case study innovative infrastructure project finance (new road for lao development)

Australian Journal of Asian Country Studies

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Case study: Innovative Infrastructure Project finance

(New Road for Lao Development)

Asst.Prof. Pradit Withisuphakorn (DBA)

Director,

NIDA MSc in Financial Investment and Risk Management (FIRM),

NIDA Business School,

National Institute of Development Administration (NIDA),

118 Serithai Rd, Bangkapi, Bangkok, Thailand 10240.

Personal Phone: +6681 6220310, +1 206 294 2575

e-mail: [email protected], [email protected]

Abstract

Infrastructure (road, telecom, education, etc.) is crucial for long term economic development similar to

the bone and blood vessels which are vital to the healthy growth of human body. Especially in

underdeveloped country such as Lao PDR, the faster the Road, Transportation and Communication

System Development, the faster the country economic development and distribution of income.

However, underdeveloped country like Lao PDR is facing trouble in fund raising internally and

externally to support their infrastructure development project like the road network. Recently, there is

no credit rating assigned for Lao Securities. Thus, the new debt will incur very high cost of capital and

may be impossible. Furthermore, the conventional government bond fund raising and government

infrastructure project investment may lead to the over debt burden and worsen macro-economic

situation and suspected governance issues. This is the real case study which already applied and

success in ‗Project Finance‘ and ‗Financial Structuring‘ for the new road development in suburb

developing area in Vientiane Capital, Lao PDR. This financial structuring for infrastructure

development using the future value of land (after the road has been constructed) to help finance the

present (which the road does not exist and no cash on hand). This financial structuring has been

considered all stakeholders to get win-win and the result is that the road can be constructed and the

government achieved the goal for infrastructure development with minimal cash expenses (low sunk

cost). Everybody won because the government can gain extra benefits (for infrastructure development)

and got some extra cash (from project NPV) while the contractors got the cash for their works, Lao

people (especially people in the road construction area) got the fair treatment and fair return for asset

value appreciation. This model, when it is successfully applied, should alleviate the need for borrowing

and minimize cash required from GOL (Government of Lao PDR) for new road development.

Furthermore, the people in the target area will gain from this new road project development. This

model should be suitable and can be applied to another developing countries especially the countries

which have strong political and good vision government.

Keywords: Infrastructure Project Finance, Road Project feasibility, Urban Economic Development.

1. Introduction

Lao PDR is located in Indochina with China (PRC) on the North, Vietnam in the East, Thailand and

Myanmar in the West and Combodia on the South. Currently, the economic structure of Lao PDR is

changing as an economy transforms from a subsistence agriculture and raw material-based economy to

a processing and market-oriented economy. This also has a positive impact on the domestic natural

resources. Economic structure and value added in each of each sector has exhibited an increase, which

is in accordance with set direction. In 2008-2009, the agriculture and forestry sector accounted for

30.4% of the GDP and had value added at 14.36 billion Kip (1 USD = 8,000 Kips); Industry sector

covered 24.9% and had value added at 11.74 billion Kip; Services sector was equivalent to 38.4% and

had value added at 18.14 billion Kip. In 2009-2010, it is projected that agriculture and forestry sector

covers about 39.2%, industry sector covers 26% and services sector covers 39% of the GDP. Details on

the sector growth will be provided in Section 3, Part 1 of this Report]. In summary, in the past five

years, the sectoral composition of the GDP suggests that agriculture and forestry sector accounted for

30.4%, industry 26.1%, and services 37.2%. Regarding to Communication, transport, post and

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ACEI

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telecommunication, during 2006-2010, public works and transport focused on implementing 25

projects to support for the priority 11 programmes and 111 projects.

Map 01: Logistic Map of Lao PDR

Master Plan on Communication and Transport. There are two focal projects: (1) Construct/improve

communication, transport and networking between sub-regions and regions; and (2) Construct/improve

communication, transport and networking within the country. Currently, the transportation system

consists of four types: (1) Merchandised road transport with the length of 33,768km, handling 80% of

the total transport volume during 2006-2008 – goods transport increased by 5-8%, and passenger

transport by 8-10% annually. This mode of transport has enabled supplying goods and passenger

transport to all districts throughout the country.

