The Island: 31/07/2005" By Kanes
Private-Public Partnership for Development was the theme at the Annual Sessions of the Sri Lanka Economic Association (SLEA) held two weeks ago at the BMICH. Has this partnership worked in the crucial area of infrastructure/public utilities that is the key to growth and development? Although Sri Lanka liberalized its economy and has unleashed the market forces to play a greater role in resource allocation, the development of infrastructure/public utilities has not matched the rapid increasing demands of the open economy. For instance, the importation of vehicles has increased rapidly but the roads have not expanded to accommodate this increase resulting in major traffic congestions.
Sri Lanka on average has been spending 3.5 per cent of GDP on infrastructure development. However, in some years it has been very low because the capital expenditure of the government is always the victim in a budget balancing exercise and the cuts it has suffered during the last two decades has been significant and thus seriously affected the on-going infrastructure development activities. In countries such as Malaysia and Thailand, 6-8 per cent of GDP is allocated for infrastructure development. Due to massive budgetary problems at the time of the North/East war, the government decided that the private sector should be invited to play a role in infrastructure/public utilities development. The infrastructure/public utilities earmarked for private sector participation were ports, telecommunications, power, roads, railways, water, etc.
Required Policy Framework
In the 1980s various approaches for private sector participation in infrastructure emerged in the world. They ranged from service contract (concession, lease, franchise) to Build Operate Transfer (BOT) to Build Operate Own (BOO) type arrangements. The World Development Report of 1994 gives a good description of these techniques. The International Financial Institutions argued that private sector participation in infrastructure could lead to delivering less expensive and reliable services to the people at large. However, in order to realize these benefits the government had to create a conducive legal and regulatory framework (contract, property rights, competition, and so on), and ease risk perceptions that hinder investment. It was also argued that BOO/BOT is an innovative approach compared to sovereign borrowing and debt financing — it induced financial ‘additionality’, technology transfer, and skill development that offset any disadvantages the technique possessed.
Accordingly, in the early 1990s, the Secretariat for Infrastructure Development (SIDI) 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 SIDI was absorbed by the BOI and renamed Bureau of Infrastructure Investment (BII) with additional powers. Sri Lankan public utilities have been traditionally overstaffed and functioned as dispensers of subsidized services. Thus, the political risks were on the high side and there was a case for considering modalities of introducing private partnerships that involved less political risks. At least as an interim step before adopting of BOT which required a change in the status quo, was the creation of a new regulatory framework. But Sri Lanka embarked on ambitious BOT projects in the power and roads sectors before getting the legal and regulatory framework in place.
Progress and Problems
If we take stock of the progress in infrastructure/public utilities development over the last 10-12 years, with private sector involvement, it is far from satisfactory. Of course there are some success stories such as the telecommunications, Colombo Port, and the Sri Lankan Airlines but these were not BOO/BOT arrangements and involved developing a public-private partnership via divestiture of shares below 50 per cent to the private sector. But if we examine the BOO/BOT type of projects the record is unsatisfactory.
A number of problems can be identified. First, the fundamentals governing the basic legal framework for inviting the private sector for infrastructure development was not in place. There has not been political and economic stability for large scale private investment to take place. In such an environment, the question of political commitment to go ahead with a project under different political regimes has remained a question. Second, the institutional and regulatory framework to govern the public-private partnership has been far from satisfactory; and the risk minimizing strategy has been inadequate. It appears that these areas have been gradually evolving with ups and downs with the changes in political regimes.
In regard to the first, the best example is the Trincomalee coal power plant project that was negotiated before the change of government in 1994. The earlier government gave the winning bidder – Mihaly International Canada – a one year period of exclusivity to prepare a comprehensive feasibility study. This was done by issuing a Letter of Intent to the company. However, the new government that assumed office decided to terminate this exclusivity indicating that they had failed to meet the conditions of the contract. Although the LOI did not constitute a legal obligation on the part of the government to enter into an implementation agreement, the lack of a formal legal agreement to back the documentation procedure led to a dispute between the government and Mihaly, with the company threatening to claim US $ 150 million as damages and compensation. A more recent example is the row over the fuel subsidy claim from the Treasury by the Lanka Indian Oil Corporation (LIOC) where the privatization agreement under the previous government is subject to different interpretation by the LIOC and the Treasury.
