36052 Vietnam Country Framework Report on Private Participation in Infrastructure Copyright © 1999 The findings, interpretations, and conclusions expressed in this The International Bank for paper are entirely those of the authors and should not be attributed Reconstruction and Development in any manner to the World Bank, to its affiliated organizations, THE WORLD BANK 1818 H Street, N.W. to members of its Board of Executive Directors or the countries Washington, D.C. 20433, U.S.A they represent, or to the Public-Private Infrastructure Advisory Facility. Neither the World Bank nor All rights reserved Manufactured in the the Public-Private Infrastructure Advisory Facility guarantees the United States of America accuracy of the data included in this publication or accepts First Printing November 1999 responsibility for any con-sequence of their use. 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Please contact the Copyright Clearance Center before photocopying items. For permission to reprint individual articles or chapters, please fax your request with complete information to the Republication Department, Copyright Clearance Center, fax 978-750-4470. All other queries on rights and licenses should be addressed to the World Bank at the address above or faxed to 202-522-2422. Acknowledgment This Country Framework Report for Vietnam is Report Program Advisor) and comprising Jordan one of the first in a series of country reviews aimed Schwartz (transport), Timothy Irwin (power), and at improving the environment for private sector Chiaki Yamamoto (water). In addition, Anil involvement in infrastructure. Prepared at the Malhotra, Kazi Mahbub-Al Matin, and Minh Van request of the Government of Vietnam, Country Nguyen at the World Bank Country Office in Framework Reports have three main objectives: Hanoi provided in-country coordination and · To describe and assess the current status and technical support to the team. Augustine H. Vinh, performance of key infrastructure sectors. PricewaterhouseCoopers LLP; Michael Porter, · To describe and assess the policy, regulatory, Tasman International; Jennifer Handz, Freehill and institutional environment for involving Hollingdale & Page; and Norman R Nicholls the private sector in those sectors. provided consulting services. · Through the above, to assist policymakers in The report also draws on inputs from various framing future reform and development staff from the World Bank and other development strategies and to assist potential private sector institutions, as well as discussions with investors in assessing investment opportunities. representatives of the private sector. The Work in This report was begun under the auspices of the progress for the report was presented during Private World Bank Group's Infrastructure Action Sector Forum, held in Hanoi in December 1999. Program, with funding from the World Bank and The Country Framework Report process was the Japanese Government. It is being published supported by an advisory group comprising jointly by the World Bank and the Public-Private representatives from the private sector, financial Infrastructure Advisory Facility, the new institutions, and bilateral donor agencies. multidonor technical assistance facility established Members of the Advisory Group for this report in July 1999, which is carrying forward the include Lee M. Baker, AMCHAM; Takuma program of Country Framework Reports begun Hatano, Japan Bank for International under the Infrastructure Advisory Facility. Cooperation; Takashi Kudo, Keidanren (Japan The report was initiated by Andrew Steer, the Federation of Economic Organizations); David H. World Bank Country Director for Vietnam and Renton, Cameron McKenna; William Chew, prepared by a core team led by Aldo Baietti (team Standard and Poor's; Christine Wallich, Asian leader) and Russell Muir (Country Framework Development Bank. 3 Table of Contents ACKNOWLEDGEMENT 3 EXECUTIVE SUMMARY 5 PART A: CROSS SECTORAL ISSUES 23 1. General Business Environment 23 1.1.Trends in Foreign Direct Investment 23 1.2. Post-approval issues 24 1.3. Perceptions of Corruption in the Business Environment 24 1.4.Addressing Biases Against Businesses 24 2. General Legal Environment 24 3. Foreign Investment Regime 26 3.1. Foreign Investment Law 26 3.2. Investment Licensing Process 26 3.3. BOTs under the Foreign Investment Law 26 3.4. Limited Government Coordination in Dealing with PPI 27 4. Foreign Exchange 27 4.1. Cautious Shift to Market-determined Rate 27 4.2. Foreign Exchange Management 27 5.Tax Regime 28 5.1. Relevant taxes 28 5.2. Corporate Income Tax (CIT) 28 5.3. Personal Income Tax 28 5.4.Value Added Tax (VAT) 29 6. Labor Issues 29 6.1. Labor Code 29 6.2.Dollar-Denominated Wage 29 6.3. Recruitment of local labor 29 5 Contents 7.Access to Local Finance 29 8. Environmental Regime 29 9. Right of Way and Resettlement. 30 PART B: INFRASTRUCTURE PERFORMANCE AND CURRENT ENVIRONMENT 31 1. ENERGY 31 1.1. Market Structure 31 1.2. Physical Performance 32 1.3.Tariffs and Financial Performance 33 1.4. Future Demand and Investment Opportunities 34 1.4.1. Future Demand 34 1.4.2. Opportunities for Private Greenfield Investment 34 1.4.3. Planned Privatization of Existing Assets 35 1.5. Existing Private Participation 35 1.6. Restrictions on Entry 35 1.6.1. Legal Restrictions on Entry 35 1.6.2. Institutions Responsible for Approving and Facilitating Private Participation 36 1.6.3. De-Facto Restrictions on Entry 36 1.7. Risk Allocation 36 1.8. Protection of Investors from Political and Regulatory Risks 37 2. WATER AND SANITATION 38 2.1. Market Structure 38 2.2.Technical Performance 39 2.2.1. Coverage and Consumption 39 2.2.2. Efficiency 39 2.2.3. Quality 39 2.3. Commercial Performance and Tariffs 40 2.3.1. Current Tariff Rates 40 2.3.2.Tariff Setting Method 40 2.3.3. Metering 41 2.4. Demand Forecasts and Public Investment Plans 41 2.5. Legal Environment and Regulatory Institutions 41 2.6. Private Participation in the Sector 42 2.6.1. Binh An Water Corporation Limited: BOT bulk water supply project 42 3. TELECOMMUNICATIONS 44 3.1. Market Structure 44 3.2.Technical Performance 44 3.3. Commercial Performance and Tariffs 45 3.4. Demand forecasts and public investment plans 45 3.5. Legal Environment 45 3.6. Regulatory Institutions 45 3.7. Private Sector Participation in the Sector 46 3.8. Restrictions on Entry and Competition 48 6 Contents 4. TRANSPORT SECTOR ANALYSIS 48 4.1.Transport Sector Structure 48 4.2. Entry Barriers and Limits onVertical and Horizontal Integration 49 4.2.1. Restrictions onVertical and Horizontal Integration 49 4.2.2. Restrictions on Foreign Ownership 49 4.2.3. De Facto Restrictions on Entry 50 4.2.4. Risk Allocation 51 5.AIRPORTS 51 5.1. Market Structure and Ownership 51 5.2. Physical performance 51 6. RAILWAYS 52 6.1. Market Structure and Ownership 52 6.2. Physical Performance 52 6.3. Financial Performance 53 6.4. Current and Potential Private Sector Participation in Rail 54 7. PORTS 55 7.1. Market Structure and Ownership 55 7.2.Technical Performance 56 7.3. Financial Performance and Cost of Service 57 7.4. Demand Forecasts and Investment Opportunities 57 7.4.1. Demand Forecasts 57 7.4.2. Investment Opportunities 58 7.4.3. Current and Potential Private Sector Participation in Ports 58 8. ROADS 60 8.1. Market Structure and Ownership 60 8.2.Technical performance 61 8.3. Financial Performance and Cost of Service 61 8.4. Current and Potential Private Sector Participation in Roads 62 8.4.1. Operational Private Sector Road Investments 62 8.4.2. Possible Future Road BOT Projects 62 PART C: PROPOSED ACTION PROGRAM 65 1. CROSS-SECTORAL ISSUES 66 1.1. Legal Environment for PPI 66 1.2. Institutional Reform 67 1.3. Sharing of Risk in PPI Projects: Government and the Private Sector 68 2. ENERGY 69 2.1. Market Reform 69 1.1.1. Current Market Structure 70 1.1.2. Competition in the Market for Electricity 70 1.1.3.Alternative Market Structures 70 2.2. Financial Discipline 72 2.3. Regulatory Reform 73 2.4. Ownership Reform 74 2.4.1. Progress to Date 74 2.4.2. Risks Remaining with the Government 74 7 Contents 2.4.3. Further Ownership Reform: Equitizing Distribution and Shifting More Risk to the Private Sector 75 2.5. Summary of Recommendations 75 3. WATER AND SANITATION 76 3.1. Market Reform 76 3.2. Financial Discipline 77 3.3. Regulatory Reform 79 3.4. Ownership Reform 79 3.5. Summary of Policy Recommendations 82 4. TELECOMMUNICATIONS 83 4.1. Market Structure Reform 84 4.1.1. Re-organization ofVNPT 84 4.1.2. New Entry 85 4.1.3. Cross ownership 85 4.2. Regulatory Reform 85 4.2.1. Redefining the Role of DGPT 86 4.3. Ownership Reform 86 4.3.1. Concession and License Contract 86 4.3.2. Equitization of Existing Assets 87 4.4. Summary of Policy Recommendations 88 5.AIRPORTS 88 5.1. Market Reform 88 5.2. Ownership Reform 88 6. RAILWAYS 89 6.1. Market Reform 89 6.2. Financial Reform 90 6.3. Ownership 90 7. PORTS 91 7.1. Market Reform 91 7.2. Financial Reform 91 7.3. Ownership Reform 92 8 Executive Summary Vietnam's Recent Performance in sectors of infrastructure in Vietnam. Even with some the Infrastructure Sectors improvement in performance in recent years, the current indicators are still below the Government's Significant improvements in the supply own targets for the sectors. This performance is set of infrastructure have been made in against international benchmark indicators such as, recent years... coverage and access, efficiency measures of physical The dramatic increase in the provision of performance, and quality standards. infrastructure services in Vietnam since the late In addition, many of the state-owned 1980s greatly facilitated rapid growth in GDP and infrastructure companies in Vietnam are exports. In the transport sector, the Government characterized by poor financial performance and has accepted several large loans to rehabilitate and rely heavily on subsidies from the state budget or expand the roads and waterway networks while in ODA funds to fund both maintenance and the power sector, electricity generation has doubled capital investments. These poor financial results and crude oil production tripled. Historically, are a consequence of a number of complex inter- increased public spending and institutional related factors including: (i) tariff levels which are reforms in the state sector have contributed to this too low to cover all costs of operation and provide marked expansion in infrastructure services. a fair return on the local investment capital; (ii) ...but the performance is still short of weak management know how and commercial the Government's targets ... orientation; and (iii) the perceived need by state- Despite these laudable developments, the owned firms and organizations to achieve social infrastructure in Vietnam suffers from a number of objectives at the expense of financial and major inadequacies which the Government commercial ones. Lastly, the impact of the recent recognizes. The two tables below highlight the East Asia crisis has had a negative impact on the performance of the state-owned enterprises and Government's overall financial position. In recent government service agencies which dominate in all months, this has been characterized by large and 9 Executive Summary Table 1.Vietnam's Infrastructure Performance Compared with Neighboring Countries Electricity Water Telephone Railroad traffic Access to Transmission Access to safe Unaccounted mainlines per density electricity and distribution water (%)/c for water 1,000 people/e (1,000,000T (%)/a losses (%)/b (%)/d U/km)/f Vietnam 51 16 47 69 21 1.1 India 88 18 85 26 19 10.1 Lao PDR 14 n.a. 51 33 5 n.a. Indonesia 39 12 65 53 25 3.2 Philippines 58 17 83 47 29 0.5 Thailand 87 9 89 38 80 3.9 Malaysia 90 11 89 36 195 1.5 a/Vietnam's figure is for 1996 and provided by Ministry of Planning and Investment. Figures for other countries are for 1994 and are from Asian Development Bank Electric Utilities Databook. b/Vietnam's figure is for 1998 and provided by the government ofVietnam. Figures for other countries are for 1996 and are fromWorld Development Indicators. c/ Figures are for 1996 forVietnam, Lao PDR and Philippines, 1995 forThailand and Malaysia, 1993 for India and Indonesia..All are fromWorld Development Indicators. d/ Figures are for capitol cities in 1995. Data forVietnam (Hanoi) is provided by HanoiWater Business Company, for the Philippines (Manila) by MetropolitanWaterworks and Sewerage System, and figures for other countries are from Asian Development Bank'sWater Utilities Databook. e/ Figures are from for 1997 and are from ITU. f/ Figures are fromWorld Bank Railways Database. Table 2 .Vietnam's infrastructure performance compared to Low- Income Countries and East Asia Region Low Income/a EastAsia and Vietnam (excl.India and Pacific China) ElectricityT & D losses (%), 1996/b 16 19 9 Electricity production per capita (kwh), 1996 225 238 902 Access to safe water (%)/c 47 55 77 Average cost of local call (US$ per three minutes), 1996 0.108 0.098 0.110 Telephone mainlines per 1,000 people, 1996 21 16 60 Telephone mainlines per employee, 1997 16 40 113 Roads, paved (%), 1996 10-15 18 n.a. Paved roads in less than good conditions (%), 1996 91 20/d n.a. Railways (km/1,000 people), 1995 0.039 0.106 n.a. Source:World Development Indicators,World Bank Rail Database a/ Low Income countries are those with GNP per capita $785 or less. b/Figures are for 1998 forVietnam and 1996 for East Asia and Low income countries. c/ Figures are for 1996 forVietnam and 1993 for East Asia and Low income countries. d/Best practice for developing countries. sudden drops in exports and a loss of confidence The policy of promoting PPI is not new in in Vietnam as a foreign investment destination. Vietnam. For instance, on December 23, 1992 the .... and yet the private sector has had a Government amended the Law on Foreign limited role in the infrastructure sectors. Investment to make way for "Build Operate and 10 Executive Summary Transfer" (BOT) projects. A year later, the BOT restrictions on the ability of non-nationals to Regulations were enacted by Government Decree. invest in the infrastructure sectors. As such, Yet, after six years there is still little evidence of with extremely limited financial and private participation in the infrastructure sectors in technical capacity in the purely domestic Vietnam. The projects completed have been private sector, little or no development has undertaken on an ad hoc basis, without any clear taken place. evidence of a policy designed to promote private · Third, the general business environment, participation in infrastructure (PPI). As such, while slowly improving, still makes there are still no replicable models for PPI projects investment in long-term, capital investment in Vietnam which can provide investors the projects in infrastructure highly risky for both assurances that future transactions can be private sponsors and lenders. For example, completed in a transparent and timely manner. tariffs in the water and power sector are The reasons for this are complex and vary from currently set at levels below full-cost recovery sector to sector, but three general points are worth and there is no transparent, independent noting: system in place for the regulation of this and · First, some sectors such as airports, existing other issues impacting infrastructure ports, railway, and telecommunications are operations. restricted to private ownership and In summary, very little progress has been made management. in PPI in Vietnam, as reflected by the sector-by- · Second, there are a number of other sector review below: · Power: Only one Independent Power Project is in operation - a 375 MW plant in Hiep Phuoc near Ho Chi Minh City operated by Taiwanese company selling primarily to an industrial zone. There are several other BOT projects for generation in the pipeline such as Wartsila's 120MW plant at Ba Ria and the Phu My 2.2 combined-cycle gas turbine plant. However, some of these projects have been stalled in negotiations for significant periods of time. The Government has announced interest in pilot equitization projects for power distribution but no firm plans have been developed to date. · Water: There is one BOT for water supply in HCMC which is at an advanced stage of construction. This project - the Binh An Water Corporation consortium headed by a Malaysian corporation - has a 20-year contract to supply 100,000m3/day treated water mainly to Bien Hoa Industrial Zone. However, this US$36 million project is has yet to come to financial closure. Other BOT treatment facilities by Lyonnaise des Eaux and M-Power are being considered but none of them are near the final stages of negotiation. · Telecommunications: Within the general scope to accelerate the development of telecommunications service in the country, the Government has promoted private sector participation in this sector. However, for various reasons including restrictions on foreign ownership and low domestic capacity, PPI in telecom has been largely confined to the funding of additional capacity, rather than direct management of the service level operations. As such, there are a number of Business Cooperation Contracts (BCCs) for international and local networks involving firms such as Telstra, France Telecom and NTT. However, these contracts do no involve the private sector partner in the direct management or operation of the systems. There are also a number of joint ventures for the manufacture of telecommunications equipment. · Ports: There is one new privately owned and operated 1.2 million ton capacity bulk and steel facility in Baria Serese. 11 Executive Summary In addition there is a private container port facility in Ho Chi Minh City and an emerging private industrial zone with a port at Dinh Vu Industrial Zone. The equitization of facilities at Da Nang and Ben Nghe are under consideration as is the BOT construction of a transshipment center and landbridge through central Vietnam. · Roads and Bridges: A Taiwanese company operates toll bridge and 17.8km of highway between the export processing zone of Saigon South and Highway 1. Several other BOT roads and bridges are currently being promoted or negotiated with unsolicited bidders. A BOT project for a major highway connecting Vung Tao and HCMC is being negotiated with Daewoo Corporation. · Rail: There has been no significant private participation in the rail sector and very little equitization planned of core services. However, the government has recently announced its intention to seek bids for the rehabilitation of one line and has supported the idea of a separation of infrastructure from rolling stock. · Aviation: Although the Government once solicited bids for a turnkey construction contract for an expansion to the Ho Chi Minh City airport, it was eventually suspended. Airports have since been brought under the auspices of the Prime Minister's office and are no longer discussed by the Government in relation to PPI initiatives. Why ShouldVietnam be ...and the Private Sector provides a Interested in Private Participation critical way of filling this gap in Infrastructure (PPI)? Financing of such a gap will need to be sought from private sources. But, these can only be Government faces a dilemma in terms of satisfying growing demands for effectively channeled if investors perceive that they infrastructure combined with serious will receive fair and equitable treatment under a constraints in public funding... pro-private sector environment that minimizes the non-commercial risks of these capital intensive The deficiencies in the utility and transport projects. In recent years, many countries in the infrastructure sectors must be resolved if Vietnam region and around the globe have transformed wishes to continue its drive to reduce poverty and their public services to run like businesses rather substantially improve the well being of its people. than bureaucracies, and to introduce competition According to the Government's own forecasts, the country must commit US$ 3.0 billion annually, or in infrastructure. In many cases, governments have around 12 percent of GDP, in each of the next three looked to the private sector to provide technical years in order to meet the infrastructure needs of the expertise and new investment in infrastructure. nation. Moreover, much of these investments will The role of the private sector in infrastructure has be in foreign exchange. State credit from banks is been in two main areas: unlikely to be a significant financing source, given · Privatization of existing assets including that bank restructuring is underway. Government investment and management of the service has prioritized its funding such that its investment delivery level (e.g. Manila water supply in infrastructure is unlikely to exceed 3 percent of concession; the unbundling and privatization GDP. ODA, even with accelerated disbursements, at the generation and distribution level in is unlikely to provide more than an additional 2 power in Latin America; and, liberalization of percent of GDP, thus leaving a significant gap of 7 the telecommunications sector in the percent of GDP, or US$2.1 billion annually. Philippines); and 12 Executive Summary · Greenfield investment in new assets (e.g. BOT technologies and processes. Private projects in power and water in Thailand, the infrastructure arrangements have allowed Philippines; toll roads in Malaysia and China). countries to access modern technology and On a global basis, private companies invested a skills and expertise in running complex staggering US$352 billion in all infrastructure enterprises in a commercial manner. Finally, sectors during the period 1990-97, of which increasing efficiencies through PPI at existing US$212 billion went for divestitures and US$141 facilities may make costly new construction and billion for greenfield projects. Significantly, expansion unnecessary. This report presents Vietnam's neighboring countries in East Asia evidence that private owners can achieve accounted for over 36% of this overall figure. Yet, significant improvements in productivity Vietnam has not benefited from this growth in through better use of existing assets. private finance and expertise and the role of the Considerations of this kind are important in private sector has been confined to a very few Vietnam, where skilled resources are extremely selected greenfield projects. limited. What benefits can Vietnam expect from · Access to Private Finance and Increasing Private Participation in Infrastructure? Government Revenues. If Vietnam establishes a policy regime and business environment that is All of the countries that have embarked on PPI suitable for PPI, it can expect investment flows programs involving significant changes in ownership relationships have done so with a view in two areas: greenfield investments (such as the to securing specific benefits from PPI. The key proposed Phu My 2.2 project) and advantages which Vietnam can expect from concessions/sales of existing companies. This increased PPI include: policy regime for greenfield projects should include a careful assessment of the costs and · Increased Efficiency in Investment and Operations. benefits of additional private sector investment - While private finance is important, it is not the particularly independent power projects and fundamental reason for bringing private investment into the infrastructure sectors. In bulk water supply contracts - with particular Vietnam, too much water is lost, too much emphasis on ensuring that the private sector power is wasted, too many roads are in poor bears a suitable burden of the commercial and condition, and too much rolling stock is not market risks associated with these projects. operational. Experience has shown that private Nonetheless, in the right circumstances, access participation substantially improves to private finance - particularly when this is infrastructure companies' performance since focussed on the sale of existing assets - can private operators are driven by strong incentives replace the need for public expenditure and to contain costs and increase productivity in indebtedness in infrastructure, thus allowing order to realize returns on their investments. governments the choice of channeling scarce With PPI, there is strong evidence of lower cost fiscal resources to the core functions of overruns on construction, greater productivity Government in the social and health sectors. from staff and more rapid adaptation of new Where privatization is accomplished through 13 Executive Summary the sale or concessioning of existing enterprises, · the enactment of a comprehensive decree for the revenues generated may also be used to pay BOT (Build-Operate-Transfer) projects and down public debt. This policy has been adopted other incorporated and unincorporated joint by a number of countries in Latin America. venture project structures including recent Lastly, privately owned infrastructure enterprises