Building Toll Roads Under Public-Private Partnerships

Building Toll Roads Under Public-Private Partnerships

August 01, 2004

Douglas M. Fried and Jonathan Finklestone wrote in the NewsWire in June in “The Route to a Financeable Toll Road” about financing toll roads from the perspective of developers and lenders. This article looks at the same subject from the standpoint of governments when considering whether to finance roads using public-private partnerships, or “PPPs.” The author is a former senior officer of a public sector development finance institution.

Fried and Finklestone aptly summarized the spirit of PPPs at the end of their article:

Ultimately, a successfully-structured toll road project can make a significant contribution to the development of a country and the overall welfare of its citizens. A careful balance must be struck among the competing interests of the developer, the government and the lenders. The challenge is to find an equitable balance where the risks and responsibilities are allocated to the party best able to handle them.

PPPs, as the name suggests, are fixed-term collaborative arrangements that are continuously evolving in different countries. Governments that use them must negotiate an equitable balance in the risks and responsibilities for the financing, construction and operation of toll roads with the concessionaires and their lenders.

PPPs make no sense unless the public sector is prepared to discard the old bureaucratic image and make improvements in governance; such changes will be expected by private investors before they will help build the priority infrastructure for the country. The government must train its officials for the new role and provide them with technical, institutional and legal frameworks for dealing with toll roads under PPPs. It is important that a transparent and fair toll policy framework be in place before any toll road project is given the go ahead.

Here are other suggestions for governments that are considering using PPPs for road projects.

Exhaust Other Options

Typically under PPPs, the private partners claim to assist the governments in the planning and design of the toll roads. Further, they arrange money and use their managerial experience and know how for cost-effective construction. They assume operational responsibility and recover their investments with profit through toll collection over a concession period that might extend up to 20 years. They actually are looking for high profit opportunities. By offering the governments to construct certain highways under build, operate and transfer, or “BOT,” financing, they will be spending the money up front, two or more years before toll collection would start. In order to bind the governments to the arrangements, they will require execution of a number of interrelated agreements, and they will want a number of guarantees and concessions. They might attempt to enhance their profits by passing to the governments even those risks that purely belong to them. Unlike the governments, the private investors can hire the best technical and legal experts, and they might attempt to conclude agreements that are heavily tilted in their favor. This calls for proper vetting of all major parameters of the projects and careful negotiation of the concession agreements by the governments.

A BOT project is generally costlier to finance and difficult to negotiate, and it takes longer to realize than a more traditional public-sector project.

There are other options besides BOT. In the past, governments have usually built roads relying on in-house expertise for supervising private contractors for construction as per approved design and specifications. Roads were financed through budgetary allocations, sometimes mixed with loans from international financing institutions. Governments would normally service the loans from own resources, and road users were not required to pay any tolls. More recently, due to liquidity constraints, countries have started auctioning the rights to toll collection. The private contractors collect tolls from the road users and periodically pay agreed amounts to the government. There is now enough of a track record in many countries to demonstrate that such arrangements work well when they are negotiated properly with credible private parties, and the private parties are monitored to prevent any exploitation by them of the road users.

A government might take measures to mobilize resources locally for financing construction of infrastructure projects before resorting to BOT. Highway bonds issued by the federal or provincial government are one option. A government might allow an income tax exemption for the interest paid on the bonds with a view to making them more attractive to the investors. Local commercial banks and development finance institutions might be attracted to meet part of the capital cost or to fill a financing gap. A government might also explore relatively cheaper credits from the World Bank or Asian Development Bank for financing construction of important highways. Once the highways or related infrastructure projects are operational, toll rights can still be auctioned off in a transparent manner on a yearly basis. Through this approach, the users are expected to pay reasonable tolls, and the government is expected to generate enough cash for debt servicing and maintenance of roads. BOT financing might still be considered after other options have been exhausted.

Governments better keep in view the axiom, “Look before you leap.” There will be pressure to honor contracts, no matter how one-sided or unfavorable, once the contracts have been executed with concessionaires and banks. To avoid unpleasant situations, governments should do their homework properly.

