Need to revisit private sector financing strategies

The adequacy of infrastructure helps determine one country’s success and another’s failure in diversifying production, expanding trade, coping with population growth, and reducing poverty. Good infrastructure raises productivity and lowers production costs but it has to expand fast enough to accommodate growth.

South Asian countries are competing for infrastructure financing, due to high demand in “emerging” and “developing” nations. Although Sri Lanka has liberalized its economy in the last 30 years and embraced a reasonably market-driven economic model, the development of infrastructure/public utilities has not matched the rapidly increasing demands of this open economy.

The Asian Development Bank estimates that more than USD $1 trillion will be needed over the next decade to meet Asia's infrastructure investment needs. Energy and transport alone will require a combined total of USD $450 billion, followed by telecommunications, water supply, and waste disposal. South Asian countries with current major infrastructure requirements are Bangladesh, India, Pakistan and Sri Lanka.

Sri Lanka on average has been spending 3.5 percent of gross domestic product (GDP) on infrastructure development.

However, in recent years, infrastructure spending has been further restricted because the capital expenditure of the government is always the victim in a war budget balancing exercise: the cuts it has suffered during the last two decades have been significant and thus seriously affected ongoing infrastructure development activities. In fact, this disparity has been publicly acknowledged by the government.

In a public address on August 1, 2007, Fisheries and Ocean Resources Minister Felix Perera said: "We are unable to give you everything. Subsidies and development simultaneously, despite the ongoing war is quite an arduous task for any government." By contrast, in “Tiger” economies such as Malaysia and Thailand, 6-8 percent of GDP is annually allocated for infrastructure development.

History of BOT/BOO projects
The importance of private industry involvement in Sri Lanka’s infrastructure development has received both public and private sector plaudits. These private-public partnerships (PPP) range from service contract (concession, lease, franchise) to Build Operate Transfer (BOT) to Build Operate Own (BOO) type arrangements. These models involve a consortium submitting a proposal to finance, design, build, operate, and sometimes transfer the project back to the government after a certain period of time.

The World Development Report of 1994 argued that private sector participation in infrastructure development through BOO/BOT projects could lead to delivering less expensive and more efficient services to citizens due to a fully competitive bidding process, de-politicized decision making, lower overall project cost, benefit of private sector finance mobility, access to best private sector management available, access to the latest technology, and private sector risk-sharing.

Since capital expenditure was curtailed to accommodate the rising defence budget, UNP and SLFP governments of the last decade have formally accepted BOO/BOT projects as a priority item for the government. Accordingly, in the early 1990s, the Secretariat for Infrastructure Development (SID) and the Private Sector Infrastructure Development Corporation (PSIDC) (with adequate funds for private investors to borrow) were established in Sri Lanka. In the mid-1990s the SID was absorbed by the BOI and renamed Bureau of Infrastructure Investment (BII) with additional powers to regulate private-public partnerships.

However, BII had several design shortcomings which curtailed its effectiveness. Firstly, the decision making process was plagued by political interference. Secondly, coordinating other agencies such as the Urban Development Authority, Road Development Authority, line ministries and the Labour Department proved ineffective. Finally, the institutions did not have the statutory authority to make decisions on tariff or pricing policy; such decisions were made by politically aligned sub-committees appointed by the Cabinet, resulting in some delayed or halted projects. Progress in these areas has also been handicapped due to changes in political regimes.

Regional BOO/BOT Projects
Malaysia and the Philippines have employed several innovations in meeting their own infrastructure demands. These include the privatization of existing public infrastructure assets in the telecommunications, ports, roads, and power generation sectors, and contracting out to the private sector the operation and maintenance of infrastructure services. Governments in the region are driven by economic and security agendas to retain control over economically significant public utilities, however creation of new infrastructure facilities through BOO/BOT projects rather than privatization of existing structures has been actively pursued by the Sri Lankan government’s Treasury and BII as a means of relieving the burden of the year-on-year budget deficit.

The Philippines is widely regarded as a regional role model in the use of the BOT mechanism.

The country has had recent notable success in solving its power crisis by introducing an aggressive deregulated BOT program which opened up power generation to foreign investors. Japanese, Hong Kong, American, and European investors are currently developing in excess of 6,000 MW of new generation capacity, which has relieved Manila of the daily eight-hour electrical brownouts of several years ago.

Crucial to the success of the Philippine’s efforts has been national-level government developing comprehensive BOT laws, preparing suitable projects, and acting as a one-stop investment promotion shop. Other countries pursuing similar BOT policies and programmes are Bangladesh, People's Republic of China, and India to fuel large-scale sustainable infrastructure development. Singapore’s public investment vehicle Temasek Company has been instrumental to fund national economic development.

It is a much lauded and imitated model in the South Asia region, with close competitor Malaysia following suit along with Khazanah. The national investment agency is seeking to duplicate Temasek’s success by retaining an interest in major national infrastructure assets, but converting them to operate as public companies to maximize the utilities’ efficiency and performance.
The current government aims to encourage infrastructure development projects managed on BOO/BOT basis including power plants, highways, ports, telecommunications, railways, transport systems, industrial parks, solid waste management, water supply and drainage, and land reclamation. However, based on regional models of success, the government must revise the legal and regulatory framework (contract, property rights, competition, impartial regulatory body) to ease risk perceptions that currently hinder large-scale private sector investment in the country.

Looking ahead
From an economic perspective, defence expenditure is unlikely to reduce significantly in the coming years. Even if peace is reached, defence expenditure debt will continue for another 4-5 years due to the deferred payment schedule of previous military purchases. Looking forward, this leaves BOO/BOT projects as the key providers of the country’s infrastructure needs.

The inherent problem is not the lack of private finances for infrastructure projects but rather managing the transition for private sector involvement in this essential enterprise. So far, Sri Lanka has not been very successful in minimizing the teething problems involved in this transition: the required institutional, legal, and regulatory structures are still evolving.

There is common consensus that infrastructure along with an educated workforce are key to Sri Lanka’s development.

If the government wants to achieve sustainable national economic growth as proposed in the Mahinda Chintana development plan, it needs to harness the potential of the private sector by implementing badly needed economic and structural reform.