amendments; throughout the world - most of which are · obtaining cabinet-level approval to implement operating efficiently - have become a significant projects on a BOT or joint-venture basis (e.g. in source of ongoing taxation revenues, in contrast January 1999 the Government announced the to the large budget-drains represented by public selection of a private company through a enterprises in many countries. competitive process for the development of the · Potential to Stimulate Foreign Direct Investment. Phu-My-2-2 power plant; in April 1999 Petro- Greater efficiency in the infrastructure sectors Vietnam and its partners signed three can rapidly improve the competitiveness of all memorandums of understanding for the the manufacturing and service sectors, development of the first manor natural gas ultimately leading to further growth in foreign project in Vietnam); direct investment. Experience in reforming · the announcement of phased increases in the economies in Latin America, Eastern Europe tariffs for electricity bringing prices and East Asia (e.g. Thailand, the Philippines, significantly closer to the estimated long run Indonesia, China) confirms the potential of marginal cost of supply infrastructure privatization or greenfield · the allocation of some responsibilities to line operations as a way to catalyze large inflows of ministries to develop and negotiate with private foreign direct investment (FDI). This will be infrastructure investors; and particularly important in Vietnam where FDI has fallen in recent months, reversing the strong · the establishment of a part-time BOT group in growth trend in the previous three years. MPI in 1998 to help the line agencies in the implementation of BOT type projects in What are the Key Policy and infrastructure sectors. Regulatory Factors which have Over the past year, the Government has also Influenced the Development of held a series of meetings to discuss the business PPI inVietnam? environment in Vietnam with representatives of While the Government continues to the private sector and has made considerable make efforts to improve the business efforts to address their legitimate areas of concern environment... in recent months. Most recently, the Government issued a Decision to improve the country's The Government of Vietnam has been trying to business climate for foreign investment and from obtain private investment in infrastructure since July 1, 1999 several measures intended to cut the 1993 and it has embarked on a series of reforms costs of doing business will be introduced. First aimed at improving the business environment. differential pricing for Vietnamese and foreigners Initiatives to this end have included: will be gradually removed, starting with initial 14 Executive Summary reductions in rates for telecommunications, years of prolonged negotiations with the electricity and water. Second, foreign-invested government. Daewoo Corporation's enterprises will no longer be required to negotiation over a highway BOT project has denominate the salaries of local staff in US been ongoing for three years. Dollars. Third, the range of tax breaks, import · Absence of a Regulatory Regime. Vietnam duty exemptions and other incentives applied to currently lacks a well-developed regulatory "specially encouraged" foreign-invested entities, framework that will enable the country to was widened to encompass a greater variety of pursue a path of increased PPI. Existing enterprises. Fourth, the registration fee for foreign arrangements cannot ensure that private enterprises starting operation in Vietnam, and investors and operators will be forced to other business fees, are to be reduced. Fifth, abide by clear "rules of the game", partly personal income tax rates on Vietnamese because regulators (such as DGPT, workers/managers in foreign invested enterprises VinaMarine and VR) are too closely involved will be reduced and legislation to that effect is in both policy making and the operation of being drafted. Sixth, work permit procedures will their respective sectors. be simplified for foreigners. · Predominance Towards Negotiated Transaction ... However, a number of problems remain Rather than Competitive Bidding. While the Despite the Government's continuing efforts to Government has established transparent encourage private investment a number of bidding procedures through Decree obstacles remain in the way of PPI projects. 88/1999/ND-CP, most projects to date, (all · Legal Environment. The legal framework for BCCs in telecom sector, the only BOT project PPI has been established through passage of in water, most power BOT and all transport legislation starting with the 1987 Foreign projects) have been negotiated transactions. Investment Law, the 1993 decree to introduce Strong interest expressed by reputable firms in concepts of BOT, and the 1996 decree to the Phu My 2.2 project, the first competitively expand BOT schemes. In January 1999 further bid BOT project, confirms the importance of a amendments were introduced to the law competitive process. Governing BOT conracts. Nonetheless, some What Strategy ShouldVietnam Adopt residual legal restrictions on PPI remain from to Increase PPI? the investors' perspective. The five main areas If the Government decides that it wishes to of concern are foreign exchange, state pursue a policy which places the foreign and guarantees, loan security, lenders step-in rights domestic private sector in a pivotal role in the and dispute resolution. provision of infrastructure services, there are a · General Business Environment. Excessive number of different strategies that it could bureaucracy is also a commonly cited source of consider to achieve this objective. These fall into concern. For example, private consortia had to two broad categories: short term and medium abandon projects to build or rehabilitate port term strategies, both which will require an facilities at Vung Tao and in Ben Nghe after alternative model for PPI. 15 Executive Summary A strategy in the ShortTerm:A few bold Equally importantly, investors have complained moves.... about the absence of a central coordinating body in Vietnam's track record today on PPI is limited - Vietnam for the PPI program and a general lack of a feature which potential international sponsors and experience among the officials selected to negotiate financiers are quick to identify as a weakness when large infrastructure deals (both greenfield projects considering any new investments. It is therefore and concessions or equitization of existing important for the Government to make a serious operations). The Government should consider attempt to unblock financially and economically recruiting additional international legal and viable private investments which are stalled in financial advisors to assist it in negotiating and negotiations and begin to assemble a track record of closing transactions as it has done in the Phu-My PPI successes.This means that timely decisions have 2.2 project. to be made on the terms and conditions of a few key Gaps remain between the Government's intent projects that are in an advanced stage of negotiation. to proceed aggressively with its PPI strategy, on Even if the decision may not be to go ahead with a the one hand, and the realities of decision-making particular project, it provides a clearer signal to a processes and business practices in Vietnam, on private sponsor than no decision at all. As such, the other. Notwithstanding the establishment of there is much to be gained from coming to a firm the part-time BOT Group in the Ministry of decision - one way or another - on the two or three Planning and Investment, the Government's outstanding BOT projects in the power and water ability to identify, design and execute PPI sector.The quick equitization or concessioning of an activities is limited. Policy makers and the existing port under a competitive bidding process technical staff of line ministries brought into might also rejuvenate confidence in the dealings on BOT projects do not have an accurate Government's willingness to implement a serious picture of their respective roles, responsibilities, PPI program, given the difficulties faced by and requirements. The Government should international operators during their past attempts to consider establishing a "one-stop-shop" - a PPI invest in Vung Tao and Ben Nghe. Center - with predictable step-wise procedures for ... and continued progress with the negotiating with the required authorities within a business environment defined time frame. This should include responsibility for coordinating both "greenfield" However, to achieve closure in a few investments or introducing different forms of outstanding PPI projects, a number of specific private participation into existing companies problems must be resolved in terms of the legal through methods such as leases, concessions or environment and the general business climate. For equitization. The Government will thus limit the instance, the Government could facilitate further risks confronted by the private sector in PPI initiatives by making some additional changes negotiation, allowing them to calculate a cost of to some of the exiting laws and regulations capital that reflects only the investment itself, and governing issues such as foreign exchange issue, is not bloated by the risks associated with an state guarantees, loan security, lenders step-in rights unclear bidding process and an unpredictable and dispute resolution. legal and policy environment. 16 Executive Summary The MediumTerm:An alternative bankrupt or are under serious financial distress. Moreover, model for private participation - the financial pressures of the crisis have accentuated the beyond BOTs risk allocation weakness in these schemes. It has been found that under the terms of many of these BOT In developing a reform strategy for effective projects, most downside financial risks are borne by PPI, Vietnam has the advantage of being able to governments, thus almost fully negating the benefits of draw on the lessons of experience of a growing introducing private sector participation in the first place. The Report recommends that future PPI in the region number of countries that have successfully should be undertaken in light of three fundamental addressed similar issues. To date, the Government guidelines. Namely: the Government should strive to has looked to the private sector only as a means of restructure sector and privatize state-owned monopolies filling financing gaps for additional capacity - i.e. such that (i) market risks can be borne by the private bulk water supply or generation capacity - rather sector; (ii) service level inefficiencies must be addressed early in the reform process; and (iii) private finance should than seeking the broader efficiency benefits that be a complementary benefit, not the sole objective of PPI. come with private ownership and management. In some instances it may be unwise for the In the case of Vietnam, this suggests four main Government to expand expensive capacity and for reform elements which should drive the utilities and the Government to assume further Government's policy framework in the medium- financial obligations if demand could be met by term. These are: improved efficiency at the service level. A better alternative would be to bring in the private investor · Market Reform: Restructuring markets to to tackle the real inefficiencies at the service and facilitate competition; customer level thus reducing requirements for · Financial Discipline: Establishing cost- additional expensive capacity. covering tariffs; · Regulatory Reform: Establishing clear rules of Impact of East Asia Crisis on BOT Projects the game; and In the wake of the recent financial crisis in East Asia, the choice of PPI modalities and the hierarchy of · Ownership Reform: Deciding the form and preferences have shifted markedly.In particular, the crisis extent of private involvement. has exposed the weaknesses of the typical BOT scheme for Market Reform. International experience has bulk supply where core market reforms in the sector are not in place and where retail tariffs cannot be readily highlighted that one of the critical elements which adjusted to recover costs in full. In a separate review determines the level of efficiency in infrastructure undertaken by the World Bank in June 1999 on the is the degree of competition which exists in the impact of the East Asia crisis on PPI, there is strong sector. These reforms have involved introducing evidence to suggest that Governments should approach competition in two main ways: competition in the these types of schemes very cautiously. Following the crisis, market and competition for the market. In many Governments in East Asia and their state owned utilities have amassed massive liabilities as a consequence of some countries undertaking infrastructure privatization of these poorly negotiated BOT schemes, particularly with programs, private participation has been combined IPPs in power. In Indonesia, the liabilities are estimated to with the restructuring and "unbundling" (e.g. the surpass $10 billion and over $6 billion in the Philippines. separation of different elements of a service such as Many of the utilities in these countries are effectively power into generation, transmission and 17 Executive Summary distribution) of infrastructure markets to enable and re-balancing, even when these changes are beneficial competition in potentially competitive phased in over time, may give rise to charges that segments of these industries. Competition between many users in low income countries cannot afford private firms, or between public and private firms, to pay. This is a particularly important and can have an important impact in bringing market sensitive issue in Vietnam. Nonetheless, the pressures to bear, forcing firms to reduce costs, Government must face the reality that there is no provide services to consumers at competitive way out of this financing dilemma. Either costs prices, and provide a high quality of service. Even must be recovered from consumers who make use in situations where competition "in" the market is of the service through cost-covering charges, or not possible, lower costs and efficiency can be derived through competition "for" the market, from the population in general through taxation. through an open and competitive bidding process While the latter may be a viable way to pay for the where firms bid on price, least subsidy, or lowest shortfall, it distorts the fundamentals of the tariff to consumers. operation and gives a false notion of the true In Vietnam's case, the Government should economic cost of the service. The alternative to the consider a variety of market reforms at the industry recovery cost option is widespread inadequacies in level. These might include options such as: (i) infrastructure which leave many who are willing to separating generation, transmission and pay for services without access to these services. In distribution services in the power sector while still addition, most private investors will not be willing maintaining the enterprise in the public sector in to make large investments in infrastructure unless the short-term to introduce efficiency; (ii) they are allowed to have a certain degree of separating VNPT's core activities such as postal, autonomy over their operation and do not need to long distance, mobile and value added services; and rely on government's political patronage to recover (iii) restructuring Vietnam Railways by continuing the full costs of operation. to spin off its non-core business units and Business Environment Reform. Vietnam's separating rolling stock from infrastructure business environment has been improved through operations; and (iv) increasing competition in the the passage of new legislation and an easing of port sector by decentralizing the major ports and bureaucratic pressures in recent years. However, as allowing them to set their own tariffs at was noted above, there are still some fine tuning competitive levels changes which will be necessary to maintain Financial Discipline. An important element of interest in PPI. In addition, it is important for the the proposed infrastructure reform strategy will be Government to begin the task of setting up to move towards full-cost recovery and the removal independent, transparent regulatory bodies that of cross-subsidies in tariffs between different classes establish clear "rules of the game" to govern the of consumers. Presently, most utilities in Vietnam scope, rights and obligations of the private sector are charging prices well below their costs with the investors, consumers and the Government. result that the SOEs are unable to expand services Ownership Reform. It is important for the beyond high density areas or even maintain the Government of Vietnam to recognize that Private quality of existing services. However, tariff reform Participation in Infrastructure (PPI) can take 18 Executive Summary many forms, depending on the nature of the rights to these concession options - particularly in the and obligations granted to the private sector. area of cellular operations. While all forms of PPI promise benefits, the more Water. It is recommended that serious ambitious options such as concessions or consideration be given to more far-reaching divestiture present the largest benefits as changes in the sector by pursuing a pilot lease highlighted in the table below. agreement or a concession contract in an urban Bennefits Grow with Degree of Private Involvement Pontential Benefit Management Lease BOT Concession Demonopolize Divest Contract Management Expertise Tariff Discipline Access to Private Capital Capital Market Development Sales Revenue The key recommendations are summarized area. These approaches which falls short of full below: divestiture give the private partner increased responsibility for the operation of the utility. In Telecommunications. In the case of Vietnam, the Vietnam's situation, it may well be that private sector where more far-reaching reforms are likeliest sponsors and financiers view the investment and to be the easiest and have the biggest impact on service levels and efficiency is telecommunications. financial risks to be high at the present time and, as Immediate attention should be given to reforming such, there may be little inclination on their part to the BCC contracts. To ensure ongoing success it is commit investment and finance capital without recommended that BCCs be changed into more substantive political and risk coverage from the straightforward commercial arrangements such as, Government. In such circumstances, the joint ventures that permit private operations, Government may wish to explore leases in parallel concessions or licensed operations. Moreover, there with public financing and rehabilitation of the is a need to restructure the sector, separate post and system. Under such an arrangement, a system telecommunication operations of VNPT, increase would be rehabilitated with public financing and competition in all segments of the market, and then turned over for commercial operation to create as transparent and efficient regulatory private operators who assume the market and process where private participation in the sector is commercial risks associated with the business. The encouraged. Experience from other parts of the Government on the other hand would need to world suggest that with a transparent regulatory ensure the de-politicization of tariff and allow the environment in place, there is likely to be a strong private operators to run the business within and rapid supply response form the private sector specified and agreed rules of the game.This model, 19 Executive Summary if successful, could then be graduated to a full Airports. The government should consider the concession, whereby investors would commit their concessioning of terminal operations and/or airside own financing to the operation as greater services. Although a few countries have conducted confidence on the regulatory framework is outright sales of their airports and several countries developed. have allowed the private sector to build greenfield Power. Major ownership reforms in the power air facilities, allowing private operators to manage sector should await the decisions on the type of and invest in existing terminals and runways at market restructuring that the Government wishes publicly owned airports under a lease or concession to pursue. However, once the market-structure agreement is an economically viable option which decisions have been taken, the Government's may prove to be more politically acceptable than priority in ownership reform should be the total private ownership. Passengers and carriers equitization or concessioning of distribution benefit as private sector operators have been able to perhaps starting with some pilot distribution modernize facilities and shift costs away from projects. This would involve transferring airside fees by developing landside business ownership and management control to private opportunities. This encourages air travel and parties, foreigners included. With distribution tourism development. privatized, the problem of getting new generation Railways. Following the unbundling and projects privately financed will be greatly reduced, equitization of non-core assets, such as hotels, because private generators will have more rolling stock manufacturing and meal preparation, confidence in getting paid if they sell power to consideration should be given to the financially strong, efficient, privately owned corporatization and eventual concessioning of distribution companies. Privatizing distribution rolling stock operations and perhaps the separate will also help the government to bear less risk in concessioning of infrastructure services. While the private generation projects, thereby strengthening process of bringing the private sector into the its fiscal position. railroad industry in Vietnam is probably not going Ports. The government should consider the to be a single step, several nations have pursued the decentralization of port tariffs and management path of concessioning their rail operations in order and then pursue the concessioning of terminal to reduce the public fiscal burden associated with operations for existing facilities. By concessioning rail subsidizations and to improve a deficient terminal operations at existing ports, the service. Vietnamese or local governments can benefit from the expertise and access to capital of major port The Structure of the Country operators without having to concede the Framework Report ownership of waterfront property or underlying The main objectives of the Country infrastructure. The concession period should Framework Report on Private Infrastructure in roughly parallel the life expectancy of major Vietnam are two-fold: investments which would then be converted back to the government for reconcessioning after the · To provide reliable information for potential contract has been concluded. investors on the current position of the key 20 Executive Summary Summary of Key Actions Short-TermActions Medium-TermActions Longer-TermActions Cross-Sectoral Issues · Amend laws impacting PPI · Rationalize Government · Enact laws for PPI and to projects bodies responsible for PPI establish independent regulators in each · Upgrade BOT Group to · Develop system for infrastructure sector PPI Center monitoring off-balance sheet risks of PPI projects · Sector regulatory frameworks in place Power · Undertake study of optimal · Restructure sector by · Move towards competitive market structure and separating generation and markets strategy for future reform distribution from · Equitize a number of transmission · Conclude pending generating and distribution transactions · Begin divesting distribution facilities companies starting with a · Implement tariff increases pilot transaction. · Pass Electricity Law and · Rationalize regional cross- establish independent subsidies regulation Water and Sanitation · Develop clear policies · Develop and implement · Conclude pilot lease or aimed at market reforms policy of tariff reforms concession projects · Develop plan for phasing tariffs to cost recovery levels · Conclude BihnWater BOT Telecommunications · Change BCCs into joint · Liberalize entry into all · Equitize some or all of ventures, concessions or sub-sectors VNPT's core businesses licensed operations · Separate posts from telecoms Airports · Develop strategy for · Consider concessioning · Conclude several decentralizing control to terminal operations or transactions of key airports encourage regional airside services development and PPI Railways · Further commercialize · Separate non-integral · Initiate concessions for separate operating units services from core rolling stock operations and operations infrastructure services · Develop