The institutional structure to promote a private-public partnership had many shortcomings and they were not fully addressed by the BII either. First, the decision making process was plagued by political interference because the structure was not streamlined. Second, the coordinating network with other agencies such as the Urban Development Authority, Road Development Authority, line Ministries, Labour Department, etc., was not effective; and third, the institutions did not have the statutory authority to take decisions on tariff or pricing policy and left such decisions to be made by sub-committees appointed by the Cabinet. Consequent to these shortcomings, projects have been manipulated by various technical and non-technical committees and as a result some projects got delayed or halted.
Designing a suitable regulatory framework has also been a problem. Designing a workable regulatory framework requires considerable skills and expertise given the realities of regulatory failures ranging from regulatory capture to lack of constant regulatory innovation with increasing competition. Besides, regulation can sometimes distort competition by its impact on incentives, varies according to the public utility, and costly to set up and often fail to achieve the goals. Regulatory bodies such as the Sri Lanka Telecom Regulatory Authority, National Transport Commission, etc., were subject to political interference and could not function as workable independent regulatory bodies. The electricity sector still does not have a proper regulatory body. During the mid-1990s even designing workable power purchase agreements and risk allocation between the public and private sector were not satisfactory in the power sector. Consequently, establishment of most thermal power generation plants got delayed. The fate of the Colombo-Katunayake highway is another good example of messing up of the contract with the private partner.
Hong Kong based mega investor Gordon Wu said in 1996 that "Sri Lanka spends more time negotiating a deal than building the projects." This statement basically summarized the fate of most private-public partnerships in the area of infrastructure under BOT arrangements. This situation had not changed much over the years, so much so, the Secretary to the Treasury in his inaugural address to the SLEA Annual Sessions echoed such sentiments by stating that several projects that should have taken place some time ago are being implemented today and the government is spending more time on conceptualizing rather than realization of the dreams foreseen for the future (Daily Mirror, 18 July 2005).
Recognizing the need to get the act together and move forward in BOO/BOT projects an initiative was taken to create a good regulatory and legal framework that has a workable independence. Accordingly, a Public Utility Commission was established in 2002, which was basically a multi-sector regulatory authority – where all regulatory bodies for public utilities/infrastructure would be housed. The objective was to exploit the economies of scope in the regulatory process related to the degree of commonality in the objective (rights of way) and form (price cap) of regulation and was based on the assumption that public hearings, cost of studies, etc., are substitutable across sectors. It was supposed to be a skills-based institution with economists, lawyers, engineers and project teams incorporated into it.
Since the change of government in 2004, the Strategic Enterprise Management Agency (SEMA) has taken over the restructuring of public utilities/infrastructure. It seems to be toying with the idea of introducing the Temasek model of Singapore for restructuring some of the public utilities – run on a competitive and commercial basis without state interference or favours under state ownership. However, the plans of SEMA are not yet clear since private companies like Bharat Petroleum have been entertained on an ad hoc basis for restructuring a public utility such as the Petroleum Corporation. Furthermore, SEMA’s relationship with the Public Utilities Commission is far from clear.
But what is clear is the following – the problem in Sri Lanka is not the lack of private finances for infrastructure projects but managing the transition for private sector involvement. Sri Lanka has not been very successful in minimizing the teething problems in the transition and the required institutional, legal, and regulatory structures seem to be still evolving. If proper private-public partnership is to be introduced to infrastructure/public utilities, the government should engage in an open dialogue with the stake holders and civil society. It is only then that the teething problems could be resolved and implementation could be expedited with least political resistance.
