risk analysis of infrastructure projects.pdf

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Risk Analysis of Infrastructure Projects A Case Study on Build ~Operate

~Transfer Projects in India

AUTHOR PROFILE:

NAME: Dr. Hiren M Maniar *

INSTITUTE: - L&T Institute of Project Management, Vadodara, Gujarat, India

E Mail:- [email protected]

PHONE NO:+919898010291

* Dr.HIREN M MANIAR is currently working as a Faculty in Finance at L&T Institute of ProjectManagement, Vadodara, Gujarat, India. He may be contacted at [email protected]

Paper Published in the in International Journal The IUP Journal of Financial Risk

Management Vol.II No.4 December 2010. For more details please refer link

http://www.iupindia.in


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Abst ract :

The growth of the infrastructure sector in India has been relatively slow compared with the industrial

and manufacturing sectors. The energy shortage, an inadequate transportation network, and an

insufficient water supply system have caused a bottleneck in the countrys economic growth. The

Build-Operate-Transfer (BOT) scheme is now becoming one of the prevailing ways for infrastructure

development in India to meet the needs of Indias future economic growth and development. There

are tremendous opportunities for foreign investors. However, undertaking infrastructure business in

India involves many risks and problems that are due mainly to differences in legal systems, market

conditions and culture.

It is crucial for foreign investors to identify and manage the critical risks associated with investments

in Indias BOT infrastructure projects. Based on the survey, the following critical risks, in descending

order of criticality, are identified: delay in approval, change in law, cost overrun, dispatch constraint,

land acquisition and compensation, enforceability of contracts, construction schedule, financial

closing, tariff adjustment, and environmental risk. The measures for mitigating each of these risks are

also discussed. Finally a risk management framework for Indias BOT infrastructure projects is

developed. Main purpose of this paper is to investigate critical risks associated with Build Operate

Transfer projects in India.

Keywords: Risk management, BOT, Infrastructure projects, Mitigating measures


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INTRODUCTION

Scenario of Infrastructure development in India

India's economy has shown remarkable growth over the past several years and many foreign

economists predict a healthy growth in the near future. A private international forecasting firm predicts

that India's GDP will grow at an average annual rate of about 8 per cent between 2010 and the year

2015.

India's investment reforms, rapid economic growth and social development have led to a surge in

foreign direct investment (FDI). Annual utilized FDI in India grew from $636 million in 1991 to $26

billion in 2009, making India, in recent years, the third largest destination of FDI in the world.

A number of reasons can explain Indias attractiveness to foreign investment.

1. Relatively cheaper human resources, especially the labour. (It is okay)

2. Governments at all levels in all states are eager for funding their local economic growth and

have become increasingly friendly to foreign investors.

3. A number of major international events have shown that India is safer oasis of investment.

4. The economic and social infrastructure that used to be considered as bottlenecks has been

significantly improved in recent years. Governments at various levels in have been making

investment in infrastructure development to keep pace with the local and the national

economic growth.

5. India's economy has shown remarkable economic growth over the past two decades at an

average annual rate of about 7.5 per cent, it is expected that India's GDP will grow at an

average annual rate of about 9 per cent in year 2010.

6. India became a member of the World Trade Organization (WTO), which enables India to play a

major role the development of new international rules on trade in the WTO, gives India access

to the dispute resolution process in the WTO and makes it easier for reformers in India to push

liberalization policies.

The tremendous economic growth in India has resulted in an immense demand for basic

infrastructure like roads, tunnels, power plants, water treatment plants and so on. In 1991, India

began to investigate financing ways, specifically through the BOT scheme to meet the needs for the


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country's infrastructure and to be attractive to foreign investors. BOT has the potential to be one of

the most effective ways for India to raise funds for infrastructure projects in the near future. It also

provides opportunities for foreign investors to penetrate into new markets in India. Despite this there

may be a reluctance to engage in BOT because the application of BOT projects has a relatively short

history across the world and especially short in India. This means that the BOT scheme may not be

well understood and received by foreign investors (in terms of its policy hurdles and its effectiveness

in India)or by the Indian government representatives handling it.

Furthermore, despite the tremendous opportunities to invest in infrastructure projects in India, it is

inevitable that such projects will incur risks and obstacles. Unfortunately, the traditional mechanisms

for project risk allocation that are available in other countries, may not be suitable in India due to

differences in legal systems, market conditions and culture. In order to successfully implement BOT

schemes in India, therefore, foreign investors will need to identify and find ways to mitigate the critical

risks (considering diversity in terms of various issues pertaining to political front, policy matters and

demographic issues along with geographical challenges). The purpose of the research is to identify

and evaluate the critical risks associated with Indias BOT infrastructure projects; and develop a

framework for managing these risks that all parties to BOT infrastructure projects can refer.