action plan for rail sector private sector participation strategy and Ports · Decentralize and deregulate · Pursue concessioning of · Invite private sector to tariffs to encourage terminal operations or develop new facilities only competition and eliminate equitization of existing after full capacity of existing cross-subsidization facilities facilities has been revealed through private operations and investment 21 Executive Summary infrastructure sectors in the country as well as issues; environmental issues; and right-of the cross-cutting issues which have a direct way issues. bearing on the development of sustainable and · Part B: Infrastrucutre Performance and efficient PPI; Current Environment. This section of the · To describe and assess the supporting policy, CFR examines a range of issues from the regulatory and financial framework for sectoral perspective. It includes a description attracting private participation in infrastructure of the structure, conduct and performance of (PPI) with a view to guiding future reforms. the key infrastructure sectors, broad estimates The infrastructure sectors covered in the of demand, public investment plans and the CFR are power, water, telecommunications, potential role of the private sector in fulfilling railways, roads, ports and airports. The Report is demand; and a description and assessment of presented in a number of key inter-related the policy, regulatory and financing issues sections as follows: which on a sector basis will have a direct · Part A: Cross-Sectoral Issues. This section impact on the development and growth of PPI reviews the cross-sectoral issues impacting in Vietnam. the development of private participation in · Part C: Government Action Program. This the infrastructure sectors in Vietnam. The section of the CFR outlines cross-sectoral and main topics covered are: general business sector-specific recommendations for both short environment; foreign investment regime; and medium actions flowing from the issues foreign exchange regime; tax regime; labor raised by the analysis in Parts A and B. 22 A CROSS SECTORAL ISSUES Although the Government of Vietnam has, and 1. General Business Environment continues to make, considerable efforts to improve 1.1.Trends in Foreign Direct Investment the environment for private sector development, One of the key indicators of the relative severe impediments remain which have direct attractiveness of a country's general business consequences on the prospects for expanding PPI. environment is the volume and quality of Foreign The fact remains that - with the exception of the Direct Investment (FDI). In the case of Vietnam, rural sector - much of the economy is still in the the summary data below raises some important hands of the public sector. Moreover there are a implications regarding the country's attractiveness number of obstacles that still need to be addressed as investment destination. if the private sector is to play a more significant role in the growth and development of the economy. On the one hand, there is little doubt that These issues are addressed under the following Vietnam had been very successful in attracting a broad headings: significant amount of foreign direct investment in recent years. Indeed, between 1994-97 FDI · General Business Environment inflows averaged about US$2.2 billion annually. In · General Legal Environment terms of impact on the economic structure of the · Foreign Investment Regime country, FDI was equivalent to over 9% of GDP · Foreign Exchange Regime in Vietnam - well above those of China and Malaysia (5-6%). This made Vietnam the highest · Tax Regime recipient1 of FDI in proportion to the size of its · Labor Issues economy. · Access to Local Finance On the negative side, a closer examination of · Environmental Issues the facts highlights that these large FDI inflows to Vietnam started to decrease dramatically even · Right-of-Way before the Asian crisis began in July 1997 at a time 1Among more than 100 developing and transition countries, excluding very small economies (with less than 1 million population). 23 Part A Table 1. FDI inflows toVietnam (US$ millions) 1991 1992 1993 1994 1995 1996 1997 1998* Total Approvals 1,470 2,330 3,639 4,184 6,310 8,091 4,065 2,135 32,224 Actual 169 311 850 1,677 2,220 2,091 Source: FIAS * 1998 figures are annualized rates based on data for the first three quarters. when worldwide FDI flows were still increasing, Land, in this case, was donated "free" by HCMC but the and Asia was still experiencing rapid economic site was in a different province (Song Be) which would FDI throughout 1998, and during the first quarter receive none of the services and thus reap none of the of 1999 was already down 68% compared with the benefits of the BOT. Significant fees had to paid by the same period last year. Equally importantly, the rate BOT company for resettlement and land compensation before the project was approved and construction could of projects that were actually implemented over commence. period of 1991-1998 was disappointingly low. Although part of the fall registered in 1998 is 1.3. Perceptions of Corruption in the certainly due to excess capacities and decreased Business Environment liquidity in the region, the numbers suggest that there are more fundamental problems which are There is great concern that advances made by affecting Vietnam's ability to attract FDI. the doi moi reforms aimed at improving the framework for investing in Vietnam have in recent 1.2. Post-approval issues years influenced foreign and domestic investors The low implementation rate described above is negatively due to fears of corruption at many levels partly explained by post-approval problems. These in the bureaucracy. This has been expressed both include excessive red tape, corruption, delays and formally and anecdotally by individual firms and uncertainties that investors face even after they private sector organizations in recent months. receive an investment license, and restrictions on Transparency International together with choosing the corporate structure and joint venture Göttingen University also shares those findings, partners. A recent FIAS Report published in April Germany, which compiles and develops a 1999 concludes that the complex and opaque Corruption Perceptions Index.2 The 1998 index, procedures in Vietnam can be as much of an which was released in September 1998 is impediment in doing business as those of China 13 developed based on information collected from years ago. extensive international publications and surveys. Post-Approval Delays: the Case of BOT Bulk Out of 85 countries surveyed, Vietnam ranks Water Project poorly in terms of transparency and clarity in In the case of the private bulk water supply project for business practices, coming 74th, with a CPI score HCMC - the Binh An Water Corporation - there was a of only 2.5 out of a possible best of 10. This one year delay in the start of construction due to difficult finding confirms the perceptions that corruption right-of -way, resettlement and land use negotiations. in Vietnam is not a trivial issue and can have a 2CPI relates to perceptions of the degree of corruption as seen by business people, risk analysts and the general public and ranges between 10 (highly clean) and 0 (highly corrupt). 24 Part A serious influence on firms' investment decisions. In · Foreign-invested enterprises will no longer be the case of PPI, these concerns are magnified, required to denominate the salaries of local staff because these investments are inherently more in US dollars. risky, given their long-lead and gestation periods · The range of tax breaks, import duty and the sunken nature of fixed assets. exemptions and other incentives applied to A recent survey by the Vietnam Chamber of "specially encouraged" foreign-invested entities Commerce and Industry (VCCI) also confirms the was widened to encompass a greater variety of existence of excessive bureaucracy in Vietnam. enterprises. According to the survey, business-people in · The registration fee for foreign enterprises Vietnam spend more time grappling with starting operation in Vietnam, and other bureaucratic red tape than attending to the needs business fees, will be reduced. of their businesses. Both state and private · Personal income tax rates on Vietnamese businesses spend fully one-third of their time workers/managers in foreign invested getting approvals and passing inspections by the enterprises will be reduced and legislation to government's pervasive bureaucracy. that effect is being drafted. 1.4.Addressing Biases Against Businesses · Work permit procedures will be simplified for Over the past two years, foreign investors have foreigners. become more vocal about some of the laws, 2. General Legal Environment regulations and practices which have added to their cost of doing business or have restricted them Foreign investors have reported that the altogether. In other cases the concerns have had an Vietnamese legal system is complicated, and impact on all businesses - both domestic and severely deficient in transparency, consistency and foreign. The Government has been increasingly dependability. At a recent roundtable discussion, sensitive to the concerns raised by businessmen in foreign investors rated Vietnam's unstable and general and, in response, has issued Decision unpredictable legal framework at the top of their 53/1999/QD-TTg, dated March 26, 1999 to list of factors which negatively impacts business improve the country's tough business climate. performance.3 Investors regard Vietnamese Effective July 1, 1999, several measures to cut costs legal/regulatory environment to be less guided by of doing business will be introduced, although clear case law and more subject to political more detailed implementing guidance is required interference than many other countries seeking to in some areas. Some of the key announcement attract investment. included changes to some of the discriminatory A recent example of this complexity and labor practices against foreigners (see also Labor ambiguity is Decree 10 dated January 1998, which section below) including the following: was intended to introduce "measures for · Differential pricing for Vietnamese and encouragement and guarantees of foreign foreigners will be gradually removed, starting investment". The decree stated that any new law with initial reductions in rates for which would adversely affect the benefits telecommunications, electricity and water. stipulated in an investors' license would not apply. 3Vietnam Chamber of Commerce, 1998 meeting of the Private Sector Forum, 1998 Consultative Group Meeting , November 30, 1998, Hanoi 25 Part A However, most private sector firms and securing land and other pressures have made the international lawyers question whether a decree joint venture the most feasible and practical option can effectively overrule a law or an ordinance for most foreign investors. Furthermore, the within the strict hierarchy of Vietnamese legal licensing authorities have placed informal system. Under this system, laws which are passed restrictions on the structure of joint ventures, by the National Assembly, are considered the requiring at least 30% ownership by Vietnamese. highest form of legal instrument, followed by In mid-1998 the People's Committee of Ho Chi ordinances, which are passed by the Standing Minh City announced a plan to phase out joint- Committee of the National Assembly when the venture investments in favor of 100% FOEs. In Assembly is not in session. Lower in this hierarchy future, 100% FOEs will be encouraged in all fields are decrees which are generally passed by the except for defense-related industries and perhaps government to implement the laws or ordinances. some areas of telecom service. 3. Foreign Investment Regime 3.2. Investment Licensing Process 3.1. Foreign Investment Law In recent years, MPI has made great attempts to Matters dealing with foreign investment in streamline the process for issuance of investment Vietnam began with a legislation passed in 1977. licenses and to address investor concerns about This was subsequently replaced by the Law on excessive red tape.The 1996 FIL amended two key Foreign Investment in Vietnam (FIL), passed in factors that relate to investment licensing process. December 1987 which has since been amended 3 First, it shortened the maximum permitted time times, the latest in December, 1996. As the FIL limit for project evaluation and for issuing itself provides only a general outline, it is important investment licenses to 60 days, although this is not to refer to the FIL together with accompanying always adhered to. Second, and more recently, the decrees and circulars. One of the most important Government has delegated the authority to issue accompanying decree is Decree 12 dated February investment licenses and to monitor foreign 18, 1997, which implemented the 1996 FIL. invested projects to the following provincial The FIL authorized three forms of foreign governments: investment, namely joint venture, 100% foreign · Provincial Industrial Zone Management Board: owned enterprise (100% FOEs) and business projects up to US$ 40 million; cooperation contracts (BCCs). The BCC is an · People's Committees of Hanoi and Ho Chi arrangement mainly used in telecom sector, Minh City: projects up to US$ 10 million; whereas foreign and Vietnamese party jointly conduct a specific activity for fixed duration. No · Provincial People's Committees: projects up to separate legal entity is created under this US$ 5 million. arrangement, and while the foreign party shares in 3.3. BOTs under the Foreign Investment Law revenue streams, it its not allowed to hold equity in The December 1992 amendment to the FIL the operation. and the following 1993 decree introduced the Although 100% foreign owned enterprises are concept of Build-Operate-Transfer (BOT) to allowed to operate in principle, difficulties in entice foreign investors, establishing special 26 Part A schemes outside their conventional laws.The 1996 4. Foreign Exchange FIL expanded the concepts of BOT and now 4.1.Cautious Shift to Market-Determined defines BTO and BT. Rate By Decree 62/1998/ND-CP dated August 15, Until recently, the State Bank of Vietnam 1998 (Decree 62) the Government of Vietnam (SBV) determined daily official exchange rate in introduced new regulations on investment in BOT Vietnam. The Bank ceased announcing official projects. Following comments by various private rates in February 1999, reflecting a cautious shift sector parties, the Government issued Decree 02 in toward a more market determined exchange rate. January 1999, amending and supplementing a The SBV now announces the average exchange number of Articles in the earlier Decree. Although rate traded on the inter-bank market of the these developments by sponsors and financiers previous day, and Commercial Banks are now were all welcome, it is felt that a number of permitted to trade within a band of 0.1%. obstacles remain in the way of the timely Although the band is much narrower than 7% that implementation of BOT projects. The five main was allowed under previous system, the abolition areas of concern are foreign exchange issues; state of the official rate means that the dong could guarantees; loan security; lenders step-in rights; theoretically trade at around 30% above or below and dispute resolution. These issues are set out in its current level within one year. more detail in Part C in the Proposed Action Plan. 4.2. Foreign Exchange Management 3.4. Limited Government Coordination in Dealing with PPI In general, remittance of foreign currency abroad is controlled and subject to the approval by Investors have complained about the absence of SBV. A firm needs an authorization from SBV to a central coordinating body in Vietnam for the (i) borrow foreign currency; (ii) convert dong to BOT program and a general lack of experience dollars; and (iii) open an offshore escrow account among officials selected to negotiate large to provide the banks with security. According to infrastructure deals. Gaps remain between the the existing regulations, BOT projects, among Government's intent to proceed aggressively with others, are eligible to receive a conversion certificate its BOT strategy, on the one hand, and the realities (a guarantee from the State Bank that they can of decision-making processes and business convert dong earnings to dollars in order to pay for practices in Vietnam, on the other. In particular, current transactions such as imports, or interest the government's ability to identify, design and payment). In addition, the procedures for execute BOT activities is limited. It has been converting local currency appear to be quite widely observed that policy makers and technical straightforward. However, many foreign investors staff of line ministries involved in BOT projects remain concerned about the availability of foreign often do not have an accurate picture of their exchange. (See also the discussion in the section respective roles, responsibilities, and requirements. above on "BOTs under the Foreign Exchange Law"). To complicate matters, investors perceive that state enterprises and agencies receive priority in the allocation of foreign reserves. 27 Part A The State Bank also sets maximum rates of These taxes are imposed at the national level. interest that may be charged by local or foreign There are no local taxes. As a part of fiscal reforms, bank branches thus interfering with the market new legislation on corporate tax, VAT, and rate and affecting the supply that can be mobilized personal income tax came into effect in January for investment. Currently, the State Bank approves 1999. Both the new corporate tax and personal loans from foreign financiers where the interest rate income tax regimes are perceived as a step forward is 2% over LIBOR or less, which does not to a more progressive tax regime. represent the real risk of lending in Vietnam. 5.2. Corporate IncomeTax (CIT) Decree 63 clarifies the procedures for buying CIT harmonized the different profits tax regime foreign exchange from the State Bank. that existed for the domestic and foreign investors. In September 1997 Decree 173 was introduced CIT is now at a single rate of 32%, replacing taxes which requires companies to sell 80% of their on profits previously levied at 25%, 35% and surplus foreign current holding to banks. Initially, 45%, and is applied to all enterprises in Vietnam, the firms were required to do so within 15 days, whether domestic or foreign, including foreign but now this must be done immediately. In parties to BCCs. However, in practice most foreign addition, the Government lowered from $7,000 to firms will continue to be subject to the profit tax as $3,000 the amount of capital that can be taken out stipulated in the Law on Foreign Investment. Tax of the country without a formal declaration. holidays will be available to companies which face Although the Government has indicated that heavier tax liabilities under the new regime. Firms Decree 173 is temporary, no timetable has been which are currently paying the lower rate of tax will announced for removing this restriction. It is be exempt for three years from the new 32% widely believed that until the domestic economy corporate tax. recovers, substantive reforms are unlikely to occur 5.3. Personal IncomeTax in this area. Tax levels in Vietnam are generally high by both 5.Tax Regime regional and world standards. In particular the 5.1. Relevant taxes personal income tax, charged to Vietnamese Most foreign investors may be affected by the professionals at foreign invested firms can be following taxes: prohibitive. Effective marginal rates can reach 60% · profit tax as prescribed in the Law of Foreign for the top income bracket. The monthly income Investment; is divided into several brackets, each succeeding · corporate income tax (CIT); one being fixed at a higher rate from 10% to 60%. · value added tax (VAT); Moreover, any income beyond VND · personal income tax on Vietnamese and 8,000,000 (US$ 575) per month is subject to a expatriate employees; surtax of 30% above and beyond the tax rate. As · various withholding taxes; such, to pay an employee with a disposable income · capital assignment profit tax; of US$1,000 per month, an employer needs to pay · import/export duties; about US$3,400. 28 Part A 5.4.Value AddedTax (VAT) 6.3. Recruitment of Local labor VAT replaced the turnover tax, which was A rule that took effect on January 1,1999 inefficient and levied on a sliding scale from 0%- require foreign companies to hire local staff 30%. Most sectors of the economy will likely pay through state-run Labor Bureau. This requirement less under VAT. There are four rates of VAT: (i) 0% had been complicated, time consuming and costly, for exported goods; (ii) 5% for provision of making Vietnam less competitive for accessing essential goods and services (e.g. clean water, food specialized labor. However, after listening to the stuff, medicine); (iii) standard rate of 10% for concerns expressed by the private sector, as of July activities such as power generation, mineral 1, 1999 foreign firms will be allowed to hire local products, postal and transportation services, and staff directly if the Labor Bureau has not found a (iv) 20% for activities such as hotels and tourism. suitable local candidate within 30 days. In 6. Labor Issues addition, foreigners who now wish to work for foreign-invested enterprises will be granted work 6.1. Labor Code permits under a more simplified and investor The June 1994 Labor Code provides the friendly procedure. general framework for labor issues including labor 7.Access to Local Finance agreements, social insurance contributions, payments and rules for overtime, strike, and Over the past year, there has been a weakening employment termination. Enterprises with direct in the performance of the local banking sector. All foreign investment must give preferential banks - both state-owed commercial banks and treatment for employing Vietnamese citizens. joint-stock banks - have over-due loans of about 14%. This is worrying since the weaknesses in the 6.2. Dollar-Denominated Wage loan classification system may understate the actual Until recently, foreign enterprises had to pay extent of the problem. In addition, banks are wages at rates pegged to US dollars. As such, the highly leveraged - the ratio of foreign currency recent large drop in regional currencies affected loans to foreign currency deposits is 125% - and other countries' labor costs substantially and made face high exposure to exchange rate risk given the Vietnam less price competitive overall. Most foreign currency loans made to many domestic importantly, the practice of denominating wages in borrowers who do not have dollar receivables. dollars reduces the potential gains of a devaluation Significantly, nearly 70% of foreign currency loans that can be derived in labor competitiveness are to state enterprises. In these circumstances, through devaluation. The Government has there is little prospect of domestic private sector recognized this following discussions with the firms securing access to local finance for PPI foreign private sector and responded by issuing projects in the near future. Decision 53/1999QD-TTG which allowed for 8. Environmental Regime wages of Vietnamese employee be determined and paid in the local currency not dollars as of July 1, There are a number of environmental laws and 1999. The wages must be indexed to inflation in administrative issues with PPI activities in increments of 10%. Vietnam. GOV recognizes that developing an effective and environmentally sound approach to 29 Part A infrastructure development is vital, both for private firms following closed negotiations protecting the environment as well as for getting between central and local administrative the proposed and signed projects on line. To authorities. Although there has been no constancy enhance its effectiveness in this area, MPI has in methods applied for calculating compensation, funded a $3.5 million project entitled resulting in widespread difference in land "Environmental Issues in Planning and compensation rates, the Government expects to Investment". As part of this program the complete an amendment to Decree 22/1998/ND- government announced in April 1999 that it CP in October of 1999 that portends ot would be sending fifty officers from relevant universalize the approach resettlement and agencies to China and the US to participate in financial compensation. training courses on environmental management. Ministerial bureaucracy has also slowed the 9. Right of Way and Resettlement resettlement process. For example, National Current state regulations stipulate that Highway No 51 land clearance was seriously resettlement and related financial compensation delayed due to local government decisions which must be settled prior to any project construction. altered a previously approved compensation rate Although the Central Government is responsible and caused an uproar among the local residents. for procuring land for BOT projects, financial Lack of transparency and consistency result in compensation can vary widely from project to widespread non-compliance. In case of the Lang- project. The Central Government normally Hoa Lac highway project and National Highway authorizes local authorities to establish No. 51 upgrade project, difficulties in verifying compensation schemes, and a sum charged to land claims resulted in serious delays. 