Public private patnership with government included demand risk a case study from viet nam

Public-Private Partnerships with governmentinduced demand risk: A case study from Vietnam Vinh-Thang HOANG ABSTRACT This research considers the Phu My Bridge in Ho Chi Minh City (Vietnam) in a context of increasing private-sector participation in Vietnam’s infrastructure sector It analyzes the bridge’s financial distress as the consequence of the public sector’s failure to deliver on its commitment to complete city’s ring road project on time The paper’s model considers the private-sector investor and the government in a two-party interaction, where the government may overstate its capability to deliver supporting infrastructure If this is the case, the private sector party makes a loss to the extent that it is misled Furthermore, even if the government chooses to rescue the private sector party, its own commitment would increase but would not reach the no-deviation scenario These results call for more transparency as well as improved communication channels between the parties Finally, the paper discusses other important issues of the project that the model voluntarily leaves out Keywords: Vietnam, Phu My Bridge, Public-private partnerships, Demand risk INTRODUCTION Over the last decade, infrastructure has gathered renewed interest, especially from institutional investors given its particular characteristics as an investment (Sawant 2010) However, roads, bridges or aqueducts have been around for millennia, constructed by Université Paris-Dauphine Place du Maréchal de Lattre de Tassigny, 75775 Paris cedex 16 1 Electronic copy available at: https://ssrn.com/abstract=2723132 Electronic copy available at: http://ssrn.com/abstract=2723132 civilizations both ancient and modern to drive trade, integration and progress Once being the responsibility of the governing body, with time the private sector is increasingly called upon as well On the other hand, as the ongoing AIIB (Asian Infrastructure Investment Bank) initiative is any indication, emerging markets and particularly Asia is where a significant portion of infrastructure demand will be This demand is estimated at USD 800 billion per year from 2010 to 2020 (Bhattacharyay 2010) Asian countries such as Vietnam are also massively turning towards the private sector to finance their infrastructure In this paper, the author has chosen to explore this link between infrastructure and emerging markets by providing a case study of the Phu My Bridge in Vietnam Located in Ho Chi Minh City whom it connects two key districts, the bridge had been one of the largest in Vietnam at the time of its construction However, it is in financial distress for reasons detailed later in this paper Understanding these reasons will therefore provide valuable lessons for Vietnam in enlisting the private sector in infrastructure development, and this is the first reason that motivates this paper From an academic standpoint, the Phu My Bridge is also worth considering The paper will argue that the public sector’s behavior may be interpreted as opportunistic and this has contributed to the bridge’s financial difficulty For this, the paper will develop a theoretical model and show even with simplifying assumptions we can come upon a number of results worth interpreting The remainder of this paper is organized as follows Section provides a background to this research Section develops a theoretical model to analyze the behavior of the government in this project Section points out the limitations of the model compared to real life and what we may learn from them The final section concludes Electronic copy copy available available at: Electronic at:https://ssrn.com/abstract=2723132 http://ssrn.com/abstract=2723132 BACKGROUND TO THE STUDY 2.1 Background on Vietnam 2.1.1 Economic context Since the country’s opening up during the late 80s, Vietnam has made some great strides on creating a market economy Real GDP growth averaged 6.9% from 1990 to 2013, according to the World Bank’s data In parallel, vast institutional changes were introduced to attract foreign investments, resulting in Vietnam becoming one of the top destinations for foreign direct investments (FDI) in the region FDI commitments amounted to USD 22.4 billion in 2013 (Báo Đầu Tư 2014) The private sector in Vietnam was also a big beneficiary of the sweeping reforms The number of State-Owned Enterprises (SOEs) declined from 6545 in 1992 to about 3000 in 2010 and they only account for about 10% of the country’s employment (Le Hoang Cuong, Helen and Ruhul 2014) The private sector’s contribution to the national economy, on