2. Rural development and poverty eradication

Lao PDR has a larger proportion of poor people (poverty rate) compared to most other countries in East

Asia and Pacific. According to poverty estimates made in 2008 based on Survey pertaining to 2007-

2008, the poverty rate was 27.6%.This rate is quite high when compared with the rates prevailing in

neighboring countries like Vietnam, Cambodia, and Thailand. Poverty is higher in rural and remote

areas; for example, in priority areas in the north and south. Inequality between the rich and the poor

also poses a problem for poverty reduction. According to the principles and goals laid down by the

Party and the government relating to poverty eradication by 2010 and to achieve Millennium

Development Goals (MDGs) by 2015 and to move the nation out from its least-developed country

status by 2020, poverty reduction has become the main mission, and a priority. So far, the government

has attached high priority to poverty reduction through accelerating rural development, e.g. through

Ban and Kumban development in the whole country. Both financial and human capital, have been

invested towards this end. Focal areas have been defined and special policy has been put for remote

areas and former revolution areas. Through the real implementation, all activities were in progress and

achieved at satisfactory level, especially, focusing on building capacities of 2,760 local officials for

Kumban development, and completing Kumban development plans in 133 Kumbans in 69 poor

districts totalling 1,620 projects; of these 491 projects have been approved and funded 124 billion kip


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by the government. Additionally, village development fund has been established in 54 districts, 528

villages with the fund members of totally 34,856 families, which covered 46 poorest districts and 4

poor districts which amounted to 42,53 billion Kip to date, of which, 6,78 billion kip is a saving of the

people, totaling 1,664 projects. Besides, the Agriculture Promotion Bank provided loans worth 1,248

billion Kip to farmers to invest in agriculture, animal husbandry and small business to 130,000 families

located in 4,152 villages, in 140 districts. Nayobai Bank released total loans worth 805,55 billion Kip

to 65,431 households located in 1,171 villages, 46 districts. The Poverty Reduction Fund (PRF) of 203

billion kip has been distributed between 2006 and 2010 to implement 1,673 projects in five target

provinces, which covered 21 poor districts, 161 kumbans and 1,900 villages. Furthermore, there are

sources from also villager‘s development fund and saving group of the Women‘s Union, Lao Youth

Union, Trade Union, Lao Front for National Construction, Spring Water Fund, Rice Bank, Animal

Bank, Credits from Farmer‘s Group, saving money and other sources of fund established in a number

of villages that are supported and directed by Lao Front for National Construction, mass organization,

international organization and other financial institutions. The progress made in poverty eradication has

so far been satisfactory. Examples: poverty in terms of consumption has been decreased; food

consumption has improved; property ownership rights have risen, etc. Seen from Surveys between

1992-1993 and 2007-2008, poverty trends have shown a decline at all levels: provincial, regional and

country. In 1992-1993, the poverty rate was 46%, which declined to 39.1% in 1997-1998, 33.5% in

2002-2003, 27.6% in 2007-2008, 26% in 2009-2010. From these figures, we observed that from FY

1992-1993 to FY 1997-1998 the poverty rate decline significantly during this 10- year period. The

poverty rate in the priority areas (the poorest districts) has been decreased more than other areas.

Furthermore, roads, electricity, water supply, schools a Laos is one of the developing countries

in Indochina. Laos has developed over the last 20 years ago since economic system has been changed

to free economy. The electric power Industry is the main income.

Government of Laos has tried to develop the economy of the country in infrastructure project to

distribute prosperity to the rural area by new road project. However, Laos is experiencing a financial

crisis that large project cannot be successful in funding, and borrowing from abroad would be fiscal

problems seriously. As below, the graph was shown as gross domestic product (GDP) of Laos for 10

years (2004-2013) by total 2.1 % of GDP of Thailand although economic growth rate of Laos was 6%

per year.

Graph 1 : Gross domestic product (GDP) of Laos and Thailand (Per Billions of US dollars)

Source: world Bank


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Graph 2: Economic growth rate of Laos and Thailand (%)

Source: world Bank

The feasibility phase of infrastructure construction is quite difficult. If the financing Project to consider

funding the project will help reduce the demand for loans and reduce the fiscal burden of the

government of Laos.

3. Project Financing and Funding

Road infrastructure is one of the critical measure to create value and distribute prosperity since road

construction help blind area to worth more and induce more economic activities; Furthermore, using

the concept of financial modeling and Project financing will help Government of Lao PDR to reduce

the need for cash investment in infrastructure and at the same time reduce the possibility for corruption

(since there is no cash payment from government budgeting process).

Approximately, construction cost for road in Laos is $50 per square meter. Construction of the road at a

distance of 10 kilometers wide and 20 meters requires a total investment of 10 million USD.

Project financing model is starting with the planning value of land and the positive externality value

creation land in nearby area where the road is cut through by expropriation. We can divide related land

into three phases on the left – right as shown in figure 1.

Figure 1: road and land zone pricing

The total area of these 3 areas surrounding the road (we will call Areas 1, 2, 3), including the area for

building roads. Government will shift from land is purchased at the price of $ 50 per square meter

before the creation of roads; However, the government must have the prior approval of the referendum.

So the expropriation price is the cost of building the road then square meters costs $ 50 that cost in land

plus road construction is $ 100 per square meter (50 USD for land and 50 USD for road construction

for every square meters). For the example in this case, 10 kilometers of road construction projects

include land with expropriation, resulting in a total project cost of $ 20 million. On average, the cost for

land plus construction is $ 2 million per kilometer if the government needs to invest to cover all areas

of road construction in Laos (in many area), the project will require a large investment.

From case study to building roads cut through the undeveloped space will result in parts 1, 2 and 3 as

illustrated; the price will skyrocket 10-folds from the original value and the price will be decreasing for

the distance land from the road. According to the purchase price of land price projection , the price will


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increase from 50 dollars/m2, so the price of land will move to $500 (land next to the road), $200 (500

meters from road) and $100 per square meter (1 kilometer from the road) as the distance from the street

every 0.5 kilometers, so the case study taken as a model to resolve the problem. For funding for the

construction of the road will be separated into 2 cases.

Case 1: The government will provide the land owner before using for landowners.

1.1 To exchange land by land: If a landowner visions investment opportunities, will exchange for a

piece of land on the main road by the small size of the price of the land before and after building ratio

of 10: 1 is 10 acres of land can be exchanged for one of the nights.

1.2 To exchange land by cash: If a landowner wants to sell 100% of the proceeds to pay the owner of

the land is appraised at $ 50 per square meter, the amount to be paid will come from fundraising in case

2.

Case 2: For other investors are interested to invest. The government announced the auction method of

sale of land around the road on the left – right (at developed price). The auction will be announced in

the rest of the exchange land by land. The land will be sold before the start of the road construction.

The government can sell the land for approximately 80% of the three parts of the sides of it

(figure 1). The government of Laos will have a budget to invest in building new road. By using this

method, the governments have managed good project to control construction costs, the government has

invested money for investment in other infrastructure.

4. Conclusion

The model of the Project financing is another way to raise funds for investment in the infrastructure of

developing countries, especially countries with a strong political system and a better vision of the

government. This approach is sustainable because the government does not have to bear the fiscal

burden that could lead to excessive debt, slow economic growth and slow countries development. This

article is prepared from the case study was applied and success for "Funding" and ―Project financing"

to develop the road in developing areas in the Vientiane, the capital of Laos. Thus, this model is able to

adapt for more suitable and sustainable development.

References

Finnerty, John D. (2013). Project Financing 3rd edition, Wiley Finance Series.

Withisuphakorn, Pradit. (2012). Textbook, Project Feasibility Study (in Thai), NIDA Business School.

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