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|Importance of financing for Vietnam’s BOT ventures - illustration photo|
The ability to finance a project is one of, if not the most important factor for any potential bidder to consider prior to entering into a major undertaking such as the North-South Expressway project. A characteristic of such a mega transportation project using the build-operate-transfer (BOT) structure is high initial construction costs, and long duration of recovery of 20-30 years. During the construction period, the venture generates no income, and uses up the initial capital for operations – it is only when construction is completed and the project starts the operation stage that financing is generated. The adequate financing of the construction costs, which can likely run up to millions of US dollars, is therefore a key to the plan reaching the operational stage and generating funds.
In practice, a substantial percentage of the initial equity used for the construction stage is supplied by bank loans. Percentage-wise, this amounts to around 40-80 per cent of the project cost.
It is therefore crucial that the investor is able to secure financing to carry out an initiative as vast as the North-South Expressway.
Risks for local investors
When approached by an investor requesting loans, the bank will be considering three crucial risks: whether the investor has the capability to carry out the operation (completion risks), whether the income from the project will be sufficient to satisfy the loan (credit risk), and whether the investor can access foreign exchange for repayment purpose (exchange risk). The domestic bidding, which is restricted to Vietnamese investors generally, increases completion risks and credit risks.
It is recognised that many Vietnamese investors do not lack capabilities to construct expressway projects. Vietnam has investors such as Vingroup Construction and Vietnam Expressway Corporation who have experience participating in other expressway schemes such as the Halong-Van Don and Hanoi-Haiphong expressways.
However, it cannot be denied that domestic bidding will limit the ability of Vietnamese contractors to enter into joint ventures with international contractors such as Hyundai Engineering & Construction (HEC), Hyundai Engineering & Construction (HDEC), who may be more experienced and more familiar with cutting edge technology as well as good project management practices, and whose track records may provide more confidence for banks when considering the completion risks involved.
In relation to credit risks, domestic investors may also find themselves enjoying a less favourable outlook compared with international ones. One reason is due to the banking practice of requiring the issuance of corporate guarantees from investors as additional security. Due to this, many international investors who have credit ratings are perceived to have significantly lower credit risks generally on the basis of their credit ratings, which improve the creditworthiness of their corporate guarantees.
International investors who have received credit ratings from Fitch and Moody’s, are generally perceived by banks as having lower credit risks, and consequently banks are more comfortable in issuing loans, potentially even at better terms and lower costs. Past experiences and relationships with international lenders and funds is also a positive for international investors, who may find themselves in a more advantageous position to call upon this source of financing compared to a domestic investor.
In addition to the disadvantages highlighted above for domestic investors, the financing of the project as a whole is also affected by the lack of mechanisms for minimum revenue guarantee (MRG), where the government guarantees to the partner investor a minimum level of revenues during a certain period, and foreign exchange guarantee. Profound uncertainties on these two mechanisms would inevitably place a higher burden on the financing of the North-South Expressway project. The MRG is a measure favoured not only by investors but also banks. It is always highly appreciated by banks when considering credit risks, especially in non-steady cash flow BOT projects such as transportation projects, whose cash flow depends on the uncertain amount of road user charges.
Currently, however, there is no official legal framework for MRG in Vietnam. MRG made an appearance in the second version of the public-private partnership (PPP) draft law this May, but it disappeared again in the latest version. The lack of MRG will certainly be a negative consideration for banks when viewing the credit risk of investors looking to invest in the North-South Expressway.
Nevertheless, a welcoming risk allocation mechanism known as “sharing revenue risks” has recently been introduced in the third and fourth versions (the latter is currently the latest edition of the PPP draft law, dated this month). Under Article 77 of the latest version, given that adjustment of price failed to ensure the necessary revenue to maintain production and business activities of the project, the government may share with investors 50 per cent of the negative gap between the actual revenue and the committed revenue in the contract. In exchange, the investors have to commit to sharing with the government 50 per cent of the increased gap in revenue. This mechanism is promising, but it is uncertain whether it would be adopted and whether investors for the North-South Expressway project may qualify under it.
Second, the lack of guarantee on foreign currency convertibility also increases exchange rate risk – one of the foreign banks’ main concerns. Under stable economic conditions, the supply of foreign exchange is usually not a problem. However, if economic turmoil happens, currency convertibility is affected. The foreign exchange guarantee provides banks assurances that they would receive the repayment in their foreign currency. Nevertheless, there has yet to be any specific commitments concerning foreign currency convertibility. The latest version of the PPP draft law has provided a more specific framework, under which the government will guarantee up to 30 per cent of project revenue in VND to be convertible after subtracting the expenses in VND. However, applicability of such commitments to the North-South Expressway remains questionable.
Our analysis has shown the disadvantages of restricting international investors from bidding in the North-South Expressway project, as well as issues that may affect general financing as a whole. It is our view that international bidding should be preferred to the current domestic bidding being planned by the Ministry of Transport for the project.
As for the issues currently applicable to the financing as a whole, the MRG contemplated under the draft PPP law, if it takes effect, should be allowed for the investors in the North-South Expressway, as it would help immensely in securing the finance necessary for the scheme. It is not suggested that MRG be of widespread application but transportation projects, with its non-steady cash flow peculiarities, should be considered a prime application.
As for the exchange risks, we note that Vietnam is an exporting country with a strong foreign exchange supply, and thus there should be nothing to deter the implementation of mechanisms for granting foreign exchange. Accordingly, a foreign exchange reservation can be considered for these BOT transportation projects.