Best Practice: Capital and Revenue Support, and Debt Guarantees

The New Southern Railway (NSR) project involved an underground line with 10-km, a two-track railway, and four stations. The Airport Link Company (ALC) was awarded a 30- year concession to design, build, operate, and finance the NSR. Around one quarter of the project budget was privately financed by debt and equity. The ownership of the land in which stations were built remained under the State Rail Authority (SRA), and the ALC had to pay a lease for using it. In the pre-design stage of the project, the statutory risk (i.e. approval risk) was borne by the SRA as five local governments had to approve the line passing through their territory. The design risk of the tracks, tunnels, and station infrastructure was transferred to the ALC through a lump-sum payment. Construction risk was also transferred to the ALC since it received an inflation-adjusted, lump-sum payment in exchange for delivering the infrastructure on time and with the quality level agreed in the contract. The contract fully allocated operation risk to the concessionaire, making it responsible for the operation and maintenance costs associated with the infrastructure management. While most revenues were collected in local currency, some of the major construction inputs were imported and paid in foreign currency, so the ALC bore exchange rate risk. By government subventions, the ALC shareholders were granted tax concessions to limit tax liability after debt servicing.

The contract set out a payment mechanism based on user fees, thus transferring demand risk to the concessionaire. In addition, the ALC was allowed to charge a station fee on the passenger tickets so as to recover its initial capital costs, and to earn secondary revenues from retail activities at the stations. Some important government guarantees were set in place: the SRA agreed to compensate the ALC if usage fell short of the expected level, and to purchase the four stations if usage was so low that the concessionaire defaulted on its loans. As the SRA expected usage to increase significantly over time due to population growth and urban development, it considered these guarantees to be a relatively low risk. Eventually, a quite poor risk management led to a remarkable project failure. Usage level turned out to be only a quarter of the expected level, partly due to an excessive user charge (including the station fee) that could hardly compete against the prices offered by alternative transport means such as buses and taxis. These problems caused a default on the ALC debt just six months after the line started to operate. The government attempted to bail out the project by subsidizing fares to increase service demand (e.g. granting concession fares to groups and offering airline-train ticket packages). A large fiscal burden transpired from both subsidizing the final users and compensating the ALC through the SRA. Despite the remarkable failure, the government chose not to resume control of the project and thus kept it in private hands. Up to the present, the concessionaire has been heavily compensated, the service demand is still far from the initially expected level, and fares are still uncompetitive.

Source: Loosemore (2007)