the other hand, rose to between 57% and 67% of the GDP (ADB 2005) 2.1.2 Private participation in infrastructure development When the reforms began in Vietnam, the country’s infrastructure was in shambles due to lack of investment However, over the next two decades the country has ramped up its infrastructure spending, which now represents a significant percentage of GDP According to Vietnam’s General Statistics Office (GSO), the country spent on average 10.6% of its GDP on infrastructure from 2009 to 2011 This estimate is on the higher end of the regional range, as a research report showed none of Vietnam’s emerging neighbors in the ASEAN2 spent more than 10% of GDP (Goldman Sachs 2013) Faced with this intensifying need in infrastructure spending, Vietnam’s government budget is currently under increasing scrutiny from the public and capital markets, and the budget deficit was estimated at 5.5% in 2013 (ADB 2014) Domestic bank financing have become ASEAN: Association of Southeast Asian Nations Electronic copy available at: https://ssrn.com/abstract=2723132 more difficult since 2008 with rates sometimes as high as 20% Foreign bank financing is also challenging due to more stringent international banking regulations The Bank for International Settlement itself admitted emerging countries were “particularly concerned” about Basel III’s impact on the availability of funds (Bank for International Settlements 2014) Consequently, Vietnam is relying more and more on the private sector to keep up with infrastructure demand, something recognized very early by the government The first amendment of the country’s Law on Investment in 1992 introduced the first legal framework for BOT (Build-Operate-Transfer) contracts Subsequent Decisions issued by the government detailed other frameworks such as BT (Build-Transfer), BOO (Build-Own-Operate) or BTO (Build-Transfer-Own) Since then, 82 projects with private participation reached financial close in Vietnam until 2013, with a total cost of USD 11.6 billion (World Bank 2014) 2.2 The Phu My Bridge 2.2.1 The context The Phu My Bridge connects Districts and of Ho Chi Minh City, Vietnam’s economic powerhouse with 9% of the national population and 20% of the national GDP in 2012 At the time of its construction, the bridge had been one of the largest infrastructure projects ever undertaken in the city After completion, it would create a profound impact both for the city and for Vietnam as a whole Being part of the city’s ongoing ring road project, the Phu My Bridge provides a quick way to move from East to West of the city, and in the near future the bridge would link up two major sections of Vietnam’s 1800-km under-construction national expressway (VnExpress 2014) A map of the Phu My Bridge’s location is provided below: Electronic copy available at: https://ssrn.com/abstract=2723132 Figure 1: Location of the Phu My bridge and the ring road project – (Tang Quoc Cuong 2010, 139) 2.2.2 Implementation The Phu My Bridge was constructed under the BOT (Build-Operate-Transfer) model, for a projected investment of VND 1800 billion (USD 115 million at the time) The World Bank defines a BOT project as one where “the public sector grantor grants to a private company the right to develop and operate a facility or system for a certain period (the "Concession Period"), in what would traditionally be a public sector project” (World Bank 2014) For the Phu My Bridge, the developer is Phu My Bridge Corporation (PMC), an entity backed by a number of investors The main EPC (Engineering, Procurement & Construction) contract was awarded to BBBH consortium, which consisted of Germany’s Bilfinger Bergerm and Australia’s Balderstone Hornibrook The main debt financing package was co-syndicated by two French banks Société Générale and Crédit Agricole CIB It consisted of a USD 60 million buyer credit and another untied USD 34 million loan The buyer credit is insured by Germany’s Euler Hermes Electronic copy available at: https://ssrn.com/abstract=2723132 and reinsured by France’s Coface and Australia’s EFIC3, and the entire debt facility is lent to Ho Chi Minh City Finance & Investment Company (HFIC), a public entity established by the city’s government HFIC then lent the proceeds to PMC, thus allowing the latter to benefit de facto from the guarantee of the City’s government (this technique is known as on-lending) Loan repayments from HFIC are in turn guaranteed by Vietnam’s Ministry of Finance (MoF) The lending contract was signed in 2005 and entered into force in 2007 However, a number of domestic banks such as BIDV and Sacombank also provided financing to PMC Below is a summary