Challenges for inf rastructure development in India

The government officials as well as economists are aware, however, that the growth can be sustained

only if further reforms are made to the economy. India's banking system is regulated and controlled

by the central government, which sets interest rates and attempts to allocate credit to certain Indian

firms. The current financial state of the banking system prevents Indias government from opening the

sector to foreign competition (This is due to worsening Non- Performing Asset situation of banks in

India). Corruption poses another problem for India's banking system because loans are often made

on the basis of political connections. In many cases, bank branches extend loans to firms controlled

by local officials, even during periods when the central government has attempted to limit credit. Such

a system promotes widespread inefficiency in the economy because savings are generally not

allocated on the basis of obtaining the highest possible returns. In addition, inability to control the

credit policies of local and provincial banks has made it very difficult for the central government to use

monetary policy to fight inflation without causing major disruptions to the economy.


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Infrastructure bottlenecks, such as inadequate transportation and pollution remedial stems, pose

serious challenges to India's ability to sustain rapid economic growth. India's investment in

infrastructure development has failed to keep pace with its economic growth.

The unfledged rule of law in India has led to widespread government corruption, financial speculation,

and misallocation of investment funds. In many cases, government "connections," not market forces,

are the main determinant of successful firms in India (In the form of Public Sector Units in

Infrastructure sectors). Many foreign firms find it difficult to do business in India because rules and

regulations are generally not consistent or transparent, contracts not easily enforced, and intellectual

property rights are not protected (due to the lack of an independent judicial system). The lack of

effective rule of law, current ownership of land and widespread local protectionism in India limits

competition and undermines the efficient allocation of goods and services in the economy.

A wide variety of social problems have kept arising from India's rapid economic growth and extensive

reforms, including pollution, a widening of income disparities between the coastal and inner regions of

India, and a growing number of bankruptcies and worker layoffs. This poses several challenges to the

government, such as enacting regulations to control pollution, focusing resources on infrastructure

development in the hinterland, and developing modern fiscal and tax systems to address various

social concerns (such as poverty alleviation, health care, education, worker retraining, pensions, andsocial security).

All the unfavorable aspects will produce numerous uncertainties for infrastructure development in

India.

In 1991, Finance Minister of India Dr. Manmohan Singh outlined a number of major new economic

initiatives and goals for reforming India's economy and maintaining healthy economic growth,

including:

1. Expand domestic demand, especially through increasing spending on infrastructure in

response to the Asia financial crisis, and maintain the pace of previously planned economic

reforms.

2. Reorganize the banking system to increase the regulatory and supervisory power of the central

bank and make commercial banks operate independently. Substantially reduce the size of the


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government and reorganize the remaining government institutions. All three goals are to be

obtained within three years

Above measures Govt. of India implemented in the form of relax in FDI (Foreign Direct Investment)

and sound banking and regulatory system, which further helped to lure foreign funds in the form of

FDI and FII towards infrastructure sector.

The Indian government anticipates that banking and other financial reforms will lead to widespread

layoffs. Stimulating domestic demand, especially through infrastructure development, is viewed as a

key mechanism to re-employ workers displaced by reforms. Issuance of government bonds has

become a major source of finance for infrastructure. However, such policies will likely increase the

size of the central government's budget deficit. It is also likely that India hopes to attract foreign

investment for much of its infrastructure needs.

LITERATURE REVIEW

The followings are the main findings through the literature review:

1. The BOT scheme to financing infrastructure projects has many potential advantages and is aviable alternative to the traditional approach using sovereign borrowings or budgetary

resources.

2. BOT projects involve a number of elements, such as host government, the Project Company,

lenders, contractors, suppliers, purchasers and so on. All of which must come together for a

successful project.

3. The application of the BOT scheme in Indian infrastructure development is being carried out

stage by stage.

4. There are two broad categories of risk for BOT projects: country risks and specific project

risks. The former associated with the political, economic and legal environment and over which

the project sponsors have little or no control. The later to some extent could be controllable by

the project sponsors.

5. A few researches of risk management associated with Indias BOT projects focused on a

particular sector. Different researchers appear to have different points of view on risk

identification because they have approached the topic from different angles.


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6. A particular risk should be borne by the party most suited to deal with it, in terms of control or

influence and costs, but it has never been easy to obtain an optimal allocation of risks. Risk

management is a critical success factor of BOT projects.

Above points are as per KPMG report on India Infrastructure sector dated 22nd July 2010.

RISKS ANALYSIS OF INFRASTRUCTURE PROJECTS

Risks associated with infrastructure projects

The risks for infrastructure projects have a wide range of sources and can be classified into the

following broad categories (This is based on speech of Dr. Montek S. Ahluwalia, Deputy PlanningCommission, please refer the link

(www.planningcommission.gov.in/aboutus/speech/spemsa/msa009.doc):

1. Technical, quality or performance risk--such as employment of inexperienced designers,

changes to the technology used or to industry standards during the project.

2. Organizational risks--such as cost, time and scope objectives that are internally inconsistent,lack of prioritization of projects, inadequacy or interruption of funding, and resource conflicts

with other projects in the organization.

3. External risks--such as shifting legal or regulatory environment (including institutional

changes), poor geological conditions and weather, force majeure risks such as earthquake and

floods.

