Risk Assessment in Bop Projects

34 The IUP Journal of Financial Risk Management, Vol. VII, No. 4, 2010

Risk Analysis of Infrastructure Projects:A Case Study on Build-Operate-Transfer Projects

in IndiaHiren Maniar*

© 2010 IUP. All Rights Reserved.

The growth of the infrastructure sector in India has been relatively slow compared to that of theindustrial and manufacturing sectors. Energy shortage, inadequate transportation network, andinsufficient water supply system have caused a bottleneck in the country’s economic growth. TheBuild-Operate-Transfer (BOT) scheme is now becoming one of the prevailing ways forinfrastructure development in India to meet the needs of India’s future economic growth anddevelopment. There are tremendous opportunities for foreign investors in this field. However,undertaking infrastructure business in India involves many risks and problems that are mainly dueto differences in legal systems, market conditions and culture. It is crucial for foreign investors toidentify and manage the critical risks associated with investments in India’s BOT infrastructureprojects. The main purpose of this paper is to investigate the critical risks associated with BOTprojects in India. Based on a survey, the following critical risks, in descending order of criticality, areidentified: delay in approval, change in law, cost overrun, dispatch constraint, land acquisition andcompensation, enforceability of contracts, construction schedule, financial closing, tariff adjustmentand environmental risk. The measures for mitigating each of these risks are also discussed. Finally,a risk management framework for India’s BOT infrastructure projects is developed.

* Assistant General Manager, L&T Institute of Project Management, L&T Knowledge City, Vadodara 390019,Gujarat, India. E-mail: [email protected]

IntroductionIndia’s economy has shown remarkable growth over the past several years and manyforeign economists predict a healthy growth in the near future. A private internationalforecasting firm predicts that India’s GDP will grow at an average annual rate of about 8%between 2010 and 2015.

India’s investment reforms, rapid economic growth and social development have ledto a surge in Foreign Direct Investment (FDI). Annual utilized FDI in India grew from$636 mn in 1991 to $26 bn in 2009, making India, in recent years, the third largestdestination of FDI in the world.

A number of reasons explain India’s attractiveness to foreign investment:

• Relatively cheaper human resources, especially the labor.

• Governments at all levels and in all states are eager for funding local economicgrowth and have become increasingly friendly to foreign investors.

35Risk Analysis of Infrastructure Projects:A Case Study on Build-Operate-Transfer Projects in India

• A number of major international events have shown that India is a safer oasisfor investment.

• The economic and social infrastructure that was considered as bottleneck hasbeen significantly improved in recent years. Governments at various levels havebeen making investment in infrastructure development to keep pace with thelocal and the national economic growth.

• India’s economy has shown remarkable economic growth over the past twodecades at an average annual rate of about 7.5%, and it is expected that India’sGDP will grow at an average annual rate of about 9% in year 2010.

• India became a member of the World Trade Organization (WTO), which enablesIndia to play a major role in the development of new international rules on tradein the WTO, and provides India access to the dispute resolution process in theWTO, making it easier for reformers in India to push liberalization policies.

The tremendous economic growth in India has resulted in an immense demand forbasic infrastructure like roads, tunnels, power plants, water treatment plants and so on.In 1991, India began to investigate financing ways, specifically through the Build-Operate-Transfer (BOT) scheme to meet the needs of the country’s infrastructure and to beattractive to foreign investors. BOT has the potential to be one of the most effective waysfor India to raise funds for infrastructure projects in the near future. It also providesopportunities to foreign investors to penetrate into new markets in India. Despite thisthere may be a reluctance to engage in BOT because the application of BOT projects hasa relatively short history across the world and especially in India. This means that theBOT scheme may not be well-understood and received by foreign investors in terms ofits policy hurdles and its effectiveness in India, or by the Indian governmentrepresentatives handling it.

Furthermore, despite the tremendous opportunities to invest in infrastructure projectsin India, it is inevitable that such projects involve risks and obstacles. Unfortunately, thetraditional 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 andculture. In order to successfully implement BOT schemes in India, foreign investors willneed to identify and find ways to mitigate the critical risks considering diversity in termsof various issues pertaining to political front, policy matters and demography along withgeographical challenges. The purpose of the research is to identify and evaluate the criticalrisks associated with India’s BOT infrastructure projects, and develop a framework formanaging these risks that all parties to BOT infrastructure projects can refer to.