30 B INFRASTRUCTURE PERFORMANCE AND CURRENT ENVIRONMENT 1. ENERGY owning the entire transmission network and In physical terms, the power sector in Vietnam much of the distribution network. But the has developed and grown rapidly over the last Government is going through the process of decade. In policy terms, although the sector is still opening the sector to private participation. In dominated by the state-owned EVN, the generation, there is a privately owned IPP at Government has started the process of reform. Hiep Phuoc selling power to EVN and to Tariffs have been raised nearer to costs. EVN has businesses in the Saigon-South industrial zone. been made to run as a semi-commercial business. Other private generation plants proposed under And the private power generation is being sought the BOT framework seem close to going ahead. under the BOT framework. In the distribution sector, too, there are players other than EVN. In many places, especially in The potential for an improvement in the rural areas, EVN sells bulk power to a separate performance of the industry and an expansion of local-distribution entity that in turn sells to final its size is, however, still large. Realizing the customers. Further, the Government is potential will require the Government to continue discussing the plans for pilot equitizations of to deepen the reforms it has begun to undertake to small chunks of the distribution network. The encourage private investment and operation. But if existing market structure (ignoring the small, the Government does press ahead with final distribution companies) is depicted in fundamental reform, the opportunities for private stylized form in Figure 1 below. investment that helps Vietnam achieve its goals will be enormous. 1.1. Market Structure The state-owned Electricity of Vietnam (EVN) dominates the power sector in Vietnam, producing most of Vietnam's electricity and 31 Part B Figure 1: Current Market Structure in the Electricity Industry inVietnam 4 CUSTOMER CUSTOMER CUSTOMER DISTRIBUTION & SALES TRANSMISSION EVN GENERATION IPP 1.2. Physical Performance Nonetheless, Vietnam's power sector is still Vietnam's power sector has developed rapidly small. Installed capacity is about 5,000 MW, about over the last decade, with sales, for example, half that of the Philippines. Moreover, technical increasing from 4 terawatt-hours in 1985 to 18 in problems mean that about 20% of the power that 1998 (see Table 1). is produced never reaches a customer, being lost instead in the transmission and distribution networks. Much of the country has no access to Table 1:The Development ofVietnam's Power Sector power at all and consumption per capita per capita Indicator 1985 1990 1995 1998 is less than 200 kWh. Although much progress has Peak Demand (MW) n.a. 1,546 2,714 3.942 been made, the opportunities for improvement Sales (TWh) 3.860 6.185 11.198 17.838 remain large. Table 2 illustrates the potential for expansion and improvement by comparing Vietnam with some other countries in the region. Table 2: Selected Physical Indicators for the Power Sector inVietnam and Elsewhere Indicator Vietnam Indonesia Philippines Malaysia Thailand Proportion of households with access to power (%) 515 39 58 90 87 Installed generation capacity (MW) 4,890 14,327 9,539 7,319 13,003 Electricity generation, 1997 (GWh) 19,151 61,199 29,698 45,453 80,068 Consumption per capita per year (kWh) 204 315 399 2,032 1,294 T and D Losses as proportion of power generated (%) 16 12 17 11 9 4The diagram also simplifies the actual structure of the market by ignoring autogenerators and small,off-grid systems in rural areas. Note also that EVN is undertaking a form of internal unbundling of its function, making various business units in generation, transmission, and distribution more independent from each other. 5Note that estimates vary widely.According to EVN, the access rate is as high as 50%. 32 Part B 1.3.Tariffs and Financial Performance In other words, given EVN's total costs, tariffs are too The tariffs charged by EVN are about 5 cents low. Similarly, current tariffs are too low to cover the per kWh on average (dividing total revenue by expected cost of generating and delivering additional kilowatt-hours sold), which is high enough to power to satisfy increasing demand (estimated to be cover EVN's operating costs. However, it is around US8 cents per kWh). important to note that the current tariffs are still EVN's ability to continue to repay debt and below the long-run marginal costs and thus make payments under power-purchase agreements threaten the long-term health of the sector. (PPAs) will therefore depend on the progress the Businesses and foreigners pay more than the Government makes in increasing average tariffs-as average, while households using relatively little well as on EVN's success in reducing its costs. power pay less (see Table 3). Addressing this problem in July 1998, the Table 3: Summary of Nominal ElectricityTariffs, 15 December 1998 ConsumerTypes Typical price (US cents/kWh) Maximum Price (US cents/kWh) Residential 151 to 250 kWh/month 5.9 351 kWh and higher 8.2 Commercial >6 kV, NormalTimes 7.8 >6 kV, PeakTimes 12.3 Industrial >20kV<110 4.8 >20kV<110 11.4 Source:World Bank (1998), FuelingVietnam's Development-New Challenges for the Energy Sector. EVN has made accounting profits since its Government approved increases in average retail creation in 1995. In 1997, for example, its net tariffs to US 5.5 cents/kWh on 1 May 1999, 6.2 income was around US$37 million (see Table 4). Its cents on 1 January 2000; and then 7.0 cents 1 debt-equity ratio, however, is low and its profits do January 2001. It has also decided to gradually not provide a commercial rate of compensation for eliminate the difference between tariffs paid by the Government's equity investment in the company. foreigners and locals. Table 4: Selected Items and Ratios from EVN's Financial Statements 6 Item US Dollars: Millions 1997 1996 Sales 807 664 Operating Income 86 174 Net Income 37 139 Current Assets 1,339 930 Fixed Assets 1,981 1,904 Total Assets 3,320 2,834 Current Liabilities 1,117 829 Debt and other Long-Term Liabilities 384 226 Government's Equity 1,759 1,778 Item 1996 1997 Return on Equity (%) 2 8 Ratio of Current Assets to Current Liabilities 1.14 1.12 Ratio of Debt to Equity 0.22 0.13 Estimated Non- Technical Losses (%) 4.4 6Audited Financial Statements for EVN for the year ended 31 December 1997. 33 Part B 1.4. Future Demand and Investment new generation capacity, costing an estimated US$ Opportunities 9.5 billion. Over the same period, considerable 1.4.1. Future Demand investments will also need to be made in transmission, distribution, and retailing. The Setting the price of power high enough to cover World Bank has estimated that US$ 2 billion will costs is critical because the demand for power is need to be invested in these areas between 1998 forecast to grow rapidly, despite the current and 2002 (see Table 6) downturn.Table 5 presents a recent (i.e. post crisis) forecast of the demand for electric energy and The Government plans to finance part of these capacity. 7 investments itself, using its own revenues and Table 5: Recent and Projected Demand for Electric Energy and Capacity 1996 2000 2005 2010 Growth Rate Energy (TWh) 16.949 25.706 44.491 77.406 11.5% Capacity (GW) 3.161 4.779 8.195 14.123 11.3% The forecast is sensitive to several assumptions, borrowing, and the rest is to be financed by the including that prices will stay constant in real terms private sector. The proportions of public and and that losses will be reduced. If tariffs were raised private financing have not been decided and any to 8 US cents per kWh, the estimate of the long- decisions are likely to be subject to change. run marginal cost mentioned above and the Nevertheless, as shown in Table 6, the World Bank estimated peak demand in 2010 would fall by estimates that between 1998 and 2002 Vietnam 1,700 MW relative to the base-case estimate. will require approximately US$ 6 billion of Similarly, if losses were not reduced as assumed investment in power. About 40% of this are above, a further 850 MW or so of capacity would expected to come from public sector, 50% from be required. The need for new investment in ODA, and the remaining 10% from private sector. generation will therefore depend in part on reforms Given the scarcity of public sector funding in the distribution and retail power business. including ODA, the government should 1.4.2. Opportunities for Private alternatively refine its ground rules for greater Greenfield Investment private sector participation in the sector, and These forecasts imply that between now and channel public funding to those activities and 2010 Vietnam will need around 10,000 MW of sectors which cannot attract private financing. Table 6: Power Financing Requirements and its Source 1998-2002 (USD million) Type of Investment Finance Public Export Credits Private Required Investment and ODA Investment Hydro Plants 1,730 964 766 0 Thermal Plants 2,098 214 1,100 684 Transmission and Distribution 2,000 1,000 1,000 0 Total 5,828 2,178 2,866 684 Source: World Bank Report (1998), FuelingVietnam's Development-New Challenges for the Energy Sector 7FuelingVietnam's Development,World Bank. 34 Part B 1.4.3. Planned Equitization of Existing under the PPA on 2 March 1998. Wartsila, the Assets IFC, the primary lender, and the Government The Government's plans to equitize existing have reached agreement on key documents assets, though the transfer of both ownership and including the BOT contract and the consent- management control, are less developed than its and-acknowledgement agreement designed to plans for private greenfield investments. The clarify and safeguard the lenders' rights. Government is, however, interested in opening the Some of the proposed deals that have been distribution sector to the private sector and, as a negotiated, such as Quang Ninh, have involved start, it is discussing the equitization of a couple of informal competitions, the Government talking to small distribution units, including part of the several sponsors before selecting one for further Hanoi and Ho Chi Minh City companies' negotiations. The first project that has followed a distribution systems. formal competitive process is the Phu My 2.2 1.5. Existing Private Participation combined-cycle-gas-turbine plant. In this case, the Government hired international consultants to Private firms and individuals are already help it prepare bidding documents, including draft operating in the power sector, albeit at a small scale. project contracts, evaluate proposals, and negotiate There are some small private distributors (often with the winning bidder. Bids were received from just individual meter landlords), private six international consortia and publicly opened in autogenerators, and private generators dedicated to April 1998. In September, the Government industrial zones. shortlisted three consortia and it is now negotiating The only operating privately owned power with the first ranked led by EdF. generator selling to third parties is Hiep Phuoc, a 1.6. Restrictions on Entry 375 MW plant in the South of Ho Chi Minh City. It was built by a Taiwanese company to supply an 1.6.1. Legal Restrictions on Entry industrial zone and doesn't fall under the Although a draft is being discussed, Vietnam Government's BOT framework. The company does not yet have a law that spells out the negotiated a PPA with EVN only after the plant conditions under which firms other than EVN can was constructed and the PPA, under which it sell enter the electricity business. There is no law, for power for 5.7 US cents per kWh, has a term of example, stating that electricity is the exclusive only three years. preserve of the state. Any business wanting to enter Of the planned BOTs, Wartsila's 120 MW the industry must get various permits, however, so plant at Ba Ria is one of the closest to entry is feasible only with the approval of the completion. The deal was a negotiated one. MOI Government. and Wartsila signed the BOT contract on 19 Although there is no law that sets out the September 1997. MPI granted an investment Government's policy toward the electricity sector, license on 24 September 1997. EVN and the the Government has made policy statements that project company signed the PPA on 25 set out its approach to private investment.8 The November 1997, and MOI granted a following types of entry are welcomed in principle: government guarantee of EVN's obligations 8 See policy statement of the GOV (MOI) attached as annex toWB Project Appraisal Document for most recentT and D and disaster-recovery loan. 35 Part B · private generation selling exclusively to EVN on · underestimation by the Government of the cost a 20-year BOT basis of capital. · private generation selling exclusively to They have also expressed concerns that the businesses in export-processing and industrial existing legal framework, while permitting private zones investment in principle, contains elements that · private generation for a company's own discourage it, citing: consumption · difficulties in the application of international · private participation in distribution. arbitration under international law There are no special restrictions on horizontal · limits on the security that lenders can take or vertical integration in the industry at present, · the non-transferability of land leases deriving either from electricity-specific or general · limits on the convertibility of the dong and law. Nor are there any power-specific restrictions associated problems such as limits on availability on foreign ownership of electricity assets. of dong, interest-rate caps on foreign-currency- 1.6.2. Institutions Responsible for denominated loans, and requirements to Approving and Facilitating Private convert foreign currency into dong. Participation Most of the issues that concern investors are not Private companies wishing to enter the power specific to the power sector and are discussed more industry must make a proposal to the Government in the cross-sectoral section of this report above. or respond to a proposal calling for private Investors, potential investors, and their advisers investment made by the Government. The formal also cite some power-specific factors that constrain procedures that private companies must follow entry by new private firms: under the BOT project are the same as in other · The current rules for setting tariffs do not sectors, with the Ministry of Industry being the provide any assurance that the tariffs will cover lead technical ministry. costs-one of the reasons why EVN is considered 1.6.3. De-Facto Restrictions on Entry a poor medium-term credit-risk. Potential investors in the power sector and their · The rules governing the operation of the gas advisers have expressed several concerns about the sector-and, in particular, the pervasive role of process of getting permission to enter the sector, Petro-Vietnam-lead to long delays in the including procurement of new gas supplies. · EVN's role as both the purchaser of power from · the need for many permits private power plants and a supplier of bulk · slow decision making by the Government power in potential competition with them may · unclear (or according to some investors simply reduce its incentives to enter into PPAs with complex) decision-making processes private power plants. · corruption · the "underdevelopment" of the legal system-a 1.7. Risk Allocation general lack of clarity and a belief that nothing The types of project that the Government has is permitted unless positively provided for focussed on so far are independent power 36 Part B producers (IPPs) selling power to EVN, and the and 2010, costing about US$9.5 billion. If the proposed allocation of risks in these projects is Government were to secure this capacity in the similar to that seen in other IPP projects selling to form of IPPs selling to EVN and continued to own a state-owned monopolist.The projects ensure that EVN (or indeed if it secured the capacity using construction and operating risk, and some of the traditional publicly financed projects) it would financing risk, is borne by the private sector (or assume very large amounts of off-balance-sheet foreign SOEs), not the Government. Under a debt (on-balance-sheet debt in the case of publicly BOT, for example, the Government is not financed projects). Avoiding these liabilities and responsible for operating the plant and does not associated risks would require deeper reform, lose if the plant's operating efficiency falls or inclusive of unbundling EVN, creating a operating costs rise. Similarly, because the competitive market for power generation and Government holds no equity stake in the plant, it alternatively for distribution, setting up an bears less of the financing risks in the project. 9 independent regulation and privatizing the state- Nevertheless, the Government retains exposure owned assets commencing with a pilot distribution to commercial risks under traditional BOT company. projects of the type being planned in Vietnam. 1.8. Protection of Investors from Most important, it bears demand risk: the risk that Political and Regulatory Risks the profits from the project will be lower than Protecting investors from political and expected because there is less demand than regulatory risks over which they have little control expected for the power produced by the plant, is crucial to encouraging private investment in either because the total demand for power falls power, as in other infrastructure sectors. short of expectations or because new plants enter Accordingly, the BOT projects being developed in the market selling at a lower price. Vietnam provide equity investors with various As a corollary of this risk-bearing, BOT projects protections. For example, the Government enters create liabilities for EVN and for the Government into a long-term contract with the investors, and as the owner of EVN and guarantor of its investors may have recourse to international obligations. These liabilities are off balance sheet arbitration under, say, English law if a dispute arises for EVN and for the Government, but they are no between them and EVN or the Government. less real than on-balance-sheet debt. For example, Investors and financiers still have concerns with the present value of the liabilities assumed by EVN the strength of these safeguards. On the one hand, under a PPA with one IPP could be in the order of there are the issues raised in the cross-sectoral several hundred million US dollars. To put this discussion in this report above (such as the number in context, Table 6 shows that the book circumstances in which international arbitration is value of EVN's existing debt is approximately available and would be effective). On the other US$384 million. hand, there are issues related to EVN's The base-case forecast of electricity demand vulnerability to political and regulatory risk. mentioned earlier implied that Vietnam will need Although investors will receive and welcome about 10,000 MW of new capacity between now sovereign guarantees of EVN's obligations, they 9The Government also has no (on-balance-sheet) debt associated with a standard BOT project. But the PPA signed by EVN creates an obligation for the Government, as owner-and guarantor-of EVN, that is financially similar to debt (but not identical, because it is contingent upon the IPP company's being able to supply power.). The Government therefore bears financing risks similar-though not identical-to those it would bear if it financed a public project with conventional government borrowing. 37 Part B would prefer not to rely on them, being more 2.WATER AND SANITATION confident of being paid if EVN can meet its At the present time, the Water sector in obligations without the financial support of the Vietnam is entirely owned by the public sector. Government. EVN's ability to meet its obligations The Government has sought some degree of is, however, exposed to significant political and private participation by encouraging private BOT regulatory risk. Its profits depend on actions taken projects - mainly to provide bulk water supply to by the Government such as whether it will oblige commercial customers in industrial zones. EVN to increase its costs by hiring more staff or However, no private projects have yet to reach lower its revenue by reducing tariffs. Because EVN financial closure. Several BOT projects are is owned by the Government and because tariff- currently in various stages of preparation in Hanoi setting is political, these risks are high. and Ho Chi Minh City (HCMC). The most advanced is the Binh An Water Corporation project in HCMC, which has already started construction but has not reached financial closure. The Government's present policy does not encourage private involvement in water distribution systems or at the retail level. Water provision to urban customers is planned to remain in the responsibility of reformed State Enterprises at least in the first stage to the year 2000.10 2.1. Market Structure The water sector in Vietnam is highly decentralized, as in many other countries. National ministries retain authority over sector policy and approval of major projects, while the provincial People's Committees are responsible for water supply services in their respective jurisdictions. In urban areas Water Supply Companies are created to operate and maintain piped water systems. In rural areas these are known as Water Resource Service companies. Water Supply Companies (WSCs) and Water Resource Services are created as separate legal entities from People's Committees. However, most major decisions related to investment and tariff setting are largely influenced by the People's Committees. The structure and capacity of WSCs vary from province to province. However, in most cases their functions and 10SAR,Water Supply Project, 1997. 38 Part B responsibilities are poorly defined and they do not cent of water pipes in urban areas date back to the enter into contracts with their customers. 1960s, and most of the water supply projects 2.2.Technical Performance ignore the renovation of existing piping systems. There are few real incentives to maintain or expand The table below summarizes some of the key the distribution system. Non-revenue water technical and physical indicators of the water (NRW) is extraordinarily high in Hanoi at 63.5 % system in Vietnam and provides some benchmarks in 1999. This means that roughly two out of every for comparing this performance with other water three liters produced generates no revenue, systems in East Asia and Latin America. requiring the water company to recover all cost 2.2.1. Coverage and Consumption with only the remaining third. Inter Ministerial Circular (No. 02-TTLB) states that the acceptable Most of the population, especially in rural water loss ratio shall be set by the Chairman of the communities, do not have access to safe drinking People's Committee or the Mayor of the central water. Only 100 out of the 436 urban centers11 cities, and that the rate shall be under 30%. with population over 5000 have access to piped However, since the Construction Units of Water water. Although these distribution systems serve 7 Companies derive a majority of their income from million people this is only 47% of the urban construction activities, they tend to encourage population. Service coverage in major cities has capacity building rather than maintaining the reached 60-70% of households in the major cities existing distribution network or promoting better while in medium and small cities coverage is only commercial practices in billing and collection. In 50% and 30% respectively. This performance is far addition, the table below indicates that the number below the standards achieved in the region and is of staff per 1000 connections in Vietnam is well one of the indicators which causes greatest concern above acceptable levels, suggesting the potential for to the Government. Per capita production and significant productivity gains. consumption volumes of water in the two major 2.2.3. Quality Vietnamese cities are also below regional standards. The quality of drinking water is unreliable and 2.2.2. Efficiency compares unfavorably with WHO standards as Only about 80% of existing capacity is utilized well as those set by the Government of Vietnam due to obsolete equipment. Physical water losses itself. There is little wastewater treatment in place. are substantial, and result mainly from old and In response to poor quality water supplies, many faulty pipes and from an inadequate distribution households now resort to tapping wells or system. For example, the Gia Lam water treatment plumbing rivers and lakes without adequately plant in Hanoi has a capacity of 30,000 cubic treating the water before use, risking the health of meters per day, but daily output is limited to 5,000 the entire communities. For example, dilapidated to 10,000 cubic meters due to an inadequate pipe systems and weak water pressure have forced piping capacity. Similarly, in Ho Chi Minh City, the Water Supply Companies (WSC) in HCMC the municipal pipe network frequently overloads, to use large water tanks to deliver clean water to springing leaks or overflowing when supply many HCMC districts. In other areas, the WSC exceeds pipe capacity. The Ministry of must drill wells that are often rushed and do not Construction reports that approximately 60 per meet technical and hygienic standards. First built 11In total, there are 547 Urban Centers that are formally established. 