4. Project management risks--such as poor allocation of time and resources, inadequate quality

of the project plan, poor use of project management disciplines.

The experience of private investment in infrastructure in India over past years indicates that risks and

pitfalls go together with opportunities. Proper identification, therefore, of the risks associated with

investment in infrastructure in India and planning for effective responses thereto are essential for the


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private investors to be successful. In general, in order to be successful all capital projects shall meet

the criteria and have the characteristics as listed below.

1. A credit risk rather than an equity risk is involved.

2. A satisfactory feasibility study and financial plan have been prepared.

3. The cost of product or raw material to be used by the project is assured.

4. A supply of energy at reasonable cost has been assured.

5. A market exists for the product, commodity or service to be produced

6. The best way to appreciate the concerns of investors in infrastructure in India is to review and

consider some of the common causes for their failures as shown below.

Delay in completion, with consequential increase in the interest expense on construction

financing and delay in the contemplated revenue flow.

Capital cost overrun.

Technical failure.

Financial failure of the contractor.

Government interference, inactions.

Uninsured casualty losses.

Increased price or shortages of raw materials.

Technical obsolescence of the plant.

Loss of competitive position in the market place.

Expropriation.

Poor management.

Overly optimistic appraisals of the value of pledged security, such as oil and gas

reserves.

Financial insolvency of the host government.

In particular, for private investors to be successful in their infrastructure projects, these risks must be

properly considered, monitored and avoided throughout the life of the projects.


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Risks associated with Project Financing of Infrastructure Projects

According to P.K. Nevitt (Project Finance by Peter K. Nevitt, Frank J. Fabozzi , Euromoney

Institutional Investor (2000)) the risks that the lenders may take in project financing may include.

Country risk. Such country risk consists of a politically-motivated embargo or boycott of a

project, debt repayments or shipment of product which may reflect the foreign policy of the

country. Country risk also considers circumstances where the host country cannot permit

transfer of funds for debt service because of its own economic problems.

Political risk. Political and regulatory risks are inherent in doing business. They affect all

aspects of a project, from site selection and construction through completion, operations and

marketing. They are difficult to evaluate. Where possible, these risks are assumed by

sponsors. Where this is not possible, lenders sometimes assume such risks. The ultimate

political risk is expatriation. It is often difficult to distinct this risk from country risk

Sovereign risk. Lenders used to making credit judgments for loans to countries are in a

position to make lending decisions where the project is owned entirely or in part by an agency

of a country (This in terms of collateral or security and guarantee from Govt. of India. Being a

BOT Projects it very essential to mitigate risk from lenders perspective hence this risk is very

essential from lenders point of view).

Foreign exchange risk. Where capital expenditures, operating expenses, revenues and

borrowings are not in the same currency, the lender may be asked to assume some of the risk

through multicurrency loans which give the borrower an option, based upon a fixed exchange

rate, of repaying in different currencies. Lenders can sometimes hedge this risk.

Inflation risk . The lender must ultimately rely on projections of the cost of construction of the

project, and the cost of operations. Use of correct inflation factors in figuring out these future

costs is an area in which the lender usually has more expertise than the project company or its

promoters.

Interest rate. Loans with floating interest rates may be used for construction loans and long-

term financing, as well as for working capital and short-term needs Forecasts of future interest

rates used to or project capitalized construction costs and future debt service requirements are


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dependent upon realistic interest rate assumptions (Due to Global economic slowdown and

stimulus packages by various countries, it is advisable to have interest rate in floating condition

till we get clear picture about complete recovery of economy from economic slowdown.

However, considering uncertain economic environment it is very much essential to predict

interest rate in perfection to reduce interest outgo and speedy payment of loans for the

projects).

Risk Appraisal of infrastructure projects

This can be done based on following

Availabi li ty of permits and licenses. Where permits and licenses must be obtained and

renewed before the plant will operate, the lenders, in effect, assume the risk that such permits

and licenses will be obtained in a reasonable time in the absence of any provision by the

sponsors to pay these costs.

Operating performance risk. Once the project is complete and operating to specifications,

the project begins to assume the characteristics of an established operating company. As the

completion guarantees drops away, the lenders in many project financings become dependent

on the continued uninterrupted operation of the project and sale of its products or services to

provide the revenues necessary to repay the project loans.

Price of product. The lender must appraise the future market for the commodity and make

judgments as to whether such price projections are realistic.

Enforceability of contracts for product. Even if a project is supported by take-or-pay

contracts with adequate escalation clauses, a question still arises as to whether the contract is

enforceable, and whether the contracting party is a reliable party who will live up to its

contractual obligations. Possible force majeure defenses to performance must be considered.

Should a loan be made, for example, on the basis of a long-term contract to sell coal to a

public utility, is it possible that the responsible public utility commission might declare the


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contract unenforceable at a later date? A credit judgment has also to be made on the financial

ability and integrity of the contracting party to live up to its contractual obligation.

