects. The government should take steps to deepen the insurance market to guard stakeholders against all insurable risks, including force majeure and political risks.

The project's terms of reference should be specified with absolute clarity without which the government may lose control over the vital infrastructure.

Due diligence is typically carried out by bankers and the government at the time of financing. At this juncture, some drawbacks may be rectified at huge cost or may be beyond rectification. The government will, therefore, have to carry out financial and technical reviews periodically, right from the project planning stage.

Users of privatised retail facilities, such as airports or toll roads, should be educated on the need for and advantages of paying user charges.

The markets should be able to generate public interest in subscribing to airport bonds. Structures resembling General Airport Revenue Bonds (GARBS) in the US could be introduced. The rating agencies should be equipped to handle increased demands.

The banking sector should prepare to assess risks unique to airport projects and finance the projects through innovative instruments. Growth in high risk-high return financing has to be supported by a strong securitisation framework.

The country is `crying for infrastructure'. At this juncture, airport privatisation is a bold move by the government with far reaching implications.

PPPs work well in a conducive business and legal environment. It is to the government's and the investors' advantage if such an environment can be created without delay.

(The author is a finance consultant and visiting faculty at Indian Institutes of Management. Feedback may be sent to padmalathasuresh@yahoo.com)

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Changing labour dynamics

Greenfield airport projects — Time for private-public partnerships to take off

Automobiles: Running high on confidence

Damp squib

Gas pipeline: Optimism not misplaced

Storming a male bastion

JRD — The builder of modern Tatas

Monetary policy

Independent directors