39 Part B Table 7: Selected Physical Indicators Vietnam Philippines Thailand Malaysia Population with access to safe water (%) - urban 53 93 89 100 - rural 32 77 72 74 - total 36 85 81 88 Hanoi HCMC Manila Bangkok Kuala Lumpur Consumption per capita per day (m3) 0.05 0.14 0.20 0.27 0.20 Unaccounted for water (%) 69 30** 48 38 36 Number of staff per 1,000 connection* 13 6 5 5 1 Water availability per day (hours) 18 24 17 24 24 Source: ADB SecondWater Utilities Databank,World Development Indicators. * The ADB NationalWaterTariff Policy Study reports a figure of 4.6 for HCMC, and 28.8 for Hanoi. ** Figure for 1998. by the French in 1879, the city's pipe network has suggest that an average tariff level of US$0.43 per expanded over time to its current length of 2,000 cubic meter would allow Hanoi to finance 20 kilometers. However, much of it is in need of percent of its future investment costs in 2002 from repair, leading to large-scale leakage and water retained earnings, as well as cover its operations waste. Many contaminated water reservoirs have and maintenance costs. Equally importantly, it been in use for years without regular maintenance, may well be that tariff levels could be adequate if while lack of public awareness also contributes water losses could be reduced from the currently substantially to the loss of one third of the city's high levels in Hanoi to less than 30%. There is total water supply. To date, only 7.66 km of strong political resistance to increase water tariffs additional water pipes has been built, while over time to full-cost recovery levels. However, it is another 22 km require urgent upgrades. worth noting that this policy only exacerbate 2.3. Commercial Performance andTariffs problems of the poor since many poor Vietnamese who lack clean drinking water are currently 2.3.1. CurrentTariff Rates compelled to pay informal sources nearly ten times Water tariffs in Vietnam remain heavily the current tariffs. subsidized up to 40 %. Within this system there 2.3.2.Tariff Setting Method are considerable cross-subsidies between different classes of consumers. The Ministry of In theory tariff rates are proposed according to Construction has indicated that on average, the guidelines by WSCs subject to approval by People's tariffs approved by provincial people's committees Committees to cover production, sales and reach only 60-70% of the level that would be overheads (not maintenance and expansion). In required to cover capital and operating costs and to practice, however, few WSC follow the cost service debt obligations. For instance, from the recovery guideline and the rates cannot exceed the data available, the cost of treating one cubic meter price ceilings imposed by the State Price of water in Hanoi and HCMC is estimated to be Committee. For example, in the case of the Hanoi approximately US$0.25, whereas consumers on Water Business Company, the tariff increase average pay only US$0.13. Rough calculations suggested by the Company was reduced by the 40 Part B People's Committee due to different assumptions justifying the high bulk water tariff rates by on the operational costs. In addition, the indicating that the new water supply would be Government has recommended step by step strictly for the higher paying commercial increases in tariffs to avoid sudden price upheavals, customers. In practice, however, this policy only thus making tariff increases a slow process. leads to a higher average cost of production which 2.3.3. Metering could be even more difficult to recover without substantive financial reform and tariff re-balancing. Nearly all industrial customers are metered in More generally and for the bulk of the system, Hanoi and HCMC, whereas 80% of households water provision to customers at the distribution in HCMC and only 40% of households in Hanoi and service level is planned to remain with State have meters. Households without meters pay a flat Enterprises. Unfortunately, it is precisely at the rate based on the assumption that they will service level where the efficiencies of private sector consume only 4M3/month. Collection of tariffs is finance and management could have the greatest not a significant problem in Hanoi, as the WSC impact since it is the water supply losses in the can now disconnect the service if a customer falls distribution systems which are undermining behind by 3 months. viability of the water supply businesses in Vietnam. 2.4. Demand Forecasts and Public Simply involving the private sector through the Investment Plans expansion of BOT based bulk supply of treated The government has formulated a two-stage water to the WBCs will not address the real water sector development strategy. The first stage problems and inefficiencies facing the sector. focuses on system rehabilitation and institutional Furthermore, in light of the increased fiscal strengthening of the WSCs. The second stage strains on the Government in recent months, there would address demand and capacity expansion is bound to be growing pressure to seek ways of beyond the year 2000. Specifically, the reducing the state budget investment in the sector. Government aims to provide clean water for 80% This would suggest that the role of the private of the urban population by 2000 (100% in Hanoi sector in terms of Foreign Direct Investment has and HCMC). The Public Investment Program become even more important if the Government is prepared in June 1996 estimates that total to achieve the investment levels it needs to meet its investment requirements for water supply own quality, access and expansion targets in this (including rural areas) could be as high as VND critical sector of the economy. 16,000 billion (US$1.2 billion,12) of which VND 2.5. Legal Environment and Regulatory 5,000 billion (US$384 million) would be Institutions channeled through the State budget. According to the plan, ODA has been identified for about two There is no specific law regulating water supply thirds of this requirement - i.e. VND 10,560 in Vietnam. From the private participation billion or US$812 million. perspective, the industry is subject to the same constraints inherent in the laws, regulations and The government's strategy for the private sector practices that impact foreign investment and is limited to BOT projects in bulk water provision licensing in other infrastructure sectors. These mostly for industrial estates. The government is 12US$1 = 14,000 dong. 41 Part B points are discussed in the section of the Report although Decree No 44 issued in 1998 specifies dealing with cross-sectoral issues (Part A above). that public utilities shall not be equitized. At the National level, three ministries deal with As mentioned above, the government water resources: Planning and Investment (MPI); encourages private bulk water supply through Construction (MOC); and Agriculture and Rural BOT schemes with some form of take-or-pay Development (MARD). According to the water arrangements - particularly for the industrial sector law, MARD in charge of Water Resource where foreign customers are able to bear higher Management. tariffs. Whether a BOT project needs to be MPI is the central ministry responsible for the approved by the national government or by the allocation of resources among sectors and provincial government depends primarily on the preparation of consolidated Public Investment capital investment involved in the project. All the Plan. MOC has responsibility for appraising BOT water projects currently in the pipeline technical aspects of all water supply and sanitation require approval by the national government. As projects for urban and industrial areas. MARD is Vietnam has a unitary government - i.e. there only responsible in coordinating water supply and is administrative, not legal separation between sanitation for rural areas and the UNICEF funded central and municipal/provincial governments - rural water supply and sanitation program projects. municipal government cannot sign enforceable Within MARD, the semi-autonomous Institute of and legally binding contracts. By the same token, Water Resources Planning is responsible for water the municipal government's legal obligation is also resources planning. that of central government. For example, the HCMC Water BOT with BAWC has an inherent Other important agencies in the water sector guarantee from the HCMC People's Committee. include the National Steering Committee for It is widely assumed that the National Government Water Supply and Environmental Sanitation which will step in if the People's Committees cannot meet co-ordinates both rural and urban water supply. this obligation under the contract. The Committee recently introduced similar provincial committees in 25 of the 61 provinces. A Malaysian consortium, Binh An Water According to Water law, Use of both ground and Corporation (BAWC), is the only company that surface water is supervised by Ministry of has actually started constructing a BOT-based Agriculture and Rural Development and discharges water supply plant (see details in the Box below). to water courses is regulated by Ministry of Science, The government has also approved another BOT Technology and Environment (MOSTE). by the joint venture between Lyonnaise des Eaux 2.6. Private Participation in the Sector and a Malaysian company in HCMC. M-Power is currently awaiting the Prime Minister's approval to The current government policy is that water start a water supply plant BOT in Hanoi. provision to urban customers should remain the 2.6.1. Binh An Water Corporation Limited: responsibility of reformed state enterprises at least BOT bulk water supply project until year 2000. No policy has been expressed as to whether private provision of urban water service would be permitted after that point in time 42 Part B The Binh An Water Corporation Limited (BAWC), a 100% foreign owned consortium, has a 20 year BOT contract with HCMC Water Supply Company. The contract calls for BAWC to supply 100,000 m3/day of treated water on take-or-pay basis. Most of the water treated at the BAWC plant will be allocated to Bien Hoa Industrial Zone, where industrial customers can afford higher rates. In addition, BAWC will meet about 10% of HCMC's predicted demand. The BOT contract was negotiated, not competitively bid, with the People's Committee of HCMC in August 1994. A license was issued in March 1995. Construction started in December 1997 and was planned to be in operation by April 1999. Although the construction has nearly completed, project has been halted due to difficulty of reaching financial closure. Some key characteristics of this BOT are: · The project contract was negotiated with a single investment group. The BOT concept was used for the first time in the water sector in Vietnam and the government's inexperience led it to negotiate a deal with a single supplier rather than employ a competitive bidding process. · There was a one-year delay in the start of construction due to difficult land use negotiations. Land was donated "free" by HCMC, but the site location was in a different province (Song Be) which would receive none of the services, and reap none of the benefits of the BOT. Various fees had to be paid for resettlement and land compensation before it was approved. · The State Bank of Vietnam would not offer a guarantee to BAWC for the bulk sale contract with WBC. The only guarantee came from the HCMC People's Committee, based on an unaudited annual budget of US$286 million. It is widely assumed that the National Government will step in if the People's Committee can not meet its obligation. · Market risk and foreign exchange risk associated with this contract is almost entirely born by the government through a dollar denominated take-or-pay agreement and a guarantee from People's Committee. Allocation of risk in BAWC project Risk (a) Party to bear risk Construction risk Private Operating Risk Private Market/output risk (i) Public Transportation risk (pipe) Private Regulatory risk Private Exchange rate (ii) Private 43 Part B 3.TELECOMMUNICATIONS preferred forms of private participation in Vietnam has made considerable progress in infrastructure in light of the dramatic falls in telecommunications in recent years, particularly in Foreign Direct Investment into Vietnam in recent the availability of modern basic service and cellular months and the growing competition from other services. However, in common with many other countries in the Region for foot-loose investors. Finally, there are legislative pressures that will developing countries, it suffers from a number of emerge from the US-Vietnam Trade Agreement problems, including technical and managerial Talks and the entry requirements for World Trade inefficiencies; unequal access, particularly between Organization (WTO) membership which will the rural and urban areas; shortages of capital for require the Government to liberalize the capital expansion; and restrictive regulations.These telecommunications market. problems are exacerbated by a legacy of heavy 3.1. Market Structure centralized control. At the present time, the Government of Vietnam views Vietnam Post and Telephone (VNPT) telecommunications as a strategically important dominates the sector, and it participates in almost part of the country's infrastructure and prohibits all activities and enterprises, including those that private foreign ownership in operations while have been set up to provide a modicum of permitting only limited private participation competition in the sector. There is a proliferation through the funding of additional capacity. The of State-owned 'companies' for almost every main avenue for private foreign involvement in the telecom activity. (See details in the Diagram operation of the telecom sector has been through below). While this is may be a good way to provide focus and accountability, it is not certain that they Business Cooperation Contracts (BCCs) which are are companies in an international sense, and there schemes where foreign companies finance capital is no financial information readily available that investment and share in revenues with the telecom can be used to analyze their viability as trading company but have no direct involvement in the entities. So far VNPT has equitized only one of its operation of the systems. many companies and is currently planning to Most BCCs, however, do involve the foreign equitize four others (a hotel, a telecom partners to provide technical assistance and manufacturer, and two postal construction training to Vietnamese professionals on a wide companies). scope of telecomuncation operations. There are a 3.2.Technical Performance number of factors in play which may encourage the Government to consider more fundamental Access: Progress towards access for fixed lines reforms and liberalization of the sector. First, there as well as mobile services have improved is growing resistance amongst foreign investors in dramatically over the past 5 years: the number of pursuing further BCC arrangements given the main line grew from 0.4 per 100 inhabitants to time-consuming negotiations involved in these 2.1 in 1998; and the number of cellular projects which leave the private sector party with subscribers grew from 15,000 in 1995 to 225,000 no control over the day-to-day running of the in 1998. Since the network prior to 1990 was systems. Second, the Government is openly very small and essentially obsolete, Vietnam is seeking foreign and local private sector views on now in the enviable position of having a very 44 Part B Diagram :Telecommunications Market Structure inVietnam modern, fully digital network. The average is little reason, other than organizational, for the waiting time for service is estimated at 0.7 years, relatively poor efficiency figures. One local although there are considerable variations company that mainly deals with VNPT estimates between rural and urban areas. that 60-70% of their time is wasted on overcoming Table 8: Ownership ofTelecoms facilities and Internet access and usage inVietnam cities HCM Hanoi Danang CanTho Total Households (thousands) 793 558 116 45 Telephone (%) 31.2 49.2 24.8 28.3 Mobile Phone (%) 4.3 2.7 1.6 2.1 Computer (%) 8.4 9.9 1.5 2.9 Efficiency: VNPT's operational efficiency ranks bureaucratic blockages. They confirmed that very poorly compared to its neighboring countries obtaining a leased circuit can take around 6 (see Table below). Given the state of the network, months, but only after 'suitable pressure'. i.e. mostly new, digital and of recent vintage, there Table 9. Performance of theTelecom Sector Vietnam India Philippines Thailand Main lines/ 100 inhab. 1 2.1 1.9 2.8 7.9 Cellular lines/ 100 inhab.1 0.18 0.09 1.77 3.31 Payphones / 10,000 inhab.2 0.1 3.6 1.3 13.1 Staff/1,000 main lines 1 50 24 9 7.3 Revenue per line in US$ 1 520 234 582 429 Source: ITU,World Bank. 1. 1997, 2, 1996 45 Part B 3.3. Commercial Performance andTariffs This presents a major opportunity for the As with most other government controlled Government to turn to the private sector to meet telecommunication companies, the tariffs in some of these new investments. However, as Vietnam are full of cross -subsidies and are not noted above, there are serious concerns being closely aligned to cost. For example, the highest raised from the international firms about the tariffs are for basic telephoning where the costs are current forms of private participation and the the lowest while the tariff for connection in the restrictions that they entail. Furthermore some of cities is higher than for the rural areas, although the the private companies that may have been costs are the reverse. Similarly, local call tariffs are potential investors in the past are now facing very low whereas long distance and international competitive threats in their home territories so tariffs are relatively high.This arises from a political that, unless the investment climate is very agenda whereby those who can pay the most have attractive, they are unlikely to show any interest. the highest rates. This practice is a form of 3.5. Legal Environment disguised taxation which places an additional There is no law in Vietnam specifically on burden on industries that are trying to be telecommunications, although the Government competitive, particularly if they are export- has proposed introducing one in 1999. The orientated. However, the Government is aware of current regulatory framework is based around some of these issues and as a first step has commercial regulations and decrees, in particular announced that from July 1, international those that refer to the rules regarding foreign telephone calls are to be reduced by an average of investment. 10%. Nonetheless, there is a need to move ahead 3.6. Regulatory Institutions quickly to rebalance tariff and introduce independent regulations for greater efficiency and The primary regulatory agency is the competition in the sector. Department General of Posts and Telecoms 3.4. Demand forecasts and public (DGPT). However its actions are constrained by investment plans other governmental agencies, including the Department of Planning and Investment (DPI) The government aims to double the number of and VNPT. telephones in Vietnam over the next 3-5 years. DGPT's role involves: This will require investment of at least US$ 1billion per annum, particularly if greater emphasis · establishing the laws, policies and strategies for is given to the rural sector. In addition, finance will activities in postal, telecommunications and be required for cellular, internet and network radio frequency management; expansion. The government believes that some of · issuing standards and regulations regarding the investment money required for networks, services, equipment, RF management telecommunications will come from ODA sources. and regulating the tariffs and fees for all services; However, it is highly unlikely that ODAs will · granting licenses for the operation and making provide sufficient funds to meet these ambitious announcements of the opening and closing of investment targets. national and international services; and 46 Part B · inspecting and giving guidance in all they are arranged through 'business telecommunications and RF issues in regard to relationships' that have been developed over Vietnamese law. time. Interestingly, all of the BCC investors to 3.7. Private Sector Participation in the date are state-controlled government telcos, Sector apart from Cable & Wireless. The table below lists the main BCCs in Vietnam. At the present time the main means of achieving private participation in Vietnam's While allowing access to much needed foreign telecom sector is by: capital and expertise, BCCs come at considerable cost to all parties: the government, the foreign · local companies selling primarily CPE investor, the end users and taxpayers. Similar and equipment; more developed schemes such as Build-Transfer- · joint ventures with overseas manufacturers: Operate (BTOs) have been widely used in Asia, there are presently eight such JVs; and where governments are reluctant to accept more · the use of Business Cooperation Contracts standard commercial arrangements. In most cases (BCC) contracts. such schemes suffer from several drawbacks BCCs are essentially Build-Transfer (BT) including: (i) higher financing costs in respect of schemes and have been designed as a mechanism increased risks associated with BCCs; (ii) long to circumvent the government's restriction on negotiation and re-negotiation periods; (iii) foreign participation in telecommunications concern over changes in market, technology and operations. The BCC contracts are let without a financial conditions; (iv) concerns that, near the bidding process, although the bidding within end of the contract period, the investor will lose the contracts is by competitive tender. Instead interest and stop investing. Table 10. Business Cooperation Contract (BCCs) (withVNPT) International Partners Project Names Value Date of License Remarks (US$ million) 1.Telstra International 237.15 20 Oct 1990 Operational telecommunications 2.Voice International MCC paging 0.725 21 Dec 1989 Completed the (Australia) contracted phase 3. Sapura (Malaysia) Prepaid phone cards 3.571 6 Oct 1993 Operational 4. Comvik (Sweden) Mobile phone services 127.8 19 May 1995 Operational 5. KoreaTelecom (Korea) Telephone services 40 27 Apr 1996 Operational (Hai Dong, Hai Phong, HungYen, Quang Ninh) 6.Worldcorp Holdings Telephone directory 0.82 17 Jun 1995 Operational 7. NTT Telephone services for 194.4 12 Nov 1997 Operational northern part of Hanoi 8. FRC (France) Telephone services for 467 12 Nov 1997 Operational eastern part of HCMC 9. Cable &Wireless (UK) Telephone services for 207.06 8 Aug 1998 Being reviewed for the southwestern part of termination in advance Hanoi of the project term. 47 Part B 3.8. Restrictions on Entry and 4.TRANSPORT SECTOR ANALYSIS Competition To date, the Government of Vietnam has acted Currently there is no competition in fixed line or announced its intention to involve the private telecommunications, even though the government sector in transport infrastructure13 in four ways: has granted licenses to two other locally owned · BOT investments in ports, highways, and organizations: Saigon Postel and Vietel. The bridges; competition is limited because both of these · Consideration of a Rehabilitate Operate organizations are Government agencies and the Transfer scheme for one rail line; former has VNPT as a major shareholder. · Consideration of the equitization of selected Consequently, under their present guise, the only existing maritime assets; and competition is likely to be for capital, either from · Construction contracting to meet donor government or elsewhere. So far the DGPT has conditionalities for sectoral loans. not defined the rules under which they will operate At first glance, this program seems extensive other than to say that they can both offer services including arrangements for private greenfield nationwide, but not international services. Neither developments, the sale or equitization of existing organization currently has any capital to invest. assets and contracting of private sector firms for Although the current rules allow outside major construction projects. However, when investment only through BCCs, these viewed sector by sector and project by project it is arrangements are only attractive when the investor clear that few initiatives have been undertaken and, has the security of a monopoly situation. Even if of those underway, only small segments of one or Saigon Postel and Vietel can attract foreign interest, two sub-sectors are represented. The matrix below the likely commencement of service will be some illustrates the extent of PPI in transport time away due to the time-consuming nature of infrastructure by sector. the BCC scheme. 