of the key parties: People’s Committee of HCMC Ticket price regulator & BOT contract signatory Guarantor Lenders MoF Société Générale Crédit Agricole Other domestic lenders Phu My Bridge Corporation Domestic shareholders On-lender HFIC End-users Main contractors Bilfinger Bergerm, Baulderstone Hornibrook Export finance guarantors Coface, Euler Hermes, EFIC Sub-contractors Freyssinet, CC620 Figure 2: Summary of the main parties involved Euler Hermes, Coface and EFIC are examples of Export Credit Agencies (ECA), public or quasipublic entities that engage in export financing and international credit insurance Electronic copy available at: https://ssrn.com/abstract=2723132 Construction started in 2005, was delayed by two years due to in land acquisition issues but wrapped up successfully in 2009 PMC began to collect tolls starting from April 2010, after the ticket price was approved by the City’s government 2.2.3 Financial distress After the bridge’s opening, it became clear to PMC that its viability was threatened Two factors explain the bridge’s financial distress: First, the actual investment amount has been heavily revised upwards In 2010, just a few months after the bridge’s opening, PMC asked government of Ho Chi Minh City to approve a new investment amount of VND 3030 billion, a 68% increase over the initial approved amount of VND 1800 billion, citing various unplanned costs such as interest during construction, revised costs due to inflation and foreign exchange loss The city government appointed an independent accounting firm to audit the total project cost The result was published in May 2013 and placed the investment made by PMC at VND 3250 billion (Tuoi Tre News 2014) Second, fee revenue has been largely underneath what was needed to repay loans and recoup the initial investment Ho Chi Minh City-based economist Nguyen Xuan Thanh investigated real traffic going through the bridge and found out that in terms of Passenger Car Units (PCU), real traffic only represented 53.7% of traffic assumptions made in the initial financial plan (Nguyen Xuan Thanh 2013) In a letter addressed to the city government in 2011, PMC put the blame on the city for low traffic demand According to the company, the ring road projects of Ho Chi Minh City were incomplete and the city government had not prohibited heavy vehicles from going through the city center (VnEconomy 2011) From an economic standpoint, these claims are not without merit The rationale behind the project was to capture traffic from the South and West of the City to the North (see Figure 12 below) As the Eastern ring road project (managed by the city’s government) is not yet completed (dotted line on Figure 12), vehicles would choose to follow the old National Road Electronic copy available at: https://ssrn.com/abstract=2723132 1A (red line) or going through the busy city center instead of the Phu My Bridge (VnExpress 2014) As of February 2015, there were still at least one bridge to be constructed to close the ring road completely, and construction would only begin in the future (Official Journal of Ho Chi Minh City 2015) Phu My Bridge Figure 3: Uncompleted sections of the ring road project (VnExpress 2014) Initially, the government had agreed in the initial contract to have the Eastern ring road ready three years after the bridge’s completion at the latest (Nguyen Xuan Thanh 2013) If this is not the case, the government would receive back the project and reimburse PMC for the investment outlay plus interest This outcome, however, would have to be pronounced by a court Although PMC seems to have an advantage in this situation, there are actually reasons to believe the company had allegedly committed violations of the initial contract itself by overleveraging the project, all of which will be the topic of a later section of the paper At present, therefore, two parties are pursuing negotiation to resolve the issue 2.3 Theoretical background and contribution Public-private partnerships (PPPs) have long been a focus of research both in academia and in international organizations, but there is no clear-cut definition of a PPP both in academic research (De Clerck, Demeulemeester and Herroelen 2012) and in publications by Electronic copy available at: https://ssrn.com/abstract=2723132 international organizations (World Bank PPP IRC 2015), (OECD 2008) There seems to be agreement, however, on the necessity to analyze PPPs as mechanisms of risk allocation by which each risk is borne by the party better positioned to so PPPs are themselves contract, and they been the subject of a particular strand of contract theory literature One of the