1.1 Challenges for Infrastructure Development in IndiaThe government officials as well as economists are however, aware of the fact that growthcan be sustained only if further reforms are made to the economy. India’s banking systemis 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 thebanking system prevents the Indian government from opening the sector to foreigncompetition (due to worsening of non-performing asset situation of banks in India).Corruption is another problem of the Indian banking system. Loans are often sanctionedon the basis of political connections. In many cases, bank branches extend loans to firmscontrolled by local officials, even during periods when the central government isattempting to limit credit. Such a system promotes widespread inefficiency in the economybecause savings are generally not allocated on the basis of obtaining the highest possiblereturns. In addition, inability to control the credit policies of local and provincial bankshas made it very difficult for the central government to use monetary policy to fightinflation without causing major disruptions in the economy.

Infrastructure bottlenecks, such as inadequate transportation and pollution remedialstems, pose serious challenges to India’s ability to sustain rapid economic growth. India’sinvestment in infrastructure development has failed to keep pace with its economicgrowth.

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 itdifficult to do business in India because rules and regulations are generally not consistentor transparent, contracts are not easily enforced, and intellectual property rights are notprotected (due to the lack of an independent judicial system). The lack of effective ruleof law, current ownership of land, and widespread local protectionism in India limitcompetition and undermine the efficient allocation of goods and services in the economy.

A wide variety of social problems have arisen from India’s rapid economic growth andextensive reforms, including pollution, widening of income disparities between the coastaland inner regions of India, increasing number of bankruptcies, and worker layoffs. Thisposes several challenges to the government, such as enacting regulations to controlpollution, focusing resources on infrastructure development in the hinterland, anddeveloping modern fiscal and tax systems to address various social concerns (such aspoverty alleviation, healthcare, education, worker retraining, pensions and social security).

All these unfavorable aspects produce numerous uncertainties for infrastructuredevelopment in India.

In 1991, the then Finance Minister of India, Manmohan Singh, outlined a number ofmajor economic initiatives and goals for reforming India’s economy and maintaininghealthy economic growth, such as:

1. Expand domestic demand, especially by increasing spending on infrastructure inresponse to the Asian Financial Crisis, and maintain the pace of previouslyplanned economic reforms;


2. Reorganize the banking system to increase the regulatory and supervisory powerof the central bank and make commercial banks operate independently; and

3. Substantially reduce the size of the government and reorganize the remaininggovernment institutions.

All the three goals were to be obtained within three years.

The Government of India implemented the above measures by relaxing FDI and soundbanking and regulatory system, which further helped to lure foreign funds in the form ofFDI and FII toward infrastructure sector.

The Indian government anticipates that banking and other financial reforms will leadto widespread layoffs. Stimulating domestic demand, especially through infrastructuredevelopment, 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 budgetdeficit. It is also likely that India hopes to attract foreign investment for much of itsinfrastructure needs.

2. Literature ReviewThe following summarizes the main findings of the related literature:

• The BOT scheme of financing infrastructure projects has many potentialadvantages and is a viable alternative to the traditional approach usingsovereign borrowings or budgetary resources.

• BOT projects involve a number of elements, such as host government, theproject company, lenders, contractors, suppliers, purchasers, etc., and all of themmust work in coordination for a successful project.

• The application of the BOT scheme in Indian infrastructure development isbeing carried out stage by stage.

• There are two broad categories of risk of BOT projects—country risks andspecific project risks. The former is associated with the political, economic andlegal environment over which the project sponsors have little or no control.The latter to some extent can be controlled by the project sponsors.

• Different researchers appear to have different points of view on riskidentification because they have approached the topic from different angles.A few researches of risk management associated with India’s BOT projectsfocused on a particular sector.

• Risk management is a critical success factor of BOT projects. A particular riskshould be borne by the party most suited to deal with it, in terms of control orinfluence and costs, but it has never been easy to obtain an optimal allocationof risks.


The above points are as per KPMG report on India Infrastructure sector datedJuly 22, 2010.

3. Risks Analysis of Infrastructure Projects

3.1 Risks Associated with Infrastructure ProjectsThe risks of infrastructure projects have a wide range of sources and can be classified intothe following broad categories (This is based on the speech of Montek S Ahluwalia,Deputy Planning Commission, www.planningcommission.gov.in/aboutus/speech/spemsa/msa009.doc):

• Technical, quality or performance risk such as employment of inexperienceddesigners, changes in the technology used, or in the industry standards duringthe project.

• Organizational risks such as cost, time and scope objectives that are internallyinconsistent, lack of prioritization of projects, inadequacy or interruption infunding, and resource conflicts with other projects in the organization.

• External risks such as shifting legal or regulatory environment (includinginstitutional changes), poor geological conditions, and weather-related forcemajeure risks such as earthquakes and floods.

• Project management risks such as poor allocation of time and resources,inadequate quality of the project plan, and poor use of project managementdisciplines.