Price of raw materials and energy. This can be assessed based on prevailing raw materialsand other commodities price required for infrastructure projects.

Enforceabil ity of contracts for raw materialsIf a project has long-term contracts for raw material at attractive prices, which are used in the

underlying financial projections, a question still arises as to their enforceability and as to

whether the contracting party is reliable and will live up to the commitments. If the raw material

is imported, the risk of import restriction or force majeure events in the exporting country must

be considered. Lenders sometimes assume these risks by advancing additional loans.

Refinancing risk. If the project is arranged on a basis whereby the construction financing is to

be provided by one group of lenders, and the long-term financing after completion of

construction is to be provided by another set of lenders, the construction lenders run the risk of

not being taken out by the long-term lenders (This is due to various problems faced by BOT

projects during its construction stage, hence construction lenders are more venerable with risk

compared to long term lenders who generally prefers to lend after construction stage).Construction lenders prefer long-term financing to be arranged at the time of the construction

loan. However, this is not always possible because of long lead time. Construction lenders can

protect themselves by providing incentives to sponsors to arrange the long-term debt. This

may be achieved, for example, by gradually escalating interest rates, by triggering additional

sponsor guarantees, or by requiring a take-out by the sponsor. Project financing tend to have

the same group of lenders for both construction lending and long-term lending.

Force majeure risk. Force majeure risks are those types of risks which result from events

beyond the control of the parties to the project financing. The objective of lenders is to shift the

various force majeure risks to the sponsor, or to the sponsors suppliers and purchasers

through contractual obligations or insurance protection. To the extent that those risks are not

shifted, the lenders have assumed force majeure risk.


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Completion. The completion risk sometimes assumed by a lender arises in circumstances

where for all practical purposes it is impossible to complete the project or facility so that it

operates to the full capacity and/or specifications originally envisaged. Sponsors do not want to

be in a position of having to provide funds to attempt to complete a facility to specifications that

require expenditures out of proportion to the benefit to be realized, or which seem impossible

to achieve. Usually this risk can be handled with little exposure to the lender, but the loan may

have to be extended for a longer term due to lower production than anticipated in the financial

projections.

Risks associated with a project may arise in three major periods during the project life

cycle:

(1) Engineering and construction phase

(2) Start-up phase

(3) Operations according to specification

Risk-sharing: the lessons learned

At the heart of project financing is a contract that allocates risks associated with a project and defines

the claims on rewards. While often the cause of delay and heavy legal costs, efficient risk allocation

has been central to making it possible to finance projects and has been critical to maintaining

incentives to perform. Risks are divided not only between public and private entities but also among

various private parties. Four kinds of risks can be distinguished --- currency, commercial, policy-

induced, and country --- although the distinctions among them are not always clear-cut.

Currency risk . Much recent, privately financed infrastructure has drawn on foreign capital and

therefore faces the risk of local currency devaluation. International lenders rarely assume such

risk, preferring instead to denominate their repayments in foreign currency terms. In the past,

public enterprises or governments have borne the currency risk, but in the growing move to

private finance, the risk of currency depreciation falls on the project sponsor, and ultimately on

the consumers of the service. In many recent private projects, service prices have been linked

to an international currency.

Market (commercial) risk. Two types of commercial risk may be distinguished, those relating

to costs of production and those arising from uncertainties in demand for services. Substantial

progress has been made in shifting cost-related risks onto private sponsors and other private


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parties. Typically, contracts include bonuses for early commissioning of the project and

penalties for late completion. A contract may also specify operational obligations, such as

maintenance or the availability of capacity. In the case of utilities, a power or water supplier is

sometimes penalized for capacity availability below pre-specified level. Or the contract may

require that a plant be available in effective working order for a specified period of time.

Project sponsors are able to transfer some of these risks to other private parties. It is common,

for example, to transfer construction risk to specialized construction companies through

turnkey contracts. Also, sponsors may enter into long-term contracts with input suppliers.

Where sector policy concerns are unimportant, investors also accept market risk, but progress

in this regard has been slower. Tariffs in line with costs, sector unbundling to permit new entry,

and access to transmission networks are required in order to enable private sponsors to

assume all market risks. In telecommunications project, the market risk is typically borne by

the sponsor. In the electric power and water sector, on the other hand, limitations on

assumption of market risk arise because payments to cover costs are not assured. Also,

governments need to decisively eliminate the prospect that investors will be bailed out if

circumstances are unfavorable.

Assumption by private parties of even cost-related risks creates incentives for good

performance. Not only do sponsors have equity holdings in the project, but also lenders are

central to the monitoring process. As part of the contract, several financial covenants are

made. In such situations, commercial banks have a much greater incentive for supervising

projects than do lenders backed by sovereign guarantees.

The evidence, although limited, shows that the assumption of cost-related risks by private

sponsors and the monitoring of performance by banks are effective. Evidence, for example, on

private construction is very favorable and reflects the tight contractual conditions and severe

penalties for cost and time overruns (As per the report of Planning Commission June 2010). A

preliminary review of the IFCs infrastructure projects shows that time overruns in construction

have been only seven months on average, and cost performance has been about on target.

Such performance, however, is possible only when commercial risks are truly transferred to

private sponsors.


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Private investors may wish to insure themselves against commercial risks. The provision of

such insurance is best left to the private sector, although governments have a role in

stimulating domestic guaranty facilities, possibly by taking an initial stake in guaranty funds.

The private market for risk insurance for international transactions is small. While short-term

insurance for trade credit is available, private insurance for infrastructure projects is

uncommon.

Sector policy induced risk. Especially important issues arise in the power sector because

project sponsors focus on the credibility and solvency of their buyer, typically a government

utility that transmits and distributes power. The instrument that projects the power supplier is

the take-or-pay contract, or power purchase agreement. Under such a contract, the buyer

agrees to pay a specified amount regardless of whether the service is used. The government

thus provides a contract compliance guarantee a useful transitional measure while the long-

term goal of sector reform is being addressed.

Similar concerns arise with water and other environmental infrastructure projects (such as

water supply, wastewater treatment, and solid waste disposal operations that are typically

carried out at the municipal level by a local monopoly). Here government agencies (ormunicipal authorities) are not the direct purchasers of the service. But they can and do

influence the ability of the service provider to meter, bill, and collect. Where the municipal

authorities cannot deliver, collection guarantees from the central government are required.

Thus, in such projects, the market risk, or the risk arising from fluctuations in demand, is

effectively transferred to the government through the take-or-pay formula. This becomes

necessary because market risk is intermingled with the danger that financially troubled power

purchasers (transmission utilities) or water users may not honor their commitments. Overall

sector reform is required to eliminate policy-induced risks and thus reveal the market risk.

Country risk. Where governments do provide guarantees against policy or even commercial

risks, these may not always be acceptable to private international lenders, who may look

instead for guarantees from creditor countries or from multilateral banks to insure against

country risks. The role of the borrower government does not disappear in such situations,

since counter-guarantees are typically required.


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PROJECT RISK MANAGMENT

Project risk management had been implemented for many years in India prior to the term Project

Risk Management becoming known to most of Indian project managers and government officials in

early 1990s.

Risk identification and analysis

The long lasting implementation of project risk management in India can best be evidenced by the

construction project procedure that has been in use for over 4 decades in India. The procedure is

shown in Figure 1. The feasibility study was formally introduced into the procedure in 1992. A capital

project (including infrastructure projects) must follow the procedure.

When an organization has identified its need for a new facility, it must submit a project proposal

defining the purpose, requirements and general aspects of the project, such as location, performance

criteria, scope, layout, equipment, services and other requirements. The definition and planning of the

project shall be carried out in coordination with agencies in charge such as provincial, municipal,

autonomous region governments, central ministries or commissions. The project proposals of a

medium or large sized project must be submitted to the agencies in charge for review and comments.

The priority projects are subject to review and approval by the State Council.

The review and approval procedure makes sure that the project complies with the national economic

and social development programs and there are sufficient resources available to the project.

Once the proposal is approved site selection and feasibility study shall follow. The feasibility study

involves the process of risk identification and analysis. Various matters should be considered when

selecting the site for the proposed project and feasibility study is made, such as climate,

topographical and geological conditions, resources, transportation, potential natural calamities,

environment conservation, available services, utilities and so on. Usually, several alternative sites and

proposals should be considered and compared with each other in terms of the various factors

influencing the project.


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All the potential sites need to be investigated to determine their suitability for the project and must

meet the local planning requirements. A site choice report and a feasibility study report are usually

required and submitted to the appropriate planning authority, or the State Council in the case of a

priority project for review and approval.

Figure 1 Construction Project Procedure in India

Risk response strategies

Indias government officials and project managers use the risk response strategies that are available

to them.


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Avoidance. Risk avoidance is changing the project plan to eliminate the risk or condition or to

protect the project objectives from its impact. Some risk events that arise early in the project

can be dealt with by clarifying requirements, obtaining information, improving communication,

or acquiring expertise. Reducing scope to avoid high-risk activities, adding resources or time,

adopting a familiar approach instead of an innovative one, or avoiding an unfamiliar

subcontractor may be examples of avoidance.

Transference. Risk transfer is seeking to shift the consequence of a risk to a third party

together with ownership of the response. Transferring the risk simply gives another party

responsibility for its management; it does not eliminate it. Transferring liability for risk is most

effective in dealing with financial risk exposure. Risk transfer nearly always involves payment

of a risk premium to the party taking on the risk. It includes the use of insurance, performance

bonds, warranties, and guarantees. Contracts may be used to transfer liability for specified

risks to another party. Use of a fixed-price contract may transfer risk to the seller if the projects

design is stable. Although a cost-reimbursable contract leaves more of the risk with the

customer or sponsor, it may help reduce cost if there are mid-project changes.

Mitigation. Mitigation seeks to reduce the probability and/or consequences of an adverse risk

event to an acceptable threshold. Taking early action to reduce the probability of a risks

occurring or its impact on the project is more effective than trying to repair the consequences

after it has occurred. Mitigation costs should be appropriate, given the likely probability of the

risk and its consequences.. Risk mitigation may take the form of implementing a new course of

action that will reduce the probleme.g., adopting less complex processes, conducting more

seismic or engineering tests, or choosing a more stable seller. It may involve changing

conditions so that the probability of the risk occurring is reducede.g., adding resources or

time to the schedule. It may require prototype development to reduce the risk of scaling up

from a bench-scale model. Where it is not possible to reduce probability, a mitigation response

might address the risk impact by targeting linkages that determine the severity. For example,

designing redundancy into a subsystem may reduce the impact that results from a failure of

the original component.

Acceptance. This technique indicates that the project team has decided not to change the

project plan to deal with a risk or is unable to identify any other suitable response strategy.


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Active acceptance may include developing a contingency plan to execute, should a risk occur.

Passive acceptance requires no action, leaving the project team to deal with the risks as they

occur.

A contingency plan is applied to identified risks that arise during the project. Developing a

contingency plan in advance can greatly reduce the cost of an action should the risk occur.

Risk triggers, such as missing intermediate milestones, should be defined and tracked. A

fallback plan is developed if the risk has a high impact, or if the selected strategy may not be

fully effective. This might include allocation of a contingency amount, development of

alternative options, or changing project scope.

The most usual risk acceptance response is to establish a contingency allowance, or reserve,

including amounts of time, money, or resources to account for known risks. The allowance

should be determined by the impacts, computed at an acceptable level of risk exposure, for the

risks that have been accepted.

METHODOLOGY OF STUDY

The procedure

This research study employed a combination of methods for an integrated qualitative and quantitative

research methodology that included five stages. The first stage was a comprehensive literature

review together with lessons learned from the practice of BOT projects in developing countries,

especially in India, to develop a initial list of risks associated with Indias BOT infrastructure projects.

In the second stage of instrument development, only the critical risks associated with Indias BOT

infrastructure projects were chosen for study.

This research on BOT Projects in India mainly focus on following catgory of risk, which was notcovered in various studies on Risk analysis on BOT Projects as well as in KPMG report on India

Infrastructure sector dated 22nd July 2010.

Approval Risk

Cost overrun Risk

Law Risk

Dispatch Constrain Risk

Contracts Risk


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The filtering of the initial list was based mainly on experiences in the practice of two BOT

infrastructure projects in India supported with information from literature reviews and published case

studies. In the third stage, a survey via questionnaires to related experts was conducted to evaluate

the criticality of the short-listed risks and the effectiveness of corresponding mitigation measures. The

fourth stage was Case studied; it can provide detailed information to supplement that obtained from a

survey. Finally, a risk management framework for investing in Indias future BOT infrastructure

projects was developed.

The survey

Rating o f risk cri ticality and mitigation measure effectiveness

The evaluation of the criticality of risk is a complex subject concealed in uncertainty and vagueness.

The vague terms are unavoidable because it is easy for project managers to access risks in

qualitative linguistic terms. To improve the preciseness and reliability of survey replies, a six-degree

rating system for the criticality of risk and the effectiveness of mitigation measures have been

adopted (Six Degree of rating system is a concept used by Dan Armstrong in an article Six Degrees

of Project Management, please refer a link http://www.baselinemag.com/cp/bio/Dan-Armstrong/), as

shown in Table 1.

Table1. Rating system for r isk cr iticali ty and mitigation measure effectiveness

Data Collection

Survey is mainly focused on Infrastructure sector of India and it targeted following industries.

Power plants

Ratings Risk crit icality Mitigation measure effectiveness

0 Not applicable Not applicable

1 Not at all critical Not at all effective

2 Only slightly critical Only slightly effective

3 Critical Effective4 Very critical Very effective

5 Very much critical Very much effective


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Toll Road Projects

Aviation

Telecommunication

Social Infrastructure projects like Sewage, Drinking water etc

There were 50 respondents, who were asked various questions pertaining to various risks they faced

during project conceiving to commissioning stages of Infrastructure projects.

Analysis of data

Since the survey targets were mainly experts in India, and I had already tested it on a small sample ofrelevant respondents to make sure the survey was unambiguous and that respondents understood

terms and would interpret terms in a similar manner.

Date analysis consists of examining, categorizing, and tabulating the evidence to address the initial

propositions of the study. In order to generate recommendations, this research project analyzed date

in following three stages.

1. Data reduction It edited and summarized the date collected from the survey and case

studies, and looked for patterns and themes to reduce the data without significant loss of

information. The main method used was coding or sorting the data into categories according to

some criteria which appears to be reasonable based upon prior research.

2. Data display In this stage it used tables to display the results of the survey and enhance the

understanding of the data.

3. Drawing valid conclusions It can be initially tentative, but firmed up as the analysis

developed and needed to be verified by constantly referring back to the data.

CRITICAL RISKS AND MITIGATING MEASURES

Criticality of cr itical risks


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The survey results concerning the criticality of risks associated with Indias BOT infrastructure

projects are tabulated in Table 2. The risks are ranked from 1 to 11 on the basis of mean scores. The

risk with the highest mean score would be ranked 1 and so on.

Table 2 Criticality of r isks in Indias BOT infrastructure projects

% of respondents who answered

Critical risk Notapplicable

Not at allcritical

Onlyslightlycritical

Critical Verycritical

Verymuchcritical

Meanscore

Ranking

Delay in approval 0 4.8 4.8 33.3 28.6 28.6 3.71 1

Change in law 0 9.5 9.5 19.0 28.6 33.3 3.67 2

Cost overrun 0 0 19.0 42.9 23.8 14.3 3.33 3

Dispatch constraint 0 4.8 33.3 19.0 23.8 19.0 3.19 4

Land acquisitionand

compensation

0 0 28.6 47.6 4.8 19.0 3.14 5

Enforceability of

contracts

0 4.8 38.1 19.0 23.8 14.3 3.05 6

Construction

schedule

0 4.8 28.6 42.9 9.5 14.3 3.00 7

Financial closing 0 41.3 19.0 33.3 23.8 9.5 2.95 8

Tariff adjustment 0 9.5 28.6 33.3 19.0 9.5 2.90 9

Environmental risk 0 14.3 38.1 28.6 14.3 4.8 2.57 10

Exchange rate andconvertibility

4.8 38.1 38.1 9.5 9.5 0 1.86 11

Effectiveness of mitigating measures

The survey also asked the respondents to evaluate the effectiveness of the generally available

mitigating measures for the critical risks associated with Indias BOT infrastructure projects, which

were developed from the literature review, personal experience and informal discussion with my

colleagues.


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Based on Table 3, maintaining a good relationship with government authorities, especially officers at

the state or provincial level, is regarded as the most effective measures because a foreign consortium

will at least know from where and who and how to get the approvals.

Table 3 Effectiveness of mit igating measures for delay in approval risk

Mitigating measure Effectiveness

Mean score Ranking

Establish JV (Joint Venture) with Indian government agencies or state-

owned enterprises or local private partners, or with foreign (international)

company either already or not yet operating in India

3.43 2

Obtain governments guarantees to adjust tariff or extend concession 3.19 3

Maintain good relationship with Central and State governments 3.86 1

As shown in Table 4, respondents felt that the most effective mitigating measure for this risk was to

obtain guarantees from the government to either adjust the tariff or extend the concession period.

Table 4 Effectiveness of mit igating measures for change in law risk


Mean score Ranking

Obtain governments guarantees, e.g., adjust tariff or extend concession

period

3.86 1

Insurance for political risk 1.67 3

Maintain good relationship with Central and State governmentsauthorities

3.62 2

As shown in Table 5, respondent felt that the most effective mitigating measure for this risk was to

include penalty clauses in contracts with the project participants, e.g., constructors, input suppliers,

and the operator so that all share the responsibility, and the incentive, to perform well as individuals

but also to engage in solving problems that affect the health of the overall project even if the cause of

the problem does not lie with them.


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Table 5 Effectiveness of mitigating measures for cost overrun risk


Mean score Ranking

Enter into contracts with the project participants, e.g., constructors, input

suppliers, and the operator

3.86 1

Additional capital provided by shareholders in the form of a stand-by

subordinated loan or as a stand-by capital contribution

3.10 2

Ask the lenders to provide standby credit facilities for cost overruns 2.95 3

As shown in Table 6, the most effective measure for this risk, according to respondents, is to enter

into take-or-pay contracts with other parties. A take-or-pay contract is an agreement by the product

purchaser to pay specified payments periodically for the product purchased, and to make specified

minimum payments even if it does not take delivery.

Table 6 Effectiveness of mitigating measures for dispatch constraintrisk


Mean score Ranking

Enter into take-or-pay products (e.g., power or water) purchase

arrangements with purchaser

3.33 1

Enter into dispatch contracts with government authorities to dispatch

facilities at full capacity for a minimum number of hours each year

3.33 2

Ask government to guarantee that transmission system will be ready for

dispatch

3.10 3

As shown in Table 7, making a credit judgment on the financial ability and integrity of the contracting

party to live up to its contractual obligation is regarded as the most effective measure for mitigating

this risk.


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Table 7 Effectiveness of mit igating measures for enforceabili ty of contracts risk


Mean score Ranking

Make a credit judgment on the financial ability and integrity of the

contracting party to live up to its contractual obligation

3.57 1

Maintain good relationship with government authorities, and establish a

communication with local arbitrators

2.81 3

Appoint independent accountant to audit the contracting parties 3.10 2

All above in this section shows the survey results of effectiveness of the mitigating measures for the

short-list critical risks associated with Indias BOT infrastructure projects. While each measure may

represent an additional cost to foreign investors. The different measures should not be viewed as

alternatives but as components in an integrated approach to risk management. Many of the measures

appear complementary and it seems logical to suppose that they will be more powerful as mitigating

measures when used together than when used alone.

RISK MANAGEMENT FRAMEWORK FOR BOT INFRASTRUCTURE PROJECT

Based on the survey results and analysis as well as case studies, a risk management framework for

investing in Indias future BOT infrastructure projects can be proposed as follows.

Step 1: List all risks associated with the proposed BOT infrastructure project and then analyze these

risks in order of importance. The more critical the risk, the more attention should be paid to it.

Step 2: For each risk, list corresponding mitigation measures as more as possible, and then examinethe availability of mitigating measures in sequence based on their effectiveness. The more effective

the measure, the higher the priority for adoption. Sometimes, a combination of several mitigating

measures is needed to be adopted.

Step 3: For each risk and its mitigating measures, negotiate with Indian government and related

entities to incorporate the risk mitigation measures, and fine tune the concession agreement and

other agreements as much as possible to ensure that all of these risks are adequately covered.


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Step 4: Allocate risks to related parties according to the principle that risk should be borne by the

party most capable of controlling it. An optimal allocation of risks depends on the relative bargaining

power of the parties and the potentiality of reward for taking the risks

Step 5: Adopt the risk allocation and security structure and enter into financing process for the

project.

CONCLUSION

In this research, the critical risks associated with Indias BOT projects were investigated. The main

conclusions are as follows:

The identified critical risks in order of importance are: delay in approval, change in law, cost

overrun, dispatch constraint, land acquisition and compensation, enforceability of contracts,

construction schedule, financial closing, tariff adjustment, and environmental risk.

The measures for mitigating each of these risks have been evaluated by respondents. Most of

the measures were regarded as effective to some degree, however the most effectivemeasures to mitigate each risk are:

1. For delay in approval, maintaining a good relationship with government authorities,

especially officers at the state or provincial level;

2. For change in law, obtaining governments guarantees via adjusting either the tariff or

extending concession period;[

3. For cost overrun, entering into contracts with the project participants so that all share

the responsibility and the incentive;

4. For dispatch constraint, entering into take-or-pay contracts with other parties;

5. For land acquisition and compensation, obtain governments guarantees to achieve

timely acquisition of land;

6. For enforceability of contracts, making a credit judgment on the financial ability and

integrity of the contracting party to live up to its contractual obligation;


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7. For construction schedule, choosing quality, trust-worthy Indian partners with

knowledge of how to handle everyday construction issues;

8. For financial closing, equity financing and cooperation with government partners;

9. For tariff adjustment, negotiating to separate and redefine the tariff burden so that while

some portions of the total tariff burden remained fixed other portions were either

adjusted, re-scheduled or paid in foreign currency; and

10. For environmental risk, creating appropriate lines of communication and contacts with

government authorities and agencies.

The risk management framework proposed by this research project will be easier to apply than

others. It incorporates the findings from this research and provides step-by-step guidelines for foreign

companies who intend to invest in Indias infrastructure projects in the future. It also has the potential

to help national, provincial, and city government to examine their approach to and services in support

of BOT infrastructure projects. It suggests that mechanisms be reviewed to improve the

communication and coordination links between different levels of government, that thought be given

to developing mechanisms to coordinate actions by different government agencies and that the

lessons learned from individual BOT projects be shared among government servants so that

unintended barriers to BOT are dismantled.


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REFERENCES

1. Bond, Gary, and Laurence Carter, Financing Private Infrastructure Projects: Emerging Trends

from IFCs Experience, IFC Discussion Paper No. 23 (Washington: The World Bank, 1994).

2. Grey, S. (1995), Practical Risk Assessment for Project Management, John Wiley & Sons Ltd,

Chichester.

3. International Finance Corporation, Financing Private Infrastructure, Lessons of Experience No.

4 (Washington: The World Bank, 1996).

4. Kleimeier, S., Megginson, W. L., 1998. A comparison of project finance in Asia and the West.

In: Lang, L. H. P. (Ed.), Project Finance in Asia. Advances in Finance, Investment and

Banking. Vol. 6. Elsevier - North Holland, Amsterdam, pp. 57-90.

5. Risk Management in PPP Projects IL&FS Report (Construction Risk Management

Conference India, August 2010)

6. Qiao, L., Wang, S. Q., Tiong, L. K. R. and Chan, T. S. (2001). Framework for Critical Success

Factors of BOT Projects in China, The Journal of Structured and Project Finance, 7(1): 53-61.

7. Wang, S. Q., Dulaimi, M. F. and Aguria, M. Y. (2002). Building the External Wing of

Construction: Managing Risk in International Construction Project, Research Report, National

University of Singapore.

8. Wang,G.Q,Jia,X.L (2005). Risk Management on the BOT Investment and Financing Mode,India Water & Wastewater, 21(9): 85-88

9. World Bank. World Development Report 1994-Infrastructure for Development. Oxford

University Press, Inc. New York, 1994

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