4.1.Transport Sector Structure There is a degree of competition in cellular as there are three cellular providers- Mobifone, As part of the 1994 state sector reforms, the Vinaphone and Call-link. However, since VNPT Ministry of Transport was reorganized so as to is a major shareholder in all three firms real recast its mission from its previous centralist and competition is very limited. The situation is interventionist role to one in tune with a market similar with paging, where all companies are economy. The Ministry of Transportation is now owned by VNPT. There seems to be a slightly responsible for creating and implementing policy; greater element of competition in Internet access, setting standards; planning; programming; but the gateway is controlled by VNPT. While budgeting; and auditing instead of the daily micro- 'callback' operators no doubt exist, there is a management of sector infrastructure; facilities; and decree which makes them illegal. Also their transport services. operations would be limited by the scarcity of Four separate administrations were introduced: credit cards. VNPT is the only company · Vietnam Maritime Administration; providing data networks and dispatch radio. · Vietnam Road Administration; 13 For the purposes of this analysis, transport infrastructure likely to attract significant private sector interest is defined according to two major criteria: · Permanence or immobility of the assets, reflecting the characteristics of a natural monopoly; and · Reasonable potential for user fees that provide cost recovery of at least operations and maintenance costs, if not capital costs. Because of the first criterion, ports and airports are analyzed whereas shipping lines and airlines are not.As a result of the second principle, toll roads and bridges in high volume and industrial areas and on inter-city routes are considered, whereas rural and intra-urban roads are not. Finally, urban transit (light rail or metro) initiatives are unlikely to prove economically or financially viable inVietnam at this time or in the medium-term and so urban transport is not addressed as part of this PPI analysis. 48 Part B Diagram 1:Transport Related Initiatives for Private Participation, by Sector * Likely to have limited foreign participation ** ROT = Rehabilitate OperateTransfer · Vietnam Inland Waterway Administration; · The Government's definition of strategic assets, · Vietnam Railways including nearly all transport sectors; The Vietnam Maritime Administration · The Government's restrictions on foreign manages 16 companies, the Inland Waterways investment. Administration Bureau runs 22 companies, and 4.2.1. Restrictions on Vertical and the Vietnam Road Administration manages 55 Horizontal Integration companies, including 6 freight transport There is not an explicit or legal restriction on enterprises, 1 passenger transport enterprise, 4 vertical or horizontal integration where private regional road management units, 40 sub-units, and sector participation is allowed in transport. In fact, 4 ferry groups. Each administration was given the two port projects that are in operation include substantial autonomy and broad power over the one built in part by active shipping lines (NOL centrally administered transport infrastructure. and Mitsui) and another that is an extension of a In addition, eight special Project Management steel mill. Both of these projects could be Units were formed to deal with the management of considered vertically integrated with other large-scale rehabilitation projects such as Highway operations. Similarly, the Tan Thuan EPZ- No. 1. Foreign projects are administered by these Highway 1 Toll Road serves as part of the units. Air transport (airports and the national infrastructure network that the Taiwanese airline) has been removed from MOT's purview, company has built in and around its export and instead reports to the Prime Minister. processing zone, Saigon South. 4.2. Entry Barriers and Limits on 4.2.2. Restrictions on Foreign Ownership Vertical and Horizontal Integration There are severe restrictions on foreign There are numerous barriers to entry, both legal ownership and management of transport and informal, for investors in Vietnam's transport infrastructure in Vietnam as defined in Decrees 56 sector. Legal barriers include: and 28. In ports and rail, for example, there are limits on non-Vietnamese foreign ownership in the 49 Part B to 10 percent and any foreign ownership (namely Investment Processes overseas Vietnamese) to 40 percent. It is not clear Partially as a result of the many levels of under what conditions, Baria Serese and the involvement from governmental agencies, and Mitsui/NOL facility were built given these partially because of the tradition of accepting restrictions. unsolicited bids, investors often seek to develop a 4.2.3. De Facto Restrictions on Entry project by contacting the highest level of Aside from the legal restrictions described Government available to them. Since bidders have above, the primary obstacles to investing in only one chance to have their initial proposals Vietnam's transportation infrastructure can be accepted or rejected, they try to avoid the risk of summarized as follows: submitting first draft proposals to non-central organizations. By bypassing local agencies at the Bureaucratic Overlap inception of the bidding process, investors As with all areas of foreign direct investment in sometimes find that local government officials put Vietnam, potential private sector transport obstacles in the way of their long-term negotiation operators or investors are subjected to confusing or the eventual implementation of a project. and overlapping bureaucracies that include: Moreover, the involvement of the one organization · Prime Minister's Office that is dedicated to bringing the private sector into · People's Councils (at all administrative levels: the provision of public services, the part-time BOT provinces, cities, provincial townships, rural Group, has been limited to that of advisor to line districts, urban districts and local communities); ministries and a disseminator of promotional · People's Committees (at all administrative levels material. The Center's authority does not allow it as above); to identify projects, conduct feasibility studies, · Transport and Urban Public Works coordinate inter-agency responses to proposals or Departments of the People's Committees; to assist the bidders to prepare in their negotiations · City Departments of Planning & Investment; with sponsoring government agencies. · The Ministry of Transportation & Negotiations Communication; The process of negotiation in Vietnam is one · Sectoral institutions (such as VinaMarine and that is long and difficult. Investors complain that Vietnam Railway); and they have entered into agreements with the · Ministry of Planning & Investment's Vietnamese Government only to find that the BOTGroup. conditions and requirements of the investment The commitment to assisting the private sector shift and that their positions are undermined by to invest in and/or operate transport infrastructure growing bureaucratic requirements as the varies tremendously from one institution to the negotiation appears to approach closure. next. Investors are often unable to detect which Project Bankability bureaucracy is promoting a project and which will put up obstacles and cannot focus its bids and Without bond markets, access to local negotiation strategies accordingly. financing or even equity markets (the stock market's 1999 opening has recently been 50 Part B postponed for at least another year), transport or expand the road. As described above, the first projects in Vietnam suffer from currency and only private sector highway project that is mismatching risks and difficult exit strategies for operational in Vietnam (Tan Thuan-EPZ Toll investors. Given the financing drought that can be road), involved the Government's contribution felt throughout East Asia--approximately 80 to the project in in-kind equity (land, right of percent of FDI in Vietnam comes from within the way), but did not involve guarantees. region--and the lack of sovereign guarantees 5.AIRPORTS associated with Vietnam's transport projects, it is 5.1. Market Structure and Ownership currently very difficult for projects to reach Vietnam has three international airports: Ho financial closure. Chi Minh City, Hanoi and Da Nang. In addition, 4.2.4. Risk Allocation there are 13 domestic airports around the country. To date, the few private investments in Institutionally, Vietnam's airports stand apart from transportation infrastructure that have come to the other transport sectors in that they fall directly closure have been built with little or no under the auspices of the Prime Minister's office government volume, traffic or revenue guarantees and are thus administered by the Civil Aviation and without standard levels of construction risk Administration. This institutional arrangement sharing. However, the levels of risk absorbed by the does not bode well for future private sector developers of the Vung Tao Expressway and Baria participation in the management of the airports. Serese are probably not indicative of future Although airports are hard currency earning investors' willingness to absorb risk before investments that can either serve as bottlenecks to investing in Vietnam. trade or, with proper management and investment, · Toll Roads: Like IPPs and bulk water supply can facilitate tourism and commerce, the facilities, toll roads throughout the world have Government of Vietnam is not discussing private been built with volume or revenue guarantees participation in its airport sector. In the mid-1990s, provided by sovereign or regional governments. the Southern Airport Authority solicited Recent experiences throughout Southeast Asia qualification statements for a US$200 million have demonstrated that reliance on guarantees Build-Transfer, turn-key expansion terminal forTan for projects that are sensitive to macro- Son Nhat Airport (Ho Chi Minh City), but that economic or regional downturns exposes those bidding process was eventually suspended. There is projects to risks that may be beyond the ability no indication that the project will be resumed. of the government to cover during periods of 5.2. Physical performance economic crisis. Another common approach to risk sharing in which a government's The data below indicate that Vietnam's air participation can be calculated without traffic (at 1990 levels) was about 4 to 10 percent of postponement as with guarantees, involves the the levels of the more developed Southeast Asian use of government funds for construction of all economies. This is despite a larger population and or most of the facilities with the highway a difference in GDP considerably less than that of operator brought in only to manage, maintain aircraft calls and passenger and freight figures. 51 Part B 6. RAILWAYS integrated institution--with ownership of assets 6.1. Market Structure and Ownership ranging from traditional rail services to rolling stock manufacturing, hotels, meal services and Vietnam's rail network, owned and operated by even food manufacturing facilities--restructuring the government agency Vietnam Railway, consists of the institution and equitization or divestment of of about 2,600 kilometers of single-track line either core or ancillary services (except for one covering seven routes. The longest route is the hotel and, now, the Lao Cai-Cai Lan line) has not Hanoi-Ho Chi Minh City line, which stretches yet been proposed. 1,730 kilometers. This line is now serviced by an "express" train, which makes the journey in 6.2. Physical Performance approximately 36 hours. Although, the network extends from the The Government of Vietnam has not Chinese border in the north to the major demand traditionally allowed Vietnam Railway to consider and production centers in the south, it suffers from the introduction of private sector participation in under use and negligence. Rail is not a primary any aspect of its operations. Recently, however, the provider of transport services in Vietnam since Government recently announced its intention to traffic flows usually do not extend the length of the seek a BOT investment of $130-million to country, making long-haul transport modes upgrade the 600 km railway from Lao Cai to Cai unnecessary from a commercial perspective Lan Port. It is unclear what role the investor will (although political and social unity may be highly play in the operation of this line or how he will valued by the Government). This is because, in recover his investment in this rehabilitation project terms of transportation, the key demand and given the lack of previous experience of private production centers in the north and south do no sector operators or investors in Vietnam's rail constitute an integrated economy. Consumers in network. Although Vietnam Railway is a vertically the north are more likely to purchase goods 52 Part B shipped from overseas and producers in the south The diagram below shows Vietnam's utilization are more likely to seek raw materials from abroad of its railroad benchmarked against other regional than to purchase from the north. Furthermore, the rail systems. By most standards, Vietnam's railroad subsidized use of coastal and in-land shipping, is underutilized-only 5 percent of domestic cargo often carried out with military vessels, has made it shipments and 12 percent of passenger movements impossible for VR to charge tariffs which could are conducted over the railroad. This is a result of come close to covering operating expenses. To several factors including: illustrate this point, in 1995 the rail network · Excessive subsidization of road use, coastal and carried around 3.5 million tons and 1.92 million in-land waterway shipping; passengers, accounting for about 5% of total cargo · Lack of integration between the northern and and 12% of total passengers transported southern demand and production centers; and domestically. · Under financing and poor maintenance of the There are about 260 stations in the network railroad network, both infrastructure and and an average of one railway rolling stock. crossing every eight kilometers. The bridge network was severely damaged in the war, and the track beds are in poor state. Up to 40% of the 480 locomotives in the system are out of service at any one time. Although about 100 are steam engines and the remaining locomotives come from more than 15 different suppliers, Vietnam Railway notes that as of October 1999, it is running 200 locomotives TY7 of 400 horsepower capacity. According to the latest sectoral report of the The poor utilization discussed above contributes to World Bank, train speeds average about 25 unusually high levels of inefficiency in the use of kilometers per hour for passenger trains and 15 the systems rolling stock. The productivity figures kilometers per hour for freight trains. However, presented below demonstrate how difficult it is for Vietnam Railways notes that the average speed Vietnam to make use of its inventory of rail cars of express trains from the North to the South is and locomotives. now 55 kilometers per hour. Standardization of 6.3. Financial Performance track gauge and other investments have slowly begun to improve the rail system, though much It is difficult to make definitive statements renovation will be needed in the future in order about Vietnam Railway's finances, both because to allow the rail system to compete with roads the traditional methods of bookkeeping do not and waterways. lend themselves to financial analysis and because 53 Part B Vietnam underwent a significant period of over-all finances, but probably a slight inflation (almost a factor of 12 between 1988 and deterioration in results. Vietnam Railways reports 1997). However, in order to give a general that the Government settled bank loans in 199 indication of the results, a costing study conducted made to VR in 1995 and 1996 for investment by GTZ analyzed the effect on Vietnam Railway of purposes. 15 the infrastructure separation. According to this study, Vietnam Railway's losses were as follows: Vietnam Railways Indicative Financial Performance (1990-1995, Billions ofVND) Financial Indicator 1990 1991 1992 1993 1994 1995 CAGR Total Revenue 143.3 277.3 394.0 469.8 607.1 798.3 41% Total Costs 159.1 299.4 422.9 530.4 757.0 1006.7 45% Deficit 15.8 22.1 28.9 60.6 149.9 208.4 68% 6.4.Current and Potential Private According to Vietnam Railway reports,14 the Sector Participation in Rail railroad has broken even on operating costs since 1995. However, these operating ratios place all To date, there is no significant private sector revenues against costs associated only with rolling involvement in Vietnam Railways. However, the stock operations. Consultants' review of the Government of Vietnam announced in March of Government's contributions demonstrates that 1999 that it intends to pursue two rail projects subsidies (into what is referred to as "infrastructure under the BOT scheme and efforts are ongoing to costs") have grown significantly during that period restructure the sector by separating core and non- of time. Thus, the reported break-even on core functions. While the two BOT projects may operating costs alone is not necessarily not prove to be feasible, they indicate a willingness accompanied by an improvement in the railroad's on the Government to consider a role for the 14See "Vietnam Railways on theWay to Renovation,"Vietnam Railway 1997. 15L.S.Thompson interview with NguyenTrong Bach, Deputy General Director ofVietnam Railway. 54 Part B private sector in the operation, or at least financing, Ho Chi Minh City), both or which are nominally of rail transport. intended for expansion by private investors, as · BOT Project 173 is to build a railway or subway described below. Although the ADB approved a network in Ha Noi with an investment of $600 US$30 million loan to rehabilitate and upgrade million. The government claims it will open port facilities in 1995, it is uncertain what role Ho bidding in June 2000. Chi Minh City Port will play in the dominant southern trade given the development of other · BOT Project 174 is a $130-million upgrade of private facilities in the area. The country's only the 600 km railway from Lao Cai to Cai Lan deepwater port is Cam Ranh Bay, built by the Port. It is unclear how the investor will be United States as a naval base during the war. The allowed to recover his investment in this naval facilities in Cam Ranh Bay, including a rehabilitation project given the lack of previous shipyard, are currently under lease to the Russian experience of private sector operators or Navy. The Government of Vietnam is currently investors in Vietnam's rail network. deliberating on the future role of the facilities once 7. PORTS Russia's 25 year lease expires in 2004. Although 7.1. Market Structure and Ownership there are competing proposals for the development The maritime industry in Vietnam is controlled of a transshipment center that could serve a possible by Vinamarine, a state organization under the ADB-funded landbridge into Laos and northern auspices of the Ministry of Transportation. Thailand, the port of Da Nang, at the mouth of the Although Vinamarine is responsible for the Song Han River, currently serves the central country's seven major seaports, numerous minor highlands and much of the transit traffic to and seaports, the national shipping lines and barge from Laos. Facilities are generally in poor condition. companies, as well as the two major inland The two major inland waterway systems serve waterway systems along the Red River and as major transportation outlets, competing with Mekong Deltas, the actual operations of the public both roads and rail. The first major inland ports are carried out by different agencies and waterway system is in the Red River area of the ministries from facility to facility. north and stretches approximately 2,500 kilometers. Along this Public Port Operators inVietnam system there are five main Operator Number of Volume of CargoThroughput ports, of which Hanoi is the Ports In 1995, 000s of tons largest. The second major Ministry ofTransport 10 14,514 Local 24 3,140 inland waterway extends Other Ministries and Sectors 36 26,101 4,500 kilometers along the Mekong River and its tributaries in the south and Total 70 43,755 contains about 30 ports Source:VINAMARINE (1996). including Ho Chi Minh Vietnam's main port areas are Hai Phong (60 City. Navigation can be difficult at times, especially miles from Hanoi) and Vung Tau (75 miles from during the dry season when channels can shrink to 55 Part B as little as one meter in depth. Channels are not In 1995 and 1996, southern Vietnamese ports dredged regularly, further aggravating the problem. handled three-fourths of the nation's containers and 7.2.Technical Performance nearly the same portion of all cargo.That proportion is likely to have increased in recent years given the Vietnam's largest publicly operated commercial successful development of Saigon South's industrial port, Ho Chi Minh City Port is currently accessible park and the inception of private terminals at Baria only to ships up to 10,000 dwt. The port suffers Serese and VICT, both in southern Vietnam. While from draft restrictions and under-investment in its it is yet unclear if the industrial development in the facilities. It now finds itself competing against a south has helped to increase export tonnage and new private container terminal in Ho Chi Minh balance the trade, attractiveness of Vietnam to major City, VICT (described in Part C, Section 3 below) container carriers and, hence, port investors, will which has a deeper draft entry and two modern depend in some part upon an equalization of exports gantry cranes. Hai Phong Deep-Water Port may to imports. In the data below, all regions suffered eventually be upgraded as part of the development from an imbalance of trade of over 2.5:1, imports to of Dinh Vu Economic Zone. exports. This imbalance increases the percentage of The cargo throughput data presented below empty containers handled at the ports, decreases tells a story about Vietnam's trade and port revenues per call for the carriers, and, in turn, puts industry that has a few particular themes: downward pressure on the rates that can be charged by a potential private terminal operator. Moreover, · Dominance of the Mekong Delta region in the VICT's new role as the first private, well-equipped country's economic activity; container terminal and its proximity to Saigon · Imbalance of trade in favor of imports; and South is likely to attract export containers, further · Relative insignificance of central Vietnam in undermining the role of the public facilities in the international trade activities region. 