earliest references on the subject was done by Jean Tirole and Jean-Jacques Laffont, who provided a game-theoretic analysis of regulation and procurement contracts (Laffont and Tirole 1993) One of the concepts proposed by Laffont and Tirole to analyze the public sector’s decision-making process is called shadow cost of public funds, which will be used again later on in this paper This provided the groundwork necessary for subsequent authors’ research In a 2005 paper, the economists Dewatripoint and Legros showed if it was too costly to avoid cost overruns then letting cost overruns happen would be a better solution overall PPPs are therefore not a silver bullet to cure the ills of infrastructure projects The role of institutions is crucial in opening up public projects for competition and ensuring the latter is respected by all stakeholders (Dewatripont and Legros 2005) In another study, it is shown that PPP might be less efficient than other financing modes due to transaction costs that may be incurred by choosing the PPP model These transaction costs come from three sources: (1) principal-principal problems, (2) renegotiation and hold-up problems, and (3) soft budget constraints (Ho and Tsui 2009) Renegotiation was the particular focus in an earlier paper by Ping Ho (S P Ho 2006), which used a game structure First, the project encounters an unfavorable event such that the developer can either request a public subsidy or let it go bankrupt The government may choose to negotiate to lower the subsidy or reject the request altogether If the project goes bankrupt, the government has a negative payoff reflecting political costs of restructuring the project If the subsidy request is accepted, then the government suffers from another type of political costs due to budget spending to rescue a private sector company These specifications reflect shadow cost of public funds, a concept used later in this paper’s model Electronic copy available at: https://ssrn.com/abstract=2723132 The recent PPP market in Vietnam has not so far captured interest from researchers, with the exception being a short case study by economist Nguyen Xuan Thanh specifically about the Phu My Bridge itself (Nguyen Xuan Thanh 2013) Therefore this paper, by focusing on the Phu My Bridge, is making a contribution as it is among the firsts to study PPPs in Vietnam and the first to so with a formalized analysis of a particular project Secondly, while some papers may focus on the moral hazard of the private-sector party who is supposedly better informed, this paper studies a possible moral hazard of the public sector concerning their ability to deliver and realize its prior commitment As the paper would try to demonstrate, such decision to deliver (or not) may be interpreted as an equilibrium decision In short, the paper’s approach is pragmatic: it starts from a real project, presents a simple theoretical model and uses the model to analyze one key aspect of the project which is the possible opportunistic behavior of the public sector In doing so, it voluntarily departs from other issues The paper asks the following questions: What is the motivation of the government in the Phu My Bridge? Why would the government be induced to not give an effort in constructing the ring roads? And finally, what lessons can Vietnam learn from the project? By searching for answers to these questions, the paper tries to contribute to both the existing literature and Vietnam’s still nascent PPP market THE MATHEMATICAL MODEL 3.1 Preliminary assumptions We consider two parties, the government of Ho Chi Minh City (public sector) and Phu My Corporation (private sector) The government wants to have a bridge constructed across the Saigon River, and at the same time it also has to invest in the City’s ring road project Each party has no information on the real intents of the other party and not make assumptions regarding the behavior of their co-signatory 10 Electronic copy available at: https://ssrn.com/abstract=2723132 The collective welfare is now equal to the government’s welfare again, since PMC is compensated for its loss (Π3∗ = 0) Without substituting each variable by their respective value, the expression of this welfare is: 𝑊3𝐺∗ = 𝛼𝐼3∗ − (𝐼3∗ + 𝛽𝐼3∗2 ) − 𝐼3∗ 𝐼3∗ [( − 1) + 𝛾 ( − 1) ] 𝐼3̅ 𝐼̅3 3.5.2 Further discussion Some specific questions are now analyzed to interpret the model’s results Question n°1: Between 𝐼2∗ (opportunism without rescue) and 𝐼3∗ (opportunism with rescue), which is higher? In other words, what is the effect of the rescue feature on the government’s commitment? Answer: Consider the difference between 𝐼3∗ and 𝐼2∗ denoted Δ: 𝚫 = 𝑰∗𝟑 − 𝑰∗𝟐 = 2𝛽̅ 4𝛾𝛽̅ 4𝛾𝛽̅ 2𝛽̅ 4𝛾𝛽̅ (𝛼 (𝛼 − − + ) 𝛽 − − 1) [𝛽 + ] + 𝛼−1 𝛼−1 (𝛼 − 1)2 𝛼−1 𝛼−1−𝛼−1= 2𝛽 8𝛾𝛽̅ 8𝛾𝛽̅ 2𝛽 + [2𝛽 + ]𝛽 (𝛼 − 1)2 (𝛼 − 1)2 𝛼−1− = (𝛼 − 1)𝛽 − >0 ̅ 𝛽 4𝛾𝛽̅ 𝛽 ̅ ̅𝛽 ̅ 𝛽 2𝛾𝛽̅ 2𝛽 4𝛾𝛽 𝛽 2𝛾𝛽 + − (𝛼 − 1)𝛽 − − + − ̅⏞ (𝛽 − 𝛽̅ ) − 𝛽̅ 𝛽 2𝛾𝛽 𝛼−1 𝛼−1 𝛼−1 𝛼−1 𝛼−1 𝛼−1 = = 2 ̅ ̅ ̅2 8𝛾𝛽 4𝛾𝛽 4𝛾𝛽 [2𝛽 + ] 𝛽 [ 𝛽 + ] 𝛽 [ 𝛽 + ] 𝛽(𝛼 − 1) (𝛼 − 1)2 (𝛼 − 1)2 (𝛼 − 1)2 There is an ambiguity in the sign of Δ that needs clarification Since the denominator of Δ is positive, the only remaining condition for Δ to be positive is for the numerator to be positive as well: 2𝛾𝛽̅ (𝛽 − 𝛽̅ ) − 𝛽𝛽̅ > ⟺ 2𝛾(𝛽 − 𝛽̅ ) − 𝛽 > ⟺ 𝜸 > 𝜷 ̅) 𝟐(𝜷 − 𝜷 Therefore, for the rescue feature to have a positive impact on the government’s commitment, the sufficient and necessary condition is that 𝛾, which measures their sensitivity to shadow cost of rescue funds, must be “high enough” : 26 Electronic copy available at: https://ssrn.com/abstract=2723132 Δ>0⟺ 𝛾> 𝛽 2(𝛽 − 𝛽̅ ) The expression above says that to increase investment by the government, shadow cost of rescue fund must be an effective enough deterrent In other words, there is an arbitrage of 𝛾 and 𝛽 𝛽 Another comment is in order Let 𝛾̅ = 2(𝛽−𝛽̅ be the threshold value of 𝛾 found above and ) ̅ 𝛽 𝛽 define 𝑚 as The meaning of 𝑚 is the degree to which the government misleads Phu My Corporation (Ex: The government’s real 𝛽 is 0.5 but it reveals instead 𝛽̅ = 0.4 to the investor, 0.5 therefore 𝑚 = 0.4 = 80%) We can write: 𝛾̅ = 𝛽 2(𝛽 − 𝛽̅ ) = 2(1 − 𝑚) It appears that 𝛾̅ is an increasing function of 𝑚 The more PMC is misled, the lower 𝑚 is since a lower value of 𝛽̅ is used Therefore, the more PMC is misled, the less 𝛾 it takes for the rescue feature to have an impact on the government’s behavior (𝛾̅ is lower) The intuition is that the more PMC is misled, the larger the loss it makes Therefore a low value of 𝛾 makes sure the government is more likely to issue a rescue Question n°2: Between 𝐼̅3 and 𝐼3∗ , which is higher? In other words, does the rescue feature limit the government’s tendency to deviate? Answer: Let us calculate the difference between 𝐼̅3 and 𝐼3∗ , denoted Δ′: 8𝛾𝛽̅ 2𝛽̅ 4𝛾𝛽̅ 2𝛽̅ 4𝛾𝛽̅ (𝛼 − 1) [2𝛽 + ] − (𝛼 − − + ) 2𝛽̅ 𝛼−1− + 𝛼 − 𝛼 − 𝛼 −1 (𝛼 − 1) 𝛼−1 𝛼−1= 𝚫′ = 𝑰̅𝟑 − 𝑰∗𝟑 = − 2𝛽̅ 8𝛾𝛽̅ 8𝛾𝛽̅ 2𝛽 + [2𝛽 + ] 2𝛽̅ (𝛼 − 1) (𝛼 − 1)2 27 Electronic copy available at: https://ssrn.com/abstract=2723132 (𝛼 − 1) [𝛽 + = 4𝛾𝛽̅ 2𝛽̅ 4𝛾𝛽̅ ̅2 ̅2 ̅2 ] − (𝛼 − − + ) 𝛽̅ (𝛼 − 1)(𝛽 − 𝛽̅ ) + 4𝛾𝛽 + 2𝛽 − 4𝛾𝛽 𝛼−1 𝛼−1 (𝛼 − 1) 𝛼 − 𝛼 − 𝛼 − = ̅2 8𝛾𝛽̅ 8𝛾𝛽 [2𝛽 + ] 𝛽̅ [2𝛽 + ] 𝛽̅ (𝛼 − 1)2 (𝛼 − 1)2 >0 2𝛽̅ (𝛼 − 1) ⏞ (𝛽 − 𝛽̅ ) + 𝛼−1>𝟎 = 8𝛾𝛽̅ (2𝛽 + ) 𝛽̅ (𝛼 − 1)2 This time there is no ambiguity: 𝐼3∗ < 𝐼̅3 A rescue feature may help increasing the government’s investment, but it still does not guarantee full execution of the contract between the government and PMC Question 3: What is the impact of the 𝛾 parameter on the overall level of infrastructure investment? Answer: Let us calculate three first-order derivatives: that of 𝐼3∗ , Δ and Δ′ with respect to 𝛾 4𝛽̅ 8𝛾𝛽̅ 2𝛽̅ 8𝛽̅ 𝝏𝑰∗𝟑 𝛼 − [2𝛽 + (𝛼 − 1)2 ] − [𝛼 − − 𝛼 − (1 − 2𝛾)] (𝛼 − 1)2 = 𝝏𝜸 8𝛾𝛽̅ [2𝛽 + ] (𝛼 − 1)2 8𝛽𝛽̅ 32𝛾𝛽̅ 8𝛽̅ 16𝛽̅ (1 − 2𝛾) 8𝛽𝛽̅ 8𝛽̅ 16𝛽̅ + − + − + 3 𝛼 − (𝛼 − 1) 𝛼−1 𝛼 − 𝛼 − (𝛼 − 1)3 (𝛼 − 1) = = 2 8𝛾𝛽̅ 8𝛾𝛽̅ [2𝛽 + ] [2𝛽 + ] 2 (𝛼 − 1) (𝛼 − 1) >0 8𝛽̅ ⏞ 16𝛽̅ (𝛽 − 𝛽̅ ) + 𝛼−1 (𝛼 − 1)3 = >𝟎 8𝛾𝛽̅ [2𝛽 + ] (𝛼 − 1)2 >0 ̅3 8𝛽̅ ⏞ ̅ ) + 16𝛽 (𝛽 − 𝛽 ∗ ∗ 𝝏𝚫 𝜕𝐼3 𝜕𝐼2 𝛼 − (𝛼 − 1) = − = >𝟎 2 𝝏𝜸 𝜕𝛾 𝜕𝛾 ⏟ ̅ 8𝛾𝛽 [2𝛽 + ] =0 (𝛼 − 1)2 28 Electronic copy available at: https://ssrn.com/abstract=2723132 >0 ̅3 8𝛽̅ ⏞ ̅ ) + 16𝛽 (𝛽 − 𝛽 ′ ∗ ̅ 𝝏𝚫 𝜕𝐼3 𝜕𝐼3 𝛼−1 (𝛼 − 1) = − =− The government would invest more at present to spend less money to rescue PMC in the future (under the condition that 𝛾 is high enough – see above)  Relative increase of investment: An increase in 𝛾 also causes the investment in the rescue scenario to move relatively away from the opportunism-but-no-rescue scenario 𝜕Δ towards the no-opportunism scenario (𝜕𝛾 > and 𝜕Δ′ 𝜕𝛾 < 0) Therefore even an implicit rescue feature represents an improvement towards fulfilling the contract and maintaining the level of investment in infrastructure in Ho Chi Minh City 3.6 Summary of the models and their key lessons The four different models allowed us to have a homogeneous framework for analyzing the behavior of the government The key results are given in the table below: Model Public management (base case) (0) BOT without rescue & without opportunism (1) 𝑰 specified in contract Sensitivity to SCPF5 implied by contract No contract 𝛽 𝐼0∗ = 𝛼−1 2𝛽 Private optimal 𝑰 for HCMC gov Effective government’s welfare 𝑊0𝐺∗ = Profit of PMC (𝛼 − 1)2 −𝛽−1 4𝛽 No private developer Effective common welfare 𝑊0∗ = (𝛼 − 1)2 −𝛽−1 4𝛽 𝐼̅1 = 𝛼 2𝛽 𝛽 𝐼1∗ = 𝛼−1 2𝛽 𝑊1𝐺∗ = (𝛼 − 1)2 4𝛽 Π1∗ = 𝑊1∗ = (𝛼 − 1)2 4𝛽 BOT with opportunism & without rescue (2) 𝐼̅2 = 𝛼 2𝛽̅ 𝛽̅ 𝐼2∗ = 𝛼−1 2𝛽 𝑊2𝐺∗ = (𝛼 − 1)2 4𝛽 𝛽̅ Π2∗ = ( − 1) 𝛽 𝛾̅ ) Nevertheless, even with the rescue feature, the new level of commitment of the government is still lower than the one specified in the contract, leading to a lower total infrastructure availability The only way to achieve the level of investment specified in the contract is the government not deviating at all (𝛽 = 𝛽̅ ) This is achieved in Model Another key result worth mentioning here is to increase the parameter 𝛾, which determines how fast political losses related to rescuing a private sector company can mount up The answer to Question from the previous section shows that a higher 𝛾 has a positive effect on the final investment amount The government would rather invest now rather than rescue later In practice, the implication of this lesson is to improve fiscal transparency and discipline This is echoed by the fourth principle of private participation in infrastructure (OECD 2007) To a larger extent, the government should commit to improve institutions and transparency in all areas of the economy The more the government is transparent, the more the private sector company is able to evaluate the government’s ability to build infrastructure or, in other words, its 𝛽 The rescue feature introduced earlier on in this paper can be viewed, to a limited extent, as a renegotiation provision Many economic contracts are incomplete and cannot provide for every contingency The issue is obviously exacerbated in contracts that are long-term in nature in PPPs As a result, the contract must include the option to renegotiate in case of 30 Electronic copy available at: https://ssrn.com/abstract=2723132 problems This point is echoed by the OECD’s second principle of private participation in infrastructure development (OECD 2007) LIMITATIONS OF THE MODEL AND THEIR LESSONS The model in the preceding section has analyzed the possible opportunistic behavior on the government’s side only in an effort of simplification In reality, the failure of the project cannot be seen as being caused by the government’s insufficient investment alone This section will focus the remaining possible causes and the lessons to be learnt The following issues will be discussed:  Inadequate capital structure with excessive financial leverage  Cost overruns which led to a heavily revised investment outlay  Debt guarantee from the government  Possible moral hazard of Phu My Bridge Corporation 4.1 Inadequate capital structure with excessive leverage One key issue the paper’s model chose to leave aside was how the Phu My Bridge was financed, and yet this is a determining factor in analyzing the project’s failure In fact, the model does not allow for any upside for PMC to capture, no interest and taxes (which would be elements needed to analyze debt financing) Therefore, in our model equity and debt financing is virtually indistinguishable from each other This is obviously not the case in reality In the initial contract with the city government, PMC promised to contribute 30% of the initial investment in equity and borrow the remaining 70% from Société Générale and Crédit Agricole CIB The leverage ratio, defined as Total Investment/Equity, would have been roughly 3.33 times After the contract was signed, this ratio was not respected by PMC as the company contracted a number of loans from domestic banks to replace its own equity The new domestic-currency loans, along with foreign exchange losses on the loan with the French 31 Electronic copy available at: https://ssrn.com/abstract=2723132 banks, could have made the project’s capital structure to be comprised of 89% in debt, (Nguyen Xuan Thanh 2013) As a result, the financial leverage resulting from this supplement of debt could be as high as times In comparison, a study of 29 BOT concessions in Indonesia, one of Vietnam’s neighbors in Southeast Asia, showed the average capital structure to be 74% debt versus 26% equity (Wibowo 2005) In any case, a leverage of times is highly risky The first lesson from the Phu My Bridge experience is therefore that a project must have an adequate capital structure with the right mix of equity, senior and mezzanine debt Too much financial leverage may threaten the viability of the project In this case, in turned out that annual toll revenue from the bridge did not fully cover debt service (Nguyen Xuan Thanh 2013) A second and much more important lesson follows In fact, the parties have indeed addressed the question of financial leverage since the capital structure was fixed at 30% equity and 70% debt