The experience of private investment in infrastructure in India over past yearsindicates that risks and pitfalls go together with opportunities. Proper identification,therefore, of the risks associated with investment in infrastructure in India, and planningfor effective responses thereto are essential for the private investors to be successful.In general, in order to be successful all capital projects should meet the following criteriaor have the characteristics as listed below:

• A credit risk rather than an equity risk is involved.

• A satisfactory feasibility study and financial plan have been prepared.

• The cost of product or raw material to be used by the project is assured.

• The supply of energy at reasonable cost has been assured.

• A market exists for the product, commodity or service to be produced.

• The best way to appreciate the concerns of investors in infrastructure in Indiais to review and consider some of the common causes of their failures, as statedbelow:

– Delay in completion, with consequential increase in the interest expense onconstruction financing and delay in the contemplated revenue flow;


– Capital cost overrun;

– Technical failure;

– Financial failure of the contractor;

– Government interference or inaction;

– Uninsured casualty losses;

– Increased price or shortages of raw materials;

– Technical obsolescence of the plant;

– Loss of competitive position in the market;

– Expropriation;

– Poor management;

– Overly optimistic appraisals of the value of pledged security, such as oil andgas reserves; and

– Financial insolvency of the host government.

In particular, for private investors to be successful in their infrastructure projects, theserisks must be properly considered, monitored and avoided throughout the life of the projects.

3.2 Risks Associated with Financing of Infrastructure Projects

According to Nevitt and Fabozzi (2000), the risks that the lenders may take during projectfinancing include:

• Country risk: This includes risk of a politically-motivated embargo or boycottof a project, debt repayments or shipment of product, which involves the foreignpolicy of the country. Country risk also includes circumstances where the hostcountry cannot permit transfer of funds for debt service because of its owneconomic problems.

• Political risk: Political and regulatory risks are inherent in every business. Theyaffect all aspects of a project, from site selection and construction to completion,operations and marketing. They are difficult to evaluate. Where possible, theyare assumed by the sponsors, and where it is not possible, the lenders sometimesassume such risks. The ultimate political risk is of expatriation. It is oftendifficult to distinguish this risk from the country risk.

• Sovereign risk: Lenders used to making credit judgments for loans to countriesare in a position to make lending decisions where the project is owned entirelyor in part by an agency of a country. This in terms of collateral or security andguarantee from Government of India. Being a BOT Project it is highly essential


to mitigate the risk from lender’s perspective, hence this risk is very essentialfrom the lender’s point of view.

• Foreign exchange risk: In case capital expenditures, operating expenses,revenues and borrowings are not in the same currency, the lender may be askedto assume some of the risk through multicurrency loans which give the borroweran option, based upon a fixed exchange rate, to repay in different currencies.The lenders sometimes hedge this risk.

• Inflation risk: The lender must ultimately rely on projections of the cost ofconstruction of the project and the cost of operations. Use of correct inflationfactors in figuring out these future costs is an area in which the lender usuallyhas more expertise than the project company or its promoters.

• Interest rate: Loans with floating interest rates may be used for constructionpurpose and long-term financing, as well as for working capital and short-termneeds. Forecasts of future interest rates used to or project capitalizedconstruction costs and future debt service requirements are dependent uponrealistic interest rate assumptions. Due to global economic slowdown andstimulus packages by various countries, it is advisable to have interest rate infloating condition till we get clear picture about complete recovery of economyfrom economic slowdown. However, considering the uncertain economicenvironment it is very much essential to predict interest rate in perfection toreduce interest outgo and for speedy payment of loans for the projects.

3.3 Risk Appraisal of Infrastructure ProjectsThis can be done based on the following:

• Availability of permits and licenses: Where permits and licenses must beobtained and renewed before the plant operates, the lenders, in effect, assumethe risk that such permits and licenses will be obtained in a reasonable time inthe absence of any provision by the sponsors to pay these costs.

• Operating performance risk: Once the project is complete and operate accordingto specifications, the project begins to assume the characteristics of anestablished operating company. As the completion guarantee drops away, thelenders in many project financing become dependent on the uninterruptedoperation of the project and sale of its products or services to obtain therevenues necessary to repay the project loans.

• Price of the product: The lender must appraise the future market for thecommodity and make judgments as to whether such price projections arerealistic.

• Enforceability of contracts for product: Even if a project is supported bytake-or-pay contracts with adequate escalation clauses, a question still arises asto whether the contract is enforceable, and whether the contracting party is a


reliable party who will live up to its contractual obligations. Possible forcemajeure defenses to performance must be considered. Should a loan be made, e.g.,on the basis of a long-term contract to sell coal to a public utility? Is it possiblethat the responsible public utility commission might declare the contractunenforceable at a later date? A credit judgment also has to be made on thefinancial ability and integrity of the contracting party to live up to itscontractual obligation.

• Price of raw materials and energy: This can be assessed based on the prevailingprices of raw materials and other commodities required for infrastructureprojects.

• Enforceability of contracts for raw materials: If a project has long-term contractsfor raw materials at attractive prices, which are used in the underlying financialprojections, a question still arises as to their enforceability and as to whetherthe contracting party is reliable and will live up to the commitments. If the rawmaterial is imported, the risk of import restriction or force majeure events inthe exporting country must be considered. Lenders sometimes assume theserisks by advancing additional loans.

• Refinancing risk: If the project is arranged on a basis whereby the constructionfinancing is to be provided by one group of lenders, and the long-term financingafter completion of construction is to be provided by another set of lenders, theconstruction lenders run the risk of not being taken out by the long-termlenders. This is due to various problems faced by BOT projects during itsconstruction stage, hence construction lenders are more vulnerable to riskcompared to long-term lenders who generally prefer to lend after constructionstage. Construction lenders prefer long-term financing to be arranged at thetime of the construction loan. However, this is not always possible because oflong lead time. Construction lenders can protect themselves by providingincentives to sponsors to arrange the long-term debt. This may be achieved, forexample, by gradually escalating interest rates, by triggering additional sponsorguarantees, or by requiring a take-out by the sponsor. Project financing tend tohave the same group of lenders for both construction lending and long-termlending.

• Force majeure risk: Force majeure risks are those risks which result from eventsbeyond the control of the parties to the project financing. The objective oflenders is to shift the various force majeure risks to the sponsor, or to thesponsor’s suppliers and purchasers through contractual obligations or insuranceprotection. To the extent that these risks are not shifted, the lenders have toassume the force majeure risk.

• Completion: The completion risk sometimes assumed by a lender arises incircumstances where for all practical purposes it is impossible to complete the


project or facility so that it operates to the full capacity and/or specificationsoriginally envisaged. Sponsors do not want to be in a position of having toprovide funds to attempt to complete a facility to specifications that requireexpenditures out of proportion to the benefit to be realized, or which seemimpossible to achieve. Usually this risk can be handled with little exposure tothe lender, but the loan may have to be extended for a longer-term due to lowerproduction than anticipated in the financial projections.

The risks associated with a project may arise in three major periods during the projectlife cycle:

1. Engineering and construction phase;

2. Start-up phase; and

3. Operations according to specification.

3.4 Risk-Sharing: The Lessons LearnedAt the heart of project financing is a contract that allocates risks associated with a projectand 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 hasbeen critical in maintaining incentives to perform. Risks are divided not only betweenpublic and private entities but also among various private parties. Four kinds of risks canbe distinguished—currency, commercial, policy-induced, and country—although thedistinctions among them are not always clear-cut.

3.4.1 Currency RiskMore recently, privately financed infrastructure has drawn on foreign capital and thereforefaces 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 with the growingdemand for private finance, the risk of currency depreciation falls on the project sponsorand ultimately on the consumers of the service. In many recent private projects, serviceprices have been linked to an international currency.

3.4.2 Market (Commercial) Risk

Two types of commercial risk may be distinguished, those relating to costs of productionand those arising from uncertainties in demand for services. Substantial progress has beenmade in shifting cost-related risks onto private sponsors and other private parties.Typically, contracts include bonuses for early commissioning of the project and penaltiesfor late completion. A contract may also specify operational obligations, such asmaintenance or the availability of capacity. In the case of utilities, a power or watersupplier is sometimes penalized for capacity availability below pre-specified level. Or thecontract may require that a plant be available in effective working order for a specifiedperiod of time.


Project sponsors are able to transfer some of these risks to other private parties. It iscommon, for example, to transfer construction risk to specialized construction companiesthrough turnkey contracts. Also, sponsors may enter into long-term contracts with inputsuppliers.

Where sector policy concerns are unimportant, investors also accept market risk, butprogress in this regard has been slower. Tariffs in line with costs, sector unbundling topermit new entry, and access to transmission networks are required in order to enableprivate sponsors to assume all market risks. In telecommunications project, the market riskis 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 notassured. Also, governments need to decisively eliminate the prospect that investors willbe bailed out if circumstances are unfavorable.

Assumption by private parties of even cost-related risks creates incentives for goodperformance. Not only do sponsors have equity holdings in the project, but also lendersare central to the monitoring process. As part of the contract, several financial covenantsare made. In such situations, commercial banks have a much greater incentive forsupervising projects than do lenders backed by sovereign guarantees.

The evidence, although limited, shows that the assumption of cost-related risks byprivate sponsors and the monitoring of performance by banks are effective. Evidence, forexample, on private construction is very favorable and reflects the tight contractualconditions and severe penalties for cost and time overruns (As per the report of PlanningCommission, June 2010). A preliminary review of the International Finance Corporation’sinfrastructure projects shows that time overruns in construction have been only sevenmonths on average, and cost performance has been almost on target. Such performance,however, is possible only when commercial risks are truly transferred to private sponsors.

Private investors may wish to insure themselves against commercial risks. Theprovision of such insurance is best left to the private sector, although governments havea role in stimulating domestic guaranty facilities, possibly by taking an initial stake inguaranty funds. The private market for risk insurance for international transactions issmall. While short-term insurance for trade credit is available, private insurance forinfrastructure projects is uncommon.

3.4.3 Sector Policy Induced RiskImportant issues arise, especially in the power sector because project sponsors focus on thecredibility and solvency of their buyer, typically a government utility that transmits anddistributes 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 aspecified amount regardless of whether the service is used. The government thus providesa contract compliance guarantee—a useful transitional measure—while the long-termgoal 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 governmentagencies (or municipal authorities) are not the direct purchasers of the service. But theycan and do influence the ability of the service provider to meter, bill, and collect. Wherethe municipal authorities cannot deliver, collection guarantees from the centralgovernment are required.

Thus, in such projects, the ‘market’ risk, or the risk arising from fluctuations indemand, is effectively transferred to the government through the take-or-pay formula.This becomes necessary because market risk is intermingled with the danger thatfinancially troubled power purchasers (transmission utilities) or water users may nothonor their commitments. Overall sector reform is required to eliminate policy-inducedrisks and thus reveal the market risk.

3.4.4 Country Risk

Where governments do provide guarantees against policy or even commercial risks, thesemay not always be acceptable to private international lenders, who may look instead forguarantees from creditor countries or from multilateral banks to insure against ‘country’risks. The role of the borrower government does not disappear in such situations, sincecounter-guarantees are typically required.

4. Project Risk ManagementProject risk management had been implemented for many years in India prior to the term‘Project Risk Management’ becoming known to most of the Indian project managers andgovernment officials in the early 1990s.

4.1 Risk Identification and AnalysisThe long-lasting implementation of project risk management in India can best beevidenced from the construction project procedure that has been in use for over fourdecades in India. The procedure is shown in Figure 1. The feasibility study was formallyintroduced into the procedure in 1992. A capital project (including infrastructureprojects) must follow this procedure.

When an organization has identified its need for a new facility, it must submit a projectproposal defining the purpose, requirements and general aspects of the project, such aslocation, performance criteria, scope, layout, equipment, services and other requirements.The definition and planning of the project should be carried out in coordination withagencies in charge such as provincial, municipal, autonomous region governments, centralministries or commissions. The project proposals of a medium or large-sized project mustbe submitted to the agencies in charge for review and comments. The priority projectsshould be subject to review and approval by the State Council.

The review and approval procedure must make sure that the project complies with thenational, economic and social development programs and there are sufficient resourcesavailable to the project. Once the proposal is approved, site selection and feasibility study


Figure 1: Construction Project Procedure in India

Long-Term Capital Investment Program

Preparation of Proposals

Feasibility Study

Employer’s Estimate

Design’s Estimate

Detailed Estimate

Final Settlement

Take Over for Start-Up

Test at Completion

Preparation for Start-Up

Commencement/Progress

Site Preparation

Working Drawing

Design Development

Scheme/Concept Design

Feasibility StudyFive-Year Capital Investment Program

Program of Implementationof Approved Projects

Annual Capital Investment

should 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 andfeasibility 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 shouldbe considered and compared with each other in terms of the various factors influencingthe project.

All the potential sites need to be investigated to determine their suitability for theproject and must meet the local planning requirements. A site choice report and afeasibility study report are usually required and submitted to the appropriate planningauthority, or the State Council in the case of a priority project for review and approval.


4.2 Risk Response StrategiesIndia’s government officials and project managers use the risk response strategies that areavailable to them.

4.2.1 AvoidanceRisk avoidance is changing the project plan to eliminate the risk or condition or to protectthe project objectives from its impact. Some risk events that arise early in the project canbe dealt with by clarifying requirements, obtaining information, improving communication,or acquiring expertise. Reducing scope to avoid high-risk activities, adding resources ortime, adopting a familiar approach instead of an innovative one, or avoiding an unfamiliarsubcontractor may be examples of avoidance.

4.2.2 TransferenceRisk transfer is seeking to shift the consequence of a risk to a third party along with ownershipof the response. Transferring the risk simply gives another party responsibility for itsmanagement; it does not eliminate it. Transferring liability for risk is most effective in dealingwith financial risk exposure. Risk transfer nearly always involves payment of a risk premiumto the party taking on the risk. It includes the use of insurance, performance bonds, warrantiesand 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 project’s 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.

4.2.3 MitigationMitigation seeks to reduce the probability and/or consequences of an adverse risk event to anacceptable threshold. Taking early action to reduce the probability of a risk occurring or itsimpact on the project is more effective than trying to repair the consequences after it hasoccurred. Mitigation costs should be appropriate, given the likely probability of the risk andits consequences. Risk mitigation may take the form of implementing a new course of actionthat will reduce the problem, e.g., adopting less complex processes, conducting more seismicor engineering tests, or choosing a more stable seller. It may involve changing conditions sothat the probability of the risk occurring is reduced, e.g., adding resources or time to theschedule. 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 addressthe risk impact by targeting linkages that determine the severity. For example, designingredundancy into a subsystem may reduce the impact that results from a failure of the originalcomponent.

4.2.4 AcceptanceThis technique indicates that the project team has decided not to change the project planto deal with a risk or is unable to identify any other suitable response strategy. Activeacceptance may include developing a contingency plan to execute, should a risk occur. Passiveacceptance 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 shouldthe risk occur. Risk triggers, such as missing intermediate milestones, should be definedand tracked. A fallback plan is developed if the risk has a high impact, or if the selectedstrategy 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, orreserve, 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 ofrisk exposure, for the risks that have been accepted.

5. Methodology of Study

5.1 ProcedureThis research study employed a combination of methods for an integrated qualitative andquantitative research methodology that included five stages. The first stage was acomprehensive literature review together with lessons learned from the practice of BOTprojects in developing countries, especially in India, to develop an initial list of risks associatedwith India’s BOT infrastructure projects. In the second stage of instrument development, onlythe critical risks associated with India’s BOT infrastructure projects were chosen for the study.

This research on BOT projects in India mainly focuses on the following categories ofrisk, which were not covered in various studies on risk analysis in BOT projects as wellas in the KPMG report on Indian infrastructure sector.

• Approval risk

• Cost overrun risk

• Law risk

• Dispatch constrain risk

• Contracts risk

The filtering of the initial list was based mainly on experiences in the practice of twoBOT infrastructure projects in India supported with information from literature reviews andpublished case studies. In the third stage, a survey via questionnaires to related experts wasconducted to evaluate the criticality of the short-listed risks and the effectiveness of thecorresponding mitigation measures. The fourth stage was case studied; it provides detailedinformation to supplement that obtained from a survey. Finally, a risk managementframework for investing in India’s future BOT infrastructure projects was developed.

5.2 Survey

5.2.1 Rating of Risk Criticality and Mitigation Measure Effectiveness

The evaluation of the criticality of risk is a complex subject concealed in uncertainty andvagueness. 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 ofsurvey replies, a six-degree rating system for the criticality of risk and the effectiveness ofmitigation measures was adopted (Armstrong, 2004), as shown in Table 1.

Table 1: Rating System for Risk Criticality and Mitigation Measure Effectiveness

Ratings Risk Criticality Mitigation Measure Effectiveness

0 Not applicable Not applicable

1 Not at all critical Not at all effective

2 Only slightly critical Only slightly effective

3 Critical Effective

4 Very critical Very effective

5 Very much critical Very much effective

5.3 Data Collection

This survey is mainly focused on the infrastructure sector of India and it targeted thefollowing industries:

• Power Plants

• Toll Road Projects

• Aviation

• Telecommunication

• Social Infrastructure Projects like sewage, drinking water, etc.

There were 50 respondents, who were asked various questions pertaining to variousrisks they faced during conceiving to commissioning stages of infrastructure projects.

5.4 Analysis of Data

Since the survey targets were mainly the experts in India, the survey had already beentested on a small sample of relevant respondents to make sure that the survey wasunambiguous and that the respondents understood the terms and would interpret termsin a similar manner.

Data analysis consists of examining, categorizing, and tabulating the evidence toaddress the initial propositions of the study. In order to generate recommendations, thisresearch project analyzed data in following three stages:

1. Data Reduction: It edited and summarized the data collected from the surveyand case studies, and looked for patterns and themes to reduce the data withoutsignificant loss of information. The main method used was coding or sorting the


data into categories according to some criteria which appear to be reasonablebased upon prior research.

2. Data Display: In this stage it used tables to display the results of the survey andenhance the understanding of the data.

3. Drawing Valid Conclusions: It was initially tentative, but firmed up as theanalysis developed and was verified by constantly referring back to the data.

5.4.1 Critical Risks and Mitigating Measures

Criticality of Critical Risks: The survey results concerning the criticality of risksassociated with India’s BOT infrastructure projects are tabulated in Table 2. The risksare ranked from 1 to 11 on the basis of their mean scores. The risk with the highestmean score would be ranked 1 and so on.

Table 2: Criticality of Risks in India’s BOT Infrastructure Projects

Delay in Approval 0 4.8 4.8 33.3 28.6 28.6 3.71 1

Change in Law 0 9.5 9.5 19.0 28.6 33.3 3.67 2

Cost Overrun 0 0 19.0 42.9 23.8 14.3 3.33 3

Dispatch Constraint 0 4.8 33.3 19.0 23.8 19.0 3.19 4

Land Acquisition and Compensation 0 0 28.6 47.6 4.8 19.0 3.14 5

Enforceability of Contracts 0 4.8 38.1 19.0 23.8 14.3 3.05 6

Construction Schedule 0 4.8 28.6 42.9 9.5 14.3 3.00 7

Financial Closing 0 41.3 19.0 33.3 23.8 9.5 2.95 8

Tariff Adjustment 0 9.5 28.6 33.3 19.0 9.5 2.90 9

Environmental Risk 0 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 0 1.86 11

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Percentage of Respondents Who Answered

Critical Risk

Effectiveness of Mitigating Measures: The survey also asked the respondents to evaluatethe effectiveness of the generally available mitigating measures for the critical risksassociated with India’s BOT infrastructure projects, which were developed from theliterature review, personal experience and informal discussion with colleagues.

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


mitigating measure for delay in approval risk, because a foreign consortium will at leastknow from where, who and how to get the approvals.

As shown in Table 5, the respondents felt that the most effective mitigating measurefor cost overrun risk was to include penalty clauses in contracts with the projectparticipants, e.g., constructors, input suppliers and the operator, so that all share theresponsibility and the incentive to perform well as individuals, and also engage in solvingproblems that affect the health of the overall project even if the cause of the problem doesnot lie with them.

Table 3: Effectiveness of Mitigating Measures for Delay in Approval Risk

Mitigating MeasureEffectiveness

Mean Score Ranking

Establish joint venture with Indian government agencies or state-owned 3.43 2enterprises or local private partners, or with foreign (international)company either already or not yet operating in India

Obtain government’s guarantees to adjust tariff or extend concession 3.19 3

Maintain good relationship with central and state governments 3.86 1

Table 4: Effectiveness of Mitigating Measures for Change in Law Risk


Mean Score Ranking

Obtain government’s guarantees, e.g., adjust tariff or extend 3.86 1concession period

Insurance for political risk 1.67 3

Maintain good relationship with central and state governmentsauthorities 3.62 2

As shown in Table 4, the respondents felt that the most effective mitigating measurefor change in law risk was to obtain guarantees from the government to either adjust thetariff or extend the concession period.

Table 5: Effectiveness of Mitigating Measures for Cost Overrun Risk


Mean Score Ranking

Enter into contracts with the project participants, e.g., constructors, 3.86 1input suppliers, and the operator

Additional capital provided by shareholders in the form of a stand-by 3.10 2subordinated loan or as a stand-by capital contribution

Ask the lenders to provide standby credit facilities for cost overruns 2.95 3

As shown in Table 6, the most effective measure for dispatch constraint risk, accordingto the 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 amountsperiodically for the product purchased, and to make specified minimum payments even ifit does not take delivery.

Table 7: Effectiveness of Mitigating Measures for Enforceability of Contracts Risk


Mean Score Ranking

Make a credit judgment on the financial ability and integrity of thecontracting party to live up to its contractual obligation 3.57 1

Maintain good relationship with government authorities, and establisha communication with local arbitrators 2.81 3

Appoint independent accountant to audit the contracting parties 3.10 2

The above-mentioned survey results show the effectiveness of the mitigating measuresfor the short-listed critical risks associated with India’s BOT infrastructure projects. Eachmeasure may represent an additional cost to foreign investors. The different measuresshould not be viewed as alternatives but as components in an integrated approach to riskmanagement. Many of the measures appear complementary and it seems logical to supposethat they will be more powerful as mitigating measures when used together than whenused alone.

5.5 Risk Management Framework for BOT Infrastructure ProjectBased on the survey results and analysis as well as case studies, a risk managementframework for investing in India’s future BOT infrastructure projects can be proposed asfollows:

Step 1: List all risks associated with the proposed BOT infrastructure project and thenanalyze these risks in order of importance. The more critical the risk, the more attentionshould be paid to it.

Table 6: Effectiveness of Mitigating Measures for Dispatch Constraint Risk


Mean Score Ranking

Enter into take-or-pay products (e.g., power or water) purchase 3.33 1arrangements with purchaser

Enter into dispatch contracts with government authorities to dispatch 3.33 2facilities at full capacity for a minimum number of hours each year

Ask government to guarantee that transmission system will be 3.10 3ready for dispatch

As shown in Table 7, making a credit judgment on the financial ability and integrityof the contracting party to live up to its contractual obligation is regarded as the mosteffective measure for mitigating the enforceability of contracts risk.


Step 2: For each risk, list corresponding mitigation measures as much as possible, and thenexamine the availability of the mitigating measures in sequence based on theireffectiveness. 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 andrelated entities to incorporate the risk mitigation measures, and fine tune the concessionagreement and other agreements as much as possible to ensure that all these risks areadequately covered.

Step 4: Allocate risks to related parties according to the principle that risk should beborne by the party most capable of controlling it. An optimal allocation of risks dependson the relative bargaining power of the parties and the potentiality of reward for takingthe risks.

Step 5: Adopt the risk allocation and security structure and enter into financing processfor the project.

ConclusionIn this research, the critical risks associated with India’s BOT projects were investigated.The main conclusions are as follows:

• The identified critical risks in descending order of importance are: delay inapproval, change in law, cost overrun, dispatch constraint, land acquisition andcompensation, enforceability of contracts, construction schedule, financialclosing, tariff adjustment, and environmental risk.

• The measures for mitigating each of these risks have been evaluated by therespondents. Most of the measures were regarded as effective to some degree,however the most effective measures to mitigate each risk are as follows:

– For delay in approval, maintaining a good relationship with governmentauthorities, especially officers at the state or provincial level;

– For change in law, obtaining government’s guarantees via adjusting eitherthe tariff or extending the concession period;

– For cost overrun, entering into contracts with the project participants sothat all share the responsibility and the incentive;

– For dispatch constraint, entering into take-or-pay contracts with otherparties;

– For land acquisition and compensation, obtain government’s guarantees toachieve timely acquisition of land;

– For enforceability of contracts, making a credit judgment on the financialability and integrity of the contracting party to live up to its contractualobligation;


– For construction schedule, choosing quality, trustworthy Indian partnerswith knowledge of how to handle everyday construction issues;

– For financial closing, equity financing and cooperation with governmentpartners;

– For tariff adjustment, negotiating to separate and redefine the tariff burdenso that while some portions of the total tariff burden remain fixed otherportions are either adjusted, rescheduled or paid in foreign currency; and

– For environmental risk, creating appropriate lines of communication andcontacts with government authorities and agencies.

The risk management framework proposed by this research project is easier to applythan others. It incorporates the findings from this research and provides step-by-stepguidelines for foreign companies who intend to invest in India’s infrastructure projects inthe future. It also has the potential to help national, provincial, and city government toexamine their approach to and services in support of BOT infrastructure projects. Itsuggests that mechanisms be reviewed to improve the communication and coordinationlinks between different levels of government, a second thought be given to developmechanisms to coordinate actions of different government agencies, and the lessonslearned from individual BOT projects be shared among government servants so thatunintended barriers to BOT are dismantled.

Bibliography1. Armstrong Dan (2004), “Six Degrees of Project Management”, Baseline, February,

http://www.baselinemag.com/cp/bio/Dan-Armstrong/

2. Bond Gary and Laurence Carter (1994), “Financing Private Infrastructure Projects:Emerging Trends from IFC’s Experience”, IFC Discussion Paper No. 23, The WorldBank, Washington.

3. Grey S (1995), Practical Risk Assessment for Project Management, John Wiley & SonsLtd., Chichester.

4. International Finance Corporation (1996), Lessons of Experience No. 4: FinancingPrivate Infrastructure, The World Bank, Washington.

5. Kleimeier S and Megginson W L (1998), “A Comparison of Project Finance in Asiaand the West”, in L H P Lang (Ed.), Project Finance in Asia, Advances in Finance,Investment and Banking, Vol. 6, pp. 57-90, North Holland, Amsterdam.

6. Nevitt Peter K and Fabozzi Frank J (2000), Project Finance, Euromoney InstitutionalInvestor.

7. Qiao L, Wang S Q, Tiong L K R and Chan T S (2001), “Framework for CriticalSuccess Factors of BOT Projects in China”, The Journal of Structured and ProjectFinance, Vol. 7, No. 1, pp. 53-61.

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8. Risk Management in PPP Projects, IL and FS Report, Construction Risk ManagementConference, August 2010, India.

9. Wang G Q and Jia X L (2005), “Risk Management on the BOT Investment andFinancing Mode”, China Water & Wastewater, Vol. 21, No. 9, pp. 85-88.

10. Wang S Q, Dulaimi M F and Aguria M Y (2002), “Building the External Wing ofConstruction: Managing Risk in International Construction Project”, ResearchReport, National University of Singapore.

11. World Bank (1994), World Development Report 1994: Infrastructure for Development,Oxford University Press Inc., New York.

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