Private-Public Partnership for Development was the theme at the Annual Sessions of the Sri Lanka Economic Association (SLEA) held two weeks ago at the BMICH. Has this partnership worked in the crucial area of infrastructure/public utilities that is the key to growth and development? Although Sri Lanka liberalized its economy and has unleashed the market forces to play a greater role in resource allocation, the development of infrastructure/public utilities has not matched the rapid increasing demands of the open economy. For instance, the importation of vehicles has increased rapidly but the roads have not expanded to accommodate this increase resulting in major traffic congestions.
Sri Lanka on average has been spending 3.5 per cent of GDP on infrastructure development. However, in some years it has been very low because the capital expenditure of the government is always the victim in a budget balancing exercise and the cuts it has suffered during the last two decades has been significant and thus seriously affected the on-going infrastructure development activities. In countries such as Malaysia and Thailand, 6-8 per cent of GDP is allocated for infrastructure development. Due to massive budgetary problems at the time of the North/East war, the government decided that the private sector should be invited to play a role in infrastructure/public utilities development. The infrastructure/public utilities earmarked for private sector participation were ports, telecommunications, power, roads, railways, water, etc.
Required Policy Framework
In the 1980s various approaches for private sector participation in infrastructure emerged in the world. They ranged from service contract (concession, lease, franchise) to Build Operate Transfer (BOT) to Build Operate Own (BOO) type arrangements. The World Development Report of 1994 gives a good description of these techniques. The International Financial Institutions argued that private sector participation in infrastructure could lead to delivering less expensive and reliable services to the people at large. However, in order to realize these benefits the government had to create a conducive legal and regulatory framework (contract, property rights, competition, and so on), and ease risk perceptions that hinder investment. It was also argued that BOO/BOT is an innovative approach compared to sovereign borrowing and debt financing — it induced financial ‘additionality’, technology transfer, and skill development that offset any disadvantages the technique possessed.
Accordingly, in the early 1990s, the Secretariat for Infrastructure Development (SIDI) 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 SIDI was absorbed by the BOI and renamed Bureau of Infrastructure Investment (BII) with additional powers. Sri Lankan public utilities have been traditionally overstaffed and functioned as dispensers of subsidized services. Thus, the political risks were on the high side and there was a case for considering modalities of introducing private partnerships that involved less political risks. At least as an interim step before adopting of BOT which required a change in the status quo, was the creation of a new regulatory framework. But Sri Lanka embarked on ambitious BOT projects in the power and roads sectors before getting the legal and regulatory framework in place.
Progress and Problems
If we take stock of the progress in infrastructure/public utilities development over the last 10-12 years, with private sector involvement, it is far from satisfactory. Of course there are some success stories such as the telecommunications, Colombo Port, and the Sri Lankan Airlines but these were not BOO/BOT arrangements and involved developing a public-private partnership via divestiture of shares below 50 per cent to the private sector. But if we examine the BOO/BOT type of projects the record is unsatisfactory.
A number of problems can be identified. First, the fundamentals governing the basic legal framework for inviting the private sector for infrastructure development was not in place. There has not been political and economic stability for large scale private investment to take place. In such an environment, the question of political commitment to go ahead with a project under different political regimes has remained a question. Second, the institutional and regulatory framework to govern the public-private partnership has been far from satisfactory; and the risk minimizing strategy has been inadequate. It appears that these areas have been gradually evolving with ups and downs with the changes in political regimes.
In regard to the first, the best example is the Trincomalee coal power plant project that was negotiated before the change of government in 1994. The earlier government gave the winning bidder – Mihaly International Canada – a one year period of exclusivity to prepare a comprehensive feasibility study. This was done by issuing a Letter of Intent to the company. However, the new government that assumed office decided to terminate this exclusivity indicating that they had failed to meet the conditions of the contract. Although the LOI did not constitute a legal obligation on the part of the government to enter into an implementation agreement, the lack of a formal legal agreement to back the documentation procedure led to a dispute between the government and Mihaly, with the company threatening to claim US $ 150 million as damages and compensation. A more recent example is the row over the fuel subsidy claim from the Treasury by the Lanka Indian Oil Corporation (LIOC) where the privatization agreement under the previous government is subject to different interpretation by the LIOC and the Treasury.
The institutional structure to promote a private-public partnership had many shortcomings and they were not fully addressed by the BII either. First, the decision making process was plagued by political interference because the structure was not streamlined. Second, the coordinating network with other agencies such as the Urban Development Authority, Road Development Authority, line Ministries, Labour Department, etc., was not effective; and third, the institutions did not have the statutory authority to take decisions on tariff or pricing policy and left such decisions to be made by sub-committees appointed by the Cabinet. Consequent to these shortcomings, projects have been manipulated by various technical and non-technical committees and as a result some projects got delayed or halted.
Designing a suitable regulatory framework has also been a problem. Designing a workable regulatory framework requires considerable skills and expertise given the realities of regulatory failures ranging from regulatory capture to lack of constant regulatory innovation with increasing competition. Besides, regulation can sometimes distort competition by its impact on incentives, varies according to the public utility, and costly to set up and often fail to achieve the goals. Regulatory bodies such as the Sri Lanka Telecom Regulatory Authority, National Transport Commission, etc., were subject to political interference and could not function as workable independent regulatory bodies. The electricity sector still does not have a proper regulatory body. During the mid-1990s even designing workable power purchase agreements and risk allocation between the public and private sector were not satisfactory in the power sector. Consequently, establishment of most thermal power generation plants got delayed. The fate of the Colombo-Katunayake highway is another good example of messing up of the contract with the private partner.
Hong Kong based mega investor Gordon Wu said in 1996 that "Sri Lanka spends more time negotiating a deal than building the projects." This statement basically summarized the fate of most private-public partnerships in the area of infrastructure under BOT arrangements. This situation had not changed much over the years, so much so, the Secretary to the Treasury in his inaugural address to the SLEA Annual Sessions echoed such sentiments by stating that several projects that should have taken place some time ago are being implemented today and the government is spending more time on conceptualizing rather than realization of the dreams foreseen for the future (Daily Mirror, 18 July 2005).
Recognizing the need to get the act together and move forward in BOO/BOT projects an initiative was taken to create a good regulatory and legal framework that has a workable independence. Accordingly, a Public Utility Commission was established in 2002, which was basically a multi-sector regulatory authority – where all regulatory bodies for public utilities/infrastructure would be housed. The objective was to exploit the economies of scope in the regulatory process related to the degree of commonality in the objective (rights of way) and form (price cap) of regulation and was based on the assumption that public hearings, cost of studies, etc., are substitutable across sectors. It was supposed to be a skills-based institution with economists, lawyers, engineers and project teams incorporated into it.
Since the change of government in 2004, the Strategic Enterprise Management Agency (SEMA) has taken over the restructuring of public utilities/infrastructure. It seems to be toying with the idea of introducing the Temasek model of Singapore for restructuring some of the public utilities – run on a competitive and commercial basis without state interference or favours under state ownership. However, the plans of SEMA are not yet clear since private companies like Bharat Petroleum have been entertained on an ad hoc basis for restructuring a public utility such as the Petroleum Corporation. Furthermore, SEMA’s relationship with the Public Utilities Commission is far from clear.
But what is clear is the following – the problem in Sri Lanka is not the lack of private finances for infrastructure projects but managing the transition for private sector involvement. Sri Lanka has not been very successful in minimizing the teething problems in the transition and the required institutional, legal, and regulatory structures seem to be still evolving. If proper private-public partnership is to be introduced to infrastructure/public utilities, the government should engage in an open dialogue with the stake holders and civil society. It is only then that the teething problems could be resolved and implementation could be expedited with least political resistance.