in the initial contract What was missing was a monitoring mechanism that would allow the city government to detect if PMC had not respected this initial commitment This is again an argument in favor of more transparency and effective communication between the parties in the execution phase More effort must be made to clearly define the obligations of each party in the contract, and the government has to be very clear on the mechanisms of dispute resolution and enforcement 4.2 Disputes over the investment outlay The model in section assumed the cost to build the Phu My bridge to be a constant 𝐾, which is perfectly known by everyone with no uncertainty This assumption does not sit well with the reality that cost overruns are common with infrastructure projects, with the Phu My Bridge being another example In 2004, PMC projected a total investment outlay of VND 1807 billion, based on 2003 prices and revisable subject to the approval of Ho Chi Minh City’s government In 2007, the city 32 Electronic copy available at: https://ssrn.com/abstract=2723132 government approved a VND 200-billion increase in the investment outlay to improve the bridge’s resistance to earthquakes Nearly two years after the bridge was completed and opened to traffic, in 2011 Phu My Corporation made the independent decision to ask the city government to recognize a drastic increase in the initial investment outlay In 2012, the city government appointed an independent accounting firm to audit the project The results actually placed the investment outlay not far from the one claimed by Phu My Corporation The massive increase was explained by interest paid during construction and currency losses The first reason why the investment figure matters so much is that it would support PMC’s proposals to increase price and lengthen the concession period The disputes between PMC and the city government highlight these important questions:  Could the government have verified the investment outlay during the construction period of the bridge?  Why had PMC waited until after the bridge’s opening to ask for upwards revision of the investment outlay?  Could the parties have agreed from the very beginning on a third-party independent auditor, so as to avoid disputes later on when different estimates are used? These questions once again highlight the lack of an efficient communication mean between two parties Had the city government established an effective monitoring mechanism, the dispute over the correct investment outlay would not have existed Even if litigations and negotiations may be unavoidable, PMC and the city government could have agreed on a certain independent auditor In fact, it is difficult at the initial phase of any contract to forecast the future outcomes, especially with long contracts such as PPP and therefore, contingencies must be provided for renegotiation This in turn demands a strong and transparent dispute resolution mechanism This is the eighteenth principle of private participation in infrastructure as defined by the OECD (OECD 2007) 33 Electronic copy available at: https://ssrn.com/abstract=2723132 There is a second reason why the initial investment outlay matters so much to PMC and the city government The initial contract stipulated that if the city’s ring road was not completed by September 2012, then Phu My Corporation would be eligible to transfer back the project to the government, who would have to reimburse PMC of the investment plus interest (see section 3.5) 4.3 Debt guarantee from the municipal and national government Following the issue of the project’s over-leveraged capital structure, another issue arises which has not been taken into consideration at all by our model In fact, the syndicated bank loan is guaranteed by the both the city government and Vietnam’s national government At the time, the Phu My Bridge was the first project to benefit from the national government’s guarantee, according to a press release issued by Société Générale at the time when construction started (Société Générale 2007) The guarantee mechanism functions as follows: First, Ho Chi Minh City Finance & Investment Corporation (HFIC) acts as primary borrower with the two French banks, and this primary loan benefits from the guarantee of Vietnam’s MoF The proceeds of this primary loan are lent to PMC, and since HFIC is owned by Ho Chi Minh City’s government the lenders benefit from the latter’s signature as well Any default by PMC would have to be compensated by the city’s budget In other words, PMC benefits from a double-layered guarantee: that of the city government and that of the national government (Nguyen Xuan Thanh 2013) Shortly after the bridge was put to service in 2010, PMC realized fee revenue was insufficient to satisfy the debt repayment schedule Since 2011, the company sent multiple letters to the city government to ask for a grace period for the HFIC-PMC secondary loan, cheap/free funds to repay this loan or an extension of its tenor from 10 years initially to 20 years (N.B: HFIC still must repay its debt to Société Générale and Crédit Agricole CIB as this 34 Electronic copy available at: https://ssrn.com/abstract=2723132 is not the same loan as the one given to PMC) The city’s government agreed to let HFIC extend a refinancing loan to PMC, which it used to repay the first loan with HFIC itself Due to this guarantee, the most significant risk to the French lenders was Vietnam’s sovereign risk To summarize, until the Phu My Bridge generates enough cash flow for PMC to repay its debt with HFIC, debt service to the French banks will be met by HFIC against a refinancing loan made to PMC According to a research report written by a ACB Securities, a local investment research firm, it may not be until 2020 before PMC is able to begin repaying the refinancing loan, and until 2025 before this loan is completely repaid (ACB Securities 2012) 4.4 Possible moral hazard of PMC The above four issues are in reality linked together, and along with the government’s insufficient effort in the ring road project of Ho Chi Minh City, they all contributed to make the Phu My Bridge a negative case study of BOT management To summarize, PMC’s foreign currency-denominated debt is guaranteed by the government, thus allowing the French banks to agree to lend with a lower interest rate The project was under-capitalized and even in the best scenario does not produce enough cash to repay the contracted loans In the worst case scenario where the government fails to deliver its promise of linking the city’s ring road, then the contract requires the project to be transferred back to the public sector and PMC to be reimbursed of its initial investment In addition, the government did not detect the issues with the financial structure and does not have a formal and agreed-on mechanism in place to monitor what PMC was doing Therefore, it is reasonable to think that PMC may have had an opportunistic behavior By having both the government’s debt guarantee and its commitment to buy back the project at cost plus margin and interest, PMC had room to saddle the project with extra debt, thus compromising its financial viability even more This conclusion is indeed complementary 35 Electronic copy available at: https://ssrn.com/abstract=2723132 with this paper’s theoretical model which restricted opportunistic behavior to the government’s side CONCLUSION PPPs are inherently complex, but it is clear they are here to stay They are even more relevant in the context of Vietnam who is still in the process of learning how to best attract private and foreign capital to infrastructure development projects For this, in October 2012 the country had put together a PPP taskforce who would “test-drive” a number of pilot projects that comply with standard international PPP practice In this context, any experience from past projects is sure to help both the government and the private sector of Vietnam to learn from their mistakes This paper is meant to be another effort to assess past failures It began by providing a background, then developed a simple theoretical framework to analyze one of the issues that led to the bridge’s financial distress, which is the possible opportunistic behavior of the city government The role of the 𝛽 and 𝛾 parameters were discussed, and the results were in favor of more accountability and transparency of the government’s decision making process The aspects left out by the model were discussed in the last section of this paper If there is only one lesson to be learned from this case study, it is to strengthen transparency, include more effective communication channels and improve the decision-making capability of governmental bodies Many directions exist for future research, given the paper’s voluntarily limited scope For instance, it would be interesting to find other PPP projects in other countries where governments failed to deliver on their promises In addition, a more empirical-oriented paper could try to investigate different factors that may influence on the government’s behavior in a PPP project As for this paper’s model, some simplifying assumptions could be relaxed or dropped altogether, whereas others assumptions could be added For example, 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