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:- hm_maniar@rediffmail.com

PHONE NO: +919898010291

* Dr.HIREN M MANIAR is currently working as a Faculty in Finance at L&T Institute of Project

Management, Vadodara, Gujarat, India. He may be contacted at hm_maniar@rediffmail.com

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

Abstract:
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

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 infrastructure 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.

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, and
social 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 a
viable 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 Planning
Commission, 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

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.

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 longterm 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

Availability 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 materials
and other commodities price required for infrastructure projects.

Enforceability of contracts for raw materials

If 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, policyinduced, 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 longterm 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 (or
municipal 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.
17

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 not
covered 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 of risk criticality 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 risk criticality and mitigation measure effectiveness
Ratings

Risk criticality

Mitigation measure effectiveness

Not applicable

Not applicable

Not at all critical

Not at all effective

Only slightly critical

Only slightly effective

Critical

Effective

Very critical

Very effective

Very much critical

Very much effective

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

Power plants
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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 of
relevant 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 critical 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 risks in Indias BOT infrastructure projects

% of respondents who answered

Critical risk

Not
applicable

Not at all
critical

Only
slightly
critical

Critical

Very
critical

Very
much
critical

Mean
score

Ranking

Delay in approval

4.8

4.8

33.3

28.6

28.6

3.71

Change in law

9.5

9.5

19.0

28.6

33.3

3.67

Cost overrun

19.0

42.9

23.8

14.3

3.33

Dispatch constraint

4.8

33.3

19.0

23.8

19.0

3.19

Land acquisition
and
compensation

28.6

47.6

4.8

19.0

3.14

Enforceability of

4.8

38.1

19.0

23.8

14.3

3.05

4.8

28.6

42.9

9.5

14.3

3.00

Financial closing

41.3

19.0

33.3

23.8

9.5

2.95

Tariff adjustment

9.5

28.6

33.3

19.0

9.5

2.90

Environmental risk

14.3

38.1

28.6

14.3

4.8

2.57

10

Exchange rate and

convertibility

4.8

38.1

38.1

9.5

9.5

1.86

11

contracts
Construction
schedule

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.
21

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 mitigating measures for delay in approval risk

Mitigating measure

Effectiveness
Mean score

Ranking

3.43

Obtain governments guarantees to adjust tariff or extend concession

3.19

Maintain good relationship with Central and State governments

3.86

Establish JV (Joint Venture) with Indian government agencies or stateowned enterprises or local private partners, or with foreign (international)
company either already or not yet operating in India

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 mitigating measures for change in law risk

Mitigating measure

Effectiveness
Mean score

Ranking

3.86

Insurance for political risk

1.67

Maintain good relationship with Central and State governments

3.62

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

period

authorities

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

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

Effectiveness
Mean score

Ranking

3.86

3.10

2.95

suppliers, and the operator

Additional capital provided by shareholders in the form of a stand-by
subordinated loan or as a stand-by capital contribution
Ask the lenders to provide standby credit facilities for cost overruns

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 constraint risk

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

Effectiveness
Mean score

Ranking

3.33

3.33

3.10

arrangements with purchaser

Enter into dispatch contracts with government authorities to dispatch
facilities at full capacity for a minimum number of hours each year
Ask government to guarantee that transmission system will be ready for
dispatch

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 mitigating measures for enforceability of contracts risk

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

Effectiveness
Mean score

Ranking

3.57

2.81

3.10

contracting party to live up to its contractual obligation

Maintain good relationship with government authorities, and establish a
communication with local arbitrators
Appoint independent accountant to audit the contracting parties

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 examine
the 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.
24

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 effective
measures 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;

25

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.

26

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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