56 Part B 7.3. Financial Performance and Cost of 7.4. Demand Forecasts and Investment Service Opportunities The cost of maritime shipping of containers 7.4.1. Demand Forecasts into Vietnam reflects the low volumes and poor Historical economic growth in Vietnam has access to facilities of the vessels. Draft and Dead been the main driver of cargo. To the degree that Weight Tonnage restrictions require hubbing from the past reflects the future (i.e., Vietnam's ports Singapore or Hong Kong and a further feeder serve their own hinterland and do not develop into service from Ho Chi Minh City may be required major transshipment centers whereby cargo flows to reach Danang and Haiphong. Two major are driven by regional and world trade rather than international container carriers were surveyed for national economic activity), demand for port their delivered shipping costs from Tokyo to the services will depend upon economic recovery and three port areas of Vietnam as well as to Hong reform over the next few years. The East Asia Kong, Manila, Bangkok and Singapore. The graph Transport Sector Unit reports (in Report No. below demonstrates the shipping cost of a 20' 18748-VN, January 6, 1999) that, after a 6 percent container as quoted by these two companies, drop in cargo flows in 1997, 1998 throughput neither of which knew the purpose of the survey. should return to 1996 levels. This leveling off of The lowest cost alternatives for each route is less general cargo movements follow many years of than half of the lowest cost alternative to Ho Chi rapid growth driven by over-all economic growth. Minh and as little as 30 percent of the cost to Future growth in demand for general cargo port Danang.This penalty of up to $1000 per container services in Vietnam is thus likely to be driven by is borne by the consumers of Vietnam. While a four main factors, in decreasing order of more efficient port system with greater vessel significance: capacities may not directly reduce carrier fees · Development of the economy of the Mekong overnight, it will be necessary if Vietnam is to Delta in southern Vietnam; continue with the trend toward containerization, gain greater economies of scale in trade, and · Development of the economy of the Haiphong- provide access for larger vessels and more direct Hanoi corridor in northern Vietnam; service from regional trading partners. This, in · The role of central Vietnam in the turn, will lower shipping rates, making imports transshipment or movement by land-bridge of cheaper for consumers and Vietnamese exports cargo to Laos and northern Thailand; and more competitive on the world market. · Continued containerization of break bulk cargo. As for port operations, revenues are driven by The first two factors can be considered almost national tariff levels except for container charges independently of each other, at least for the which are regional. This system should be broken medium-term, as the two demand centers of the down to the individual port level in order to north and south are not unified as an integrated encourage competition among the facilities and to economy. The challenges facing Vietnam Railways reflect costs where they incur. is, in part, a result of the same issue. 57 Part B 7.4.2. Investment Opportunities Ho Chi Minh City. Given VICT's stated potential Medium-term investment requirements in capacity of 550,000 TEUs per year, and the Vietnam's ports will depend largely upon the southern ports total current activity of only about ability of local governments to optimize the use of 480,000 TEUs, it is unlikely that another existing facilities. This may require the greenfield facility will be required in southern equitization of ports or concessioning of terminal Vietnam to serve local cargo flows. For this reason, operations at facilities that are otherwise PPI in ports should focus on investment in and considered strategic assets by the central improved operations of existing facilities rather government. The future of Ben Nghe and than new construction. Danang is discussed in the context of their 7.4.3.Current and Potential Private Sector planned equitization in Part C, Section 3 below. Participation in Ports A concessioning option for the major ports, The port sector of Vietnam has probably seen however, would allow the government to retain the most involvement of the private sector of any ownership of the land and basic infrastructure area of infrastructure to date. Like other sectors, while allowing the private operators sufficient however, this has primarily involved greenfield time to recover any significant investments in, for development of new facilities. Existing ports such example, wharf improvements, yard equipment as Ben Nge and Danang have considered or are and gantry cranes. It is likely that the now considering equitization, but there has been Government will have to take a more pro-active no private involvement in these facilities so far. and aggressive role in dredging in order for this There continues to be tremendous speculation alternative approach to PSP in ports to succeed. about the construction of transshipment facilities Future greenfield port development will more by private developers to serve a land bridge into likely depend upon the willingness of the private Laos and Thailand through central Vietnam, but sector to absorb risk and to weather the complex the projects are yet to come to financial closure. negotiations that are an integral part of investing in Meanwhile, private facilities have been built and Vietnam. The major BOT opportunities seem to are operational in Baria Serese and at the VICT lie in the central Vietnam industrial and terminal in Ho Chi Minh City and small private transshipment development hubs envisioned by terminals are now being built incrementally as part the Vietnamese Government and at incremental of the industrial zone at Dinh Vu. These projects industrial zone growth outside of Haiphong and are described below. 58 Part B PROJECT: BARIA SERESE PORT Project Status Description Project Name: Approval: Signed Ownership: Norsk Hydro (20%); SCPA - a division of France's EMC (40%), Baria Serese Bulk on June 22nd Vietnam Government and State-owned Im/Ex Companies (40%) & Steel Facility 1995. Government Guarantees: None Location: 70 km Construction: Investors: Norad, Banque Indosuez, IFC ($10 million project) south of Ho Chi Now Operational - Project Description:The first private port in Vietnam, Baria Serese is a 1.2 million Minh City. Phase II ton capacity bulk (fertilizer, grains) and steel facility south of Ho Chi Minh City. c o n s t r u c t i o n The business license was issued by SCCI (predecessor to MPI). According to IFC, completed. they can set their tariffs as they choose and can charge in dollars and/or dongs. PROJECT:VICTTERMINAL Project Status Description Project Name: Approval: License Ownership: First Logistics Development Co. a joint venture company by Thuan Dong granted in 10/94; Vietnamese Southern Waterborne Transport Co., Transport Chartering Co. (35%) Container Port - 5/97, and Mitorient Enterprises Pte Ltd. [Mitsui &Co (25%), Neptune Orient Lines Vietnam Construction: (75%)](65%) International Phase I Government Guarantees: None (?) Container construction Project Description: Presently Ho Chi Minh City has three operating ports, Terminal complete - About which last year handled more than 500,000 TEUs. Over the past several years, the (VICT) to begin volume of container cargo handled at Ho Chi Minh City has risen sharply, Location: Ho Chi operations including 30% growth in 1996. VICT is the only Vietnamese port with modern Minh City (as of 10/98). gantry cranes. When all three phases are complete, the investors claim that the project will have a capacity of 550,000 TEUs per year with five berths and five gantry cranes. However, the MoT puts the current capacity at 80,000 TEUs and notes that the next phase (which has been approved) will increase the capacity to 160,000 TEUs. PROJECT: DINHVU INDUSTRIAL ZONE Project Status Description Project Name: Approval: Ownership: International Port Engineering & Management Co. (Belgium), AIG Dinh Vu Island Approved in (US), and Ban Chang (Thailand) Industrial Zone August 1995; Government Guarantees: None Location: 10 Construction: Project Description: What may eventually be a large industrial zone and deep-sea miles east of Hai Now in first stages multi-purpose freight facility is currently being built on a reclaimed island near Hai Phong of construction.* Phong. Although the investors have estimated that the facility will cost $560 million at completion, development of the industrial site is incremental, paralleling the commitment of potential users. To date, the Dinh Vu site has one committed investor, Caltex, which will operate on a small portion of the total available acreage. The oil products company is sub-leasing a 15-acre waterfront property which has been converted into a tank farm and barge terminal for product distribution in northern Vietnam. Although the consortium is filling Dinh Vu with dredge spoils from nearby sandbars, the access channel has not yet been dredged and is un- navigable by deep-sea vessels. *Despite the investors' description of the project, the MoT notes that no private terminals are under construction in Dinh Vu. 59 Part B 8. ROADS Regional Road Management Unit (RRMU) 1, 8.1. Market Structure and Ownership RRMU3, RRMU4, RRMU5 and RRMU7 are under the portfolio of VRA. The RRMUs are The Vietnam Road Administration is responsible for maintaining 5275 km of national responsible for policy formulation, planning, road network, and partially responsible for guidance, control and operations in the sector. maintaining provincial roads and bridges in the VRA was established in January 1993 (Decree 01- various provinces and urban centers of the regions. CP) as a department directly subordinate to the In addition, they manage vocational schools Minister of Transport. VRA has a substantial concerned with roads, and health clinics for their degree of autonomy and broad powers. It has legal personnel. VRA is under the portfolio of the status, accounts with the StateTreasury and its own Ministry of Transportation. RRMUs are permitted budget, which is reviewed by the Ministry of to borrow from commercial banks to maintain Transportation and submitted to the Prime roads, and they are permitted to use the toll Minister for approval. VRA is one of the five revenue to pay back the loans. administrations under the Ministry of Provincial roads are managed by 61 Provincial Transportation. VRA manages 55 companies, Departments of Transport, and district and urban including 6 freight transport enterprises, 1 roads are managed by the District and Urban passenger transport enterprise, 4 regional road Departments of Transport. The network of management units (Hanoi, HCM, Danang and national, provincial, district, and urban roads Vinh), 40 sub-units, and 4 ferry groups. VRA is designated by the Government of Vietnam for responsible for: maintenance is 72 km. Special-purpose roads are · All national roads and routes network in managed by different entities - including the Vietnam. Ministry of Agriculture and Rural Development, · Management and maintenance of national commercial estates, and other private interests. roads and bridges. Village and subdivision roads belong to adjacent · 88 highways and national roads with a total communities, which manage them. Coordination length of 15200 km. between the various agencies is weak. · Management of transportation. Vietnam's road system is a 105,000 kilometer · Management of budget for repairs and network including 10,732 bridges and 178 ferries. maintenance. Only bout 15 percent of the nation's roads are · Management of projects that are less than 30 paved, and most of these are narrow and of poor billion Dong. quality. Resurfacing, pothole repair and ditch · Collection of money from road tolls. cleaning are currently insufficient to keep up with · Implementation of IMUs. VRA acts as demand, leading to rapid deterioration of roads. guarantor for IMUs loans. VRA will pay from The roads in the north are generally worse than the budget if one of the IMUs cannot meet its those in the south. A number of the more financial obligations. So far, the IMUs have no important highways, including Highway 1, which problems in meeting its loan payment. links Hanoi and Ho Chi Minh City, and Highway 60 Part B 5, which links Hanoi with Hai Phong, are being allowed for the construction of one BOT highway repaired and expanded with international outside of Ho Chi Minh City (described in 3.1.2 assistance. below) and is considering several other projects 8.2.Technical performance including a ring road around Hanoi and a BOT toll road between HCMC - Bien Hoa - Vung Tao Road traffic volume has increased rapidly in Expressway that is being negotiated currently with recent years as private vehicles have enlarged the Daewoo. The Government has also allowed for vehicle fleet to around 310,000 units. In addition BOT participation in the Quan Hau Bridge across there are about 3,000,000 motorcycles. Heavy use the Nhat Le River in Quang Binh Province of bicycles (estimated at over 1 million in Hanoi (National Highway 1). The status of this project is alone) and three-wheeled bicycle taxis (cyclos) uncertain although the private financing is being creates congestion on the streets but there is little in sought domestically. the way of public transportation as a substitute. Two-wheeled vehicles and cyclos also are used 8.3. Financial Performance and Cost of extensively for carrying cargo. Service While the Ministry of Transport has slated The main network of national and provincial several engineering, design and consulting roads was maintained with a budget of $77 million in 1997 (similar to 1995 and 1996 levels) although divisions for equitization, the conversion of the World Bank's Road user Charges Model and existing roads or bridges into privately owned or the Transport Development Strategy Institute operated infrastructure does not appear to be estimate that funding requirements for under consideration at this time, with the maintenance are about $200 million per annum. exception of two. Nonetheless, Ho Chi Minh With less than 10 percent of the road network of City's Government issued bonds to finance its Vietnam paved, including nearly half of the Nguyen Tat Thanh Road repair and upgrading national network, the financial requirements for project in 1994. Moreover, the Government has upgrading and maintaining roads in Vietnam are Growth of Vehicle Use in Vietnam (in 000s, 1993-1996) 61 Part B clearly beyond the capacity of current budget. 8.4. Current and Potential Private While increased fuel taxes are being pursued to Sector Participation in Roads fund road rehabilitation and maintenance, user 8.4.1. Operational Private Sector Road fees for tolls are also being implemented. It is Investments within this context that Vietnam's BOT toll road i y strategy has been propagated in recent years. 8.4.2. Possible Future Road BOT Projects The current ability of toll facilities to cover investment costs of major expansions or of The Government is currently in negotiations greenfield roads is limited by low car and truck with Daewoo Corporation over the construction, usage (which combined total less than 5% of on a BOT basis, of a major highway connecting motorcycle use) and low ability to pay. The huge Vung Tao with Ho Chi Minh City. It also gap between car charges and motorcycle charges announced on March 9, 1999 its intention to seek (12:1) is a further indication of the general public's private financing for a number of new roads and inability to pay for cost-recovery tolls. Nonetheless, bridges. At least some of these projects, such as the road usage will continue to increase in the future, third ring road around Hanoi can be described as particularly in urban areas and on main industrial highly speculative. A description of the Daewoo corridors, making private toll road construction project and a list of the proposed BOT roads and operations more feasible. (including the Daewoo project) that will be The Government of Vietnam has begun to use considered from the year 2000 are presented below. private investors and private finance to expand and rehabilitate strategic portions of its road network. Although the completed projects of this type are few at this time, the Government continues to negotiate with potential investors and has added new ring roads, highways and bridges that may be open for investment under BOT type arrangements. The project below describes Vietnam's one operational private toll road and bridge: 62 Part B 63 Part A 64 C SUMMARY OF PROPOSED ACTIONS Summary of Key Actions ShortTermActions Medium-TermActions Longer-TermActions Cross-Sectoral · Amend laws impacting PPI · Rationalize Government bodies · Enact laws for PPI and to Issues projects responsible for PPI establish independent regulators in each · Upgrade BOT Group to PPI · Develop system for infrastructure sector Center monitoring off-balance sheet risks of PPI projects · Sector regulatory frameworks in place Power · Undertake study of optimal · Restructure sector by · Move towards competitive market structure and strategy separating generation and markets for future reform distribution from transmission · Equitize a number of generating · Conclude pending transactions · Begin divesting distribution and distribution facilities companies starting with a pilot · Implement tariff increases transaction · Pass Electricity Law and · Rationalize regional cross- establish independent regulation subsidies Water and · Develop clear policies aimed at · Develop and implement policy · Conclude pilot lease or Sanitation market reforms of tariff reforms concession projects · Develop plan for phasing tariffs to cost recovery levels · Conclude BihnWater BOT Telecommunications · Change BCCs into joint · Liberalize entry into all sub- · Equitize some or all ofVNPT's ventures, concessions or sectors core businesses licensed operations · Separate posts from telecoms Airports · Develop strategy for developing · Consider concessioning · Conclude several transactions control to encourage regional terminal operations or airside of key airports development and PPI services Railways · Further commercialize · Separate non-integral services · Initiate concessions for rolling separate operating units from core operations stock operations and infrastructure services · Develop private sector participation strategy and action plan rail sector Ports · Decentralize and deregulate · Pursue concessioning of · Invite private sector to develop tariffs to encourage terminal operations or new facilities only after full competition and eliminate equitization of existing facilities capacity of existing facilities has cross-subsidization been revealed through private operations and investment. 65 Part C 1. CROSS-SECTORAL ISSUES funds to the GOV body that provides the 1.1. Legal Environment for PPI guarantee if the amounts payable under a guarantee have not been approved in the State As indicated in Part B, the Government of Budget; and, c) whether or not some GOV Vietnam has made significant progress in bodies could honor obligations to pay in foreign addressing issues that will impact the willingness of currency. foreign investors to invest in PPI projects. However, there are a number of specific questions · Loan Security Issues. Most BOT projects require that have not yet been fully addressed under the large foreign loans and foreign lenders are 1996 Foreign Investment Law and the related generally unwilling to provide funding unless Decree 62 dated August 15, 1998 and Decree 02 adequate security is provided. Although the issued in January 1999. It is recommended that the Decrees now allow buildings constructed from Government gives high priority to addressing these loan proceeds to be mortgaged in favor of five residual, but nonetheless important, legal foreign lenders, any mortgage or pledge granted issues which will continue to frustrate further PPI by a BOT Company must be approved by the initiatives in Vietnam. These are: Government. More importantly, the land-use rights of the BOT are still excluded. As such, · Foreign Exchange Issues. While Decree 02 there is great uncertainty as to whether land-use requires the State Bank of Vietnam (SBV) to rights can be passed on if the buildings are sold. guarantee the conversion of VND revenue into In addition, Decree 62 does not allow the foreign currency for certain prescribed assignment or pledge of the foreign investor's purposes, concerns remain about the effect and interest to a Bank. These remain very real enforceability of an SBV guarantee. In obstacles to the financing of BOT projects. particular, foreign companies and lenders remain concerned about future foreign · Lenders Step-in Rights. Lenders to BOT projects exchange shortages and how priorities would be need to be sure that where a BOT enterprise allocated under such circumstances. fails to perform its obligations under the contract, the lender can "step-in" to assume the · State Guarantees. Decree 62 provides for the role of the enterprise. Although the changes in Government to nominate an "authorized state Decree 02 allow for these rights, they remain body" to guarantee (i) the performance of the conditional on approval from the Prime financial obligations of Vietnamese enterprises Minister on a case by case basis. This degree of that are involved in the implementation of discretion creates unnecessary uncertainty for BOT projects, and (ii) obligations under financiers in this critical area of project finance contract for the purchase and sale of goods and and should be corrected. services by the BOT enterprise. However, there are a number of additional concerns including: · Dispute Resolution. Since Vietnamese laws and (a) whether or not all or just some GOV bodies formal dispute resolution procedures are still are authorized under the relevant Laws and to largely untested, foreign investors and lenders issue guarantees; (b) whether or not the require that disputes be taken up in a neutral Ministry of Finance could refuse to allocate forum; and that all major documents are 66 Part A governed by foreign law. While most of these dealings on BOT projects do not have an accurate requirements have been addressed for some picture of their respective roles, responsibilities, circumstances under Decree 02, one key issue and requirements. remains unresolved. In the case where two In light of this, the Government should Vietnamese legal entities are involved - such as, consider establishing a "one-stop-shop" - a PPI a Power Purchase Agreement (PPA) between Center - with predictable step-wise procedures for the BOT company (legally a Vietnamese firm negotiating with the required authorities within a but with part or full foreign ownership) and a defined time frame. This should include Utility Company - the starting point is that responsibility for coordinating both "greenfield" Vietnamese law applies. While BOT contract investments or introducing different forms of disputes may be resolved by way of foreign private participation into existing companies arbitration, this is of little comfort to a foreign through methods such as leases, concessions or investor if major disputes arise under the PPA equitization. The Government will thus limit the and these matters must be addressed by a local risks confronted by the private sector in arbitration center or court. This remains an negotiation, allowing them to calculate a cost of issue that continues to frustrate the signing of capital that reflects only the investment itself, and BOT contracts. is not bloated by the risks associated with an 1.2. Institutional Reform unclear bidding process and an unpredictable legal Gaps remain between the Government's intent and policy environment. International experience to proceed with its PPI strategy, on the one hand, in countries as varied as the Philippines, Mexico and the realities of decision-making processes and and Bolivia (see Box below) highlights the business practices in Vietnam, on the other. importance and benefits to Government of a well- Notwithstanding the establishment of the ad hoc staffed PPI agency with access to key decision BOT Group in the Ministry of Planning and makers in Government. In Vietnam, there is also a Investment, the Government's ability to identify, strong case to be made for the use of ad hoc design and execute PPI activities is limited. external foreign advisors to assist in more complex Potential and real investors in PPI projects have negotiations and in the preparation and commented extensively that policy makers and the implementation of concession, lease or technical staff of line ministries brought into equitizsation initiatives. Case: PPI Authority with Cabinet Rank Bolivia's Ministry of Capitalization The creation of a cabinet-level authority to manage the PPI process is an approach that was used in Bolivia where a Ministry of Capitalization headed by a senior minister was established at the outset of the capitalization (privatization) program for state-owned utilities, selected transport systems and mines. In a period of just three years, the ministry oversaw the capitalization of public enterprises in the telecommunications, electricity, railways, airlines, airports, and hydrocarbon sectors.The process had strong political support at the highest levels: the Minister of Capitalization was understood to have 24-hour access to the President and to act with the authority of the presidency. Upon completion of the capitalization program, the Ministry was abolished. 