Homework

Do an analysis of existing roads as against present and projected needs. Identify bottlenecks in transportation of import-export goods and costs thereof and investigate the past experience with borrowings for roads from the World Bank and ADB. Look into all of the following: laws and practices for road construction, acquisition of land for roads and compensation to land owners, the quality of local private companies building roads, the capability of the highway department for monitoring construction, the actual cost of construction per kilometer for different terrain and specifications, the existing toll roads in the country and basis for fixing tolls, the projected road traffic for efficient import-export and regional trade, and the debt situation of the government in relation to total annual exports.

Do a critical review of the experience the government had with independent power projects that were built under PPPs, if any. Maybe the government has also had experience with river bridges, light rail, amusement parks, shopping malls and similar projects that were constructed on a BOT basis. Take time to identify any lessons learned from these projects before embarking on a new toll road project using a PPP.

Look at the experience and laws in nearby countries with toll roads built under PPPs. Once documents are reviewed locally, learning visits might also be made to those countries. Seek assistance for know-how, documents and reports from the international financing institutions, particularly the World Bank, which has done tremendous work in this sector.

Establish a special cell in the highway department to concentrate on toll roads under PPPs. The cell should monitor execution of PPP projects. Proper mechanisms should be in place to ensure compliance by the private sector with technical, legal and financial matters as per contracts. The cell should serve as a “one-stop shop” for contacts by the private sector with other departments.

The country will need a separate regulatory authority to work on the level of toll, its rationale and tenure. The regulatory authority cannot operate in a vacuum. It must be provided with clear laws, policy guidelines, and general principles of regulation. It should have operational independence once these principles have been established. The regulatory authority should be directed to take into account the impact of exemptions in taxes and issuance of shares to the concessionaire on the level of toll in real terms and the profits that the concessionaires actually make.

Any government undertaking a PPP should engage technical, financial and legal experts of international repute to assist it. Otherwise, the government risks being out negotiated by private developers. Institutions like the World Bank and the ADB can be consulted in the selection of advisors and finalization of the policy framework. It is a good idea also to consult local political groups. Strong cross party support at the national and regional levels are essential for any government trying to address the infrastructure backlog using PPPs.

Legislation will be needed to authorize the government to enter into contractual arrangements with the private sector and to provide tax incentives or other benefits, if any. This is probably a good thing, since the process of legislating helps create political support. It will reduce the chances of internal disagreement once actual construction of toll roads has started on a PPP basis. Clear legislation will also help attract more local and foreign private money. The process of writing the legislation will provide rigor for the analysis whether to use PPPs.

Before embarking on a PPP, the government should decide how all of the following issues will be handled. What rights and for how long will private sponsors have for collection of tolls from road users? What exemptions will sponsors have from import duties and income and other taxes? Will the sponsor be reimbursed for its development costs in the event that the project is cancelled? Will the government guarantee minimum traffic levels or toll revenue? How are upside revenues to be shared between the government and private sponsors? What cure and step-in rights and other protections will be given to lenders?

The government will have to decide on the criteria for pre-qualification of private consortia: technical, managerial and financial strength, creditworthiness, involvement in litigation and past record of projects completed. A request for proposals will have to be drafted and rules drawn up for open bidding among pre-qualified consortia. The government should propose a fixed-price, lump-sum, date-certain turnkey contract, with liquidated damages and bonus to ensure timely performance and a completion guarantee by the private sponsors. Thought must be given to whether to allow the concessionaire to generate revenue from other activities along the road.

The request for proposals should also address the road design and specifications, including access to the toll road, number and location of interchanges, and how change orders are to be handled. It should be clear about the role the highway department will play in construction, operation and maintenance, the bases for toll determination and periodic increases, the role of any regulatory authority in toll determination, the method for charging tolls, the government’s responsibility for education of drivers about payment of tolls and for tackling opposition from local communities, what happens if archaeological artifacts are discovered requiring route diversions, and what will be expected from the private sponsors in the way of environmental considerations and compliance.

The people displaced by the toll road should be properly rehabilitated. In addition to immediate payment for their land at market prices, the government might give preference for commercial activities along toll roads to people who surrendered their land for toll roads.