67 Part C 1.3. Sharing of Risk in PPI Projects: to be a requirement if PPI projects are to come to Government and the Private Sector closure. If the Government wishes to achieve significant In Vietnam, there has been a preference to focus progress with PPI, it must address the question of on subsidies in the form of guarantees for greenfield how to attract private sector investment in capital projects. However, this approach raises some intensive infrastructure projects in both the short important issues concerning the allocation of risk and longer term. International experience has between the private sponsors and the State in PPI shown that when Governments put in place good projects - particularly in BOT projects such as bulk policies - in particular credible commitments to water supply projects and IPPs. There is a danger cost-recovering prices - investors are willing to that poorly targeted risk bearing will undermine invest with minimal government support. the benefits of PPI. Therefore we would However, in many developing countries private recommend that the Government be cautious in its sector investors fear that Government may renege use of guarantees for greenfield projects. Ideally, it on promises and they have requested some form of should only take on those risks where it can exercise subsidy to make the transactions more attractive. some control over outcomes and minimize its These subsidies can range from outright grants or exposure to more commercial risks - such as preferential tax treatment, debt or equity construction and market demand - where the contributions by Government or guarantees of private operators may be better placed to mitigate commercial risks. these concerns. Specifically, Government should be In Vietnam it is recommended that the aware that it is taking on significant off-balance- Government's medium to long-term strategy sheet commitments and contingent liabilities when should focus on policy reforms in its it enters into guarantees or long-term purchase infrastructure sectors that help the Government agreements - such as power purchase agreements reduce the amount of commercial risk it must (PPAs) or bulk water supply contracts. These bear. The reforms should lead to improvements in liabilities are likely to be most extreme in situations commercial and technical performance and where the payments to the private operators should include the implementation of tariff guaranteed under PPAs exceed the tariffs charged reforms leading to full-cost recovery. Sustained to consumers. Moreover, since guarantees do not gains are likely to require allowing private show up in Government's accounts, there is a participation at the service level (i.e. selling to danger that officials of state-owned companies or customers directly), either by equitizing the Government departments may not know the full existing state-owned utilities or by allowing extent of their financial exposure. As we have seen greenfield private projects to sell directly to from other countries impacted by the recent East customers. Under these circumstances, the need Asia crisis, severe recession or economic crisis can for Government guarantees for commercial and simultaneously trigger many guarantees; many of market risk would be minimized. However, in the the government's contingent liabilities might thus short term, and in the absence of these reforms, it become actual and current all at once. (see the box is recognized that some form of subsidy is likely below). 68 Part A Box 1. Impact of East Asia Crisis on BOT Projects In the wake of the recent financial crisis in East Asia, the choice of PPI modalities and the hierarchy of preferences have shifted markedly. In particular, the crisis has exposed the weaknesses of the typical BOT scheme for bulk supply when core market reforms in the sector are not in place and when retail tariffs cannot be readily adjusted to recover costs in full. In a separate review undertaken by the World Bank in June 1999 on the impact of the East Asia crisis on PPI, there is strong evidence to suggest that Governments should approach these types of schemes very cautiously. Following the crisis, Governments in East Asia and their state owned utilities have amassed massive liabilities as a consequence of some of these poorly negotiated BOT schemes, particularly with IPPs in the power sectors. In Indonesia, the liabilities are estimated to surpass $10 billion and over $6 billion in the Philippines. Many of the utilities in these countries are effectively bankrupt or under serious financial distress. Moreover, the financial pressures of the crisis have accentuated the risk allocation weakness in these schemes. It has been found that under the terms of many of these BOT projects, most downside financial risks are borne by governments, thus almost fully negating the benefits of introducing private sector participation in the first place. The Report recommends that future PPI in the region should be undertaken in light of three fundamental guidelines. Namely: (i) market risks should be borne by those parties most able to mitigate them - in this case, the private sector; (ii) service level inefficiencies must be addressed early in the reform process; and (iii) private finance should be a complementary benefit, not the sole objective of PPI. If Government believes that it has no option 2. ENERGY but to proceed with guarantees for greenfield Recommendations for promoting further projects in the medium term, it is recommended private investment in the power sector and that this be undertaken under as part of a well ensuring that it benefits Vietnam are set out below developed policy rather than as a serious of under the following headings: uncoordinated ad hoc decisions. In particular, · Market Reform guarantees should be clearly identified and · Financial Discipline monitored by a professionally staffed group within · Regulatory Reform Government. One option would be to have this · Ownership Reform. function included as part of the remit of the PPI Center. 2.1. Market Reform In the past, the structure of the electricity industry in most parts of the world was simple. In any given geographic area, there was only one company that produced, transported, and sold electricity; the industry was a monopoly.16 In the last 15 or so years, however, electricity industries have undergone enormous structural changes, and 16Sometimes, there were separate distribution companies, but there was still no competition between them. 69 Part C there is now a variety of market structures. In It is this recognition that has led many planning its strategy for further private governments to undertake the restructuring involvement in the electricity industry, the mentioned above of the electricity industries in Government needs to deepen its analysis of what their countries. To encourage competition in the rules it will impose in the area of the structure of production of electricity, for example, they have the market. It needs also to decide how to complete separated generation from transmission. That the process of splitting (or unbundling) EVN into separation makes it easier for generators to smaller companies and whether these companies compete with each other by creating a level playing should be made truly independent of each other, field: if one of the generation companies also rather than simply being subsidiaries of a single owned the transmission system, that company holding company. Since the rules affecting entry could use its control of the transmission system to and unbundling critically affect the private prevent other generators from selling power. companies that invest in power, the Government 2.1.3.Alternative Market Structures needs to determine them as soon as possible. Although there are many possible market 2.1.1. Current Market Structure structures that Vietnam could adopt in the Vietnam's current market structure is a variant medium- to long-term as alternatives to the current on the traditional, vertically integrated monopoly system, two particular structures are frequently (see Error! Reference source not found. above). discussed: EVN is responsible for almost all generation, all · The single-buyer model transmission, and much distribution. The · The competitive market. differences are that there is now one IPP selling power to EVN (at Hiep Phuoc), with others in the In a simple single-buyer model, the companies pipeline, and that EVN sells in some areas to generating electricity are separated from the smaller local distribution companies or company undertaking transmission and cooperatives that in turn sell to final customers. distribution, which is typically the single wholesale buyer of power. Countries such as Thailand, 2.1.2. Competition in the Market for Portugal, and Italy have introduced single-buyer Electricity models of different types.17 Northern Ireland has a Electricity used to be thought of as a natural particularly simple version of the model, which is monopoly: a service best provided by just one firm. depicted in Figure 1 below. In Northern Ireland, Now it is recognized that only some parts of the each of four IPPs sell to the single buyer, Northern industry are natural monopolies, while others are Ireland Electricity, which owns the transmission potentially competitive. The transportation of and distribution system and sells power to final electricity through high-voltage and low-voltage customers, but does not produce any electricity wires (in the transmission and distribution itself. systems) may be a natural monopoly, but in big- enough electricity markets many companies can efficiently compete to generate electricity and sell it to consumers. 17Real world power systems are typically complex and do not conform exactly to the simplified models discussed here. 70 Part A determined by the balance of supply and demand. Variants of the competitive model have now been adopted in many developed countries (Australia, Canada, Finland, Norway, New Zealand, Spain, Sweden, the United Kingdom, and the United States) as well as much of Latin America (Argentina, Bolivia, Colombia, and Chile). The Single-buyer models are often thought to be Government of the well suited to small power systems. Their main Philippines is considering the introduction of the advantage, relative to the traditional vertically first competitive market in East Asia, similar to integrated monopoly, is the facilitation of those introduced in the countries listed above. competition in generation, through bidding for Figure 2 depicts the simplified structure of a IPPs (BOTs). competitive market. In the competitive- market model, there are typically many wholesale buyers of electricity as well as many generators. As in the single-buyer model, transmission is separated from generated, but distribution is also usually separated from transmission. The separate distribution companies and other energy users buy electricity from generators in a competitive market, in which prices are 71 Part C When they are feasible, competitive markets A competitive system probably couldn't be probably encourage more innovation and lower implement satisfactorily in Vietnam in the short costs than single-buyer systems. They also help term, because of the transmission constraints the governments shift risk to the private sector-in between the North and South and the relatively particular, they help governments avoid bearing small size of the market. Yet moving to some form the demand risks that the Government will have of competitive market is likely to make sense in the to assume under BOT projects of the type long term, and having a strategy now for moving currently being undertaken. But competitive there is highly desirable. markets work well only in systems in which there 2.2. Financial Discipline are several independent generators linked by a Private companies will invest in Vietnam's transmission grid that allows them to compete power sector only if they believe they will make with each other. Even when they are feasible in money. Unless the Government is willing to give principle their implementation tends to be them subsidies, the Government therefore has to complicated. ensure that power prices are high enough to allow Market-structure choices are complicated and well-run private companies to make profits. require careful analysis. Even if a strategic choice Investors will look at prices today to see if they between, say, a single-buyer and a competitive cover costs. But, just as important, they will try to model has been chosen, more detailed questions judge whether tariffs will be adjusted to cover costs about the extent of unbundling need to be over the life of their investment. addressed: In the IPP projects currently being negotiated, · Exactly how much vertical unbundling should investors get their assurance about current and be undertaken? In a single-buyer model, should future prices from long-term contracts signed, or to the single buyer also run the transmission be signed, with EVN, and backed up with a system or should the two be separate? Should guarantee from the Government itself. If large power consumers be able to bypass the distribution companies are to be privatized, "single buyer," as in the European single-buyer however, investors will have to be satisfied that the model. In a competitive model, should tariffs paid by final customers will be enough to generators be allowed to own distribution cover costs, since those investors will sell power to companies? Should the (potentially households and businesses, not to EVN. competitive) retail sale of power be separated At present, the average tariff charged by EVN is from distribution (that is, from the naturally about 5 cents per kWh. Cross-subsidies between monopolistic low-voltage wires business)? customer classes (foreigners and Vietnamese, · How much horizontal unbundling should be businesses and households) mean tariffs are undertaken in generation and distribution? considerably lower for some groups. The World How many separate generation companies Bank has estimated that the long-run cost of should an existing company be split into? How supplying power is in the order of 8 US cents per many distribution companies should be carved kWh. It is difficult to estimate such costs exactly, out of an existing company? but it is clear that the current tariffs charged by 72 Part A EVN do not cover full costs of the electricity with, such as those concerning land rights and the system, including the costs of new investments repatriation of profits, investors in power need to made to meet future demand.18 know what rules govern: The Government is therefore unlikely to be · Market structure (see above) able to attract more private investors in electricity · Their obligations with respect to the quality of distribution, unless it raises tariffs significantly and services they provide and expansion of their also convinces investors that tariffs will cover costs networks in the future, despite political pressures to keep · The adjustment of regulated tariffs. them as low as possible. (We discuss this Working out tariff-adjustment rules that satisfy Future IPP/BOT deals will also be harder- investors is perhaps the most difficult task, because though not impossible-to secure without retail investors know politicians face pressures to keep tariff increases, for low tariffs jeopardize EVN's tariffs low. As in other sectors, the best way of finances and investors do not want to have to rely ensuring that tariffs cover costs over the long run is on calling government guarantees in order to get a combination of paid. Recent experience in Pakistan illustrates the · Introducing competition where that is feasible, problems that can arise when IPP investors sell permitting the prices of competitively provided power to unprofitable state-owned power services to be set by a market, not by regulation. companies (see Box 2). · Setting clear, efficient, and fair rules for adjusting regulated prices in Box 2. IPPs and Sector Reform in Pakistan contracts with investors and In Pakistan, investors undertook IPP projects selling to the state-owned power other regulatory instruments company, WAPDA, on the strength of guarantees provided by the Government (such as laws) that are difficult of Pakistan and international agencies. for the government to change The IPPs were introduced without fundamental reform of the other parts of the unilaterally. power market: transmission, distribution, and the sale of power remained the · Depoliticizing the responsibility of a government-owned utility, and the government did not fundamentally change the political nature of tariff-setting. Over time, problems adjustment of regulated have arisen because technical and commercial losses have remained high, demand prices according to those has been lower than originally forecast, and tariffs have not been increased to rules, by giving the task of cover the costs. As a result, WAPDA has had difficulty paying IPPs for power. checking, approving, or The IPP investors' concern to be paid, and the Government's concerns not to making tariff adjustments to exacerbate its fiscal and macro-economic problems have led to bitter disputes and specialized bodies that are have cost the investors dearly. The share price of one of the biggest IPPs, independent of politicians. HUBCO, for example, fell 60% from its peak before the crisis. The options that need to be considered in the power sector are the same as 2.3. Regulatory Reform those which arise in other infrastructure sectors. Private investors in power need to know what Having considered their options, many countries rules will govern their operation. In addition to the have now chosen to introduce independent rules that all (foreign) investors will be concerned regulatory agencies in the energy sector. To refer 18Although EVN shows an accounting profit in its last audited financial statements (for the 1997 year), its accounting profits are insufficient to compensate the Government ofViet Nam for its equity investment in the company. In other words, it is making an economic loss. 73 Part C again to one of the examples mentioned earlier, in or mitigate the risk. Therefore, in Government's Northern Ireland, electricity and gas tariffs are case, it should assume responsibility for policy and regulated by the Office for the Regulation of regulatory risks over which it has direct control; e.g. Electricity and Gas (Ofreg). Its head is appointed honoring commitments on currency conversion, by politicians, but the Office has power to adjust remittance of funds, fuel supply and tariff tariffs by itself. In the State of Victoria in Australia, schedules. On the other hand, the private sector to take an example of competitive market, operators should normally bear construction and regulated prices are set by the Office of the operating risks. For example, the BOT contracts Regulator-General, an independent body that are currently being negotiated at Ba Ria and regulating tariffs not just of electricity and gas but Phu My 2.2 would ensure that construction and also of water supply and of port and rail services. In operating risks are borne by the private sector. the Philippines, the independent Energy 2.4.2. Risks Remaining with the Regulatory Board regulates both electricity and gas. Government Passing an electricity law will help clarify the At the same time, the Government would Government's policy here and, depending on the retain the risk that the power produced by the details, may give greater assurance to investors. It is plants will not be sufficiently valuable to make the unlikely, however, to resolve the problems initial investment worthwhile. That may happen if conclusively. future demand turns out to be less than predicted 2.4. Ownership Reform (see Box 1 above) or if future electricity suppliers 2.4.1. Progress to Date are able to offer power at lower prices. Vietnam has already started the process of The Government would bear these "demand ownership reform in the power sector, with the and technology" risks through the signature by introduction of the Hiep Phuoc IPP and the BOT EVN of a long-term power-purchase agreement, generation projects being under preparation, such guaranteed by the Government. These contractual obligations create significant "off-balance-sheet" as Phu My 2.2 and Ba Ria. Pilot distribution liabilities for the Government and EVN. Although equitizations have also been discussed. But much the liabilities will not show up in the EVN's remains to be done. balance sheet-and would not show up in the As discussed earlier, the most important aspect Government's balance sheet either if the of ownership reform is the appropriate allocation of Government were to prepare financial accounts- risk between the principal agents in both greenfield they are nonetheless real and resemble ordinary and equitization transactions: in this case, the debt obligations. Just as publicly financed power Government and the private sector investors (see projects can significantly increase the Figure 3, for a depiction of some options in terms Government's ordinary "on-balance-sheet" debt, of the legal transfer of ownership and the economic privately financed BOT can create off-balance- transfer of risk). The key factors that determine sheet debt with similar implications for the whether an agent should bear risk are the degree to Government's finances. For example, the net which the agent can influence or control the present value of the payments that would have to outcome that is risky and the agent's ability to bear be made under a long-term power purchase 74 Part A All assets agreement (a measure of the Government's off- Although BOT IPP projects are more common balance-sheet debt) could easily amount to more than the privatization of distribution, many than $1 million per MW of capacity.19 countries now have private distribution companies 2.4.3. Further Ownership Reform: (either as stand-alone distribution companies or as Equitizing Distribution and Shifting More part of vertically integrated ones). In the region, the Risk to the Private Sector Philippines has long had private distribution Fully privatizing power generation by shifting companies. Elsewhere, examples of countries with demand and technology risks to the private sector private distribution companies include Argentina, would require privatizing distribution through Australia, Bolivia, Brazil, Canada, Chile, China equitization or concessions. If that were achieved, (Hong Kong), Côte d'Ivoire, India, Kazakhstan, private distribution companies could sign any Morocco, Senegal, the United Kingdom, and the long-term power-purchase agreements with private United States. companies, potentially removing the requirement 2.5. Summary of Recommendations for Government to bear demand and technology We recommend that the Government: risk. Privatizing distribution would in turn require · Undertake a study of the optimal market the tariff and regulatory reforms mentioned above: structure for the power industry in Vietnam, the Government would have to raise tariffs to cost- considering in particular covering levels and establish satisfactory systems for · the extent to which EVN should be unbundled, further adjusting them in the future. Privatizing · the rules governing entry in the sector distribution would have the further advantage of · the appropriate strategy for moving, in the allowing highly motivated private investors to cut medium to long-term, toward some form of technical losses and improve billing and collection, competitive market. thus reducing the need for new generation. 19The exact amount would depend on the details of the contract, including the required capacity and energy payments, any minimum dispatch requirements, and the formulas for increasing the payments over time, and on estimates of various parameters, such as the appropriate rate at which to discount future payments back to present values. 75 Part C · Implement the tariff increases as agreed 3.WATER AND SANITATION · Continue progress on creating new tariff- The main policy recommendations for adjustment systems, including a regulatory promoting PPI in the water sector are set out below agency, that help ensure that future tariffs cover under the following broad headings: future costs and help persuade investors that · Market Reform this will be so. · Financial Discipline · Make the privatization of distribution its · Regulatory Reform; priority in ownership reform and-having · Ownership Reform; and determined options for market structure (see · Summary of Key Policy Recommendations recommendation above)-undertake the privatization of at least one, significant 3.1. Market Reform distribution system as a pilot. With the proposed development of a few · Develop a strategy-based on the reform of private BOT bulk water projects, both the main market structure and distribution privatization- urban WSCs in HCMC and Hanoi seem to be for transferring demand risk from the public moving toward vertically unbundled sectors in sector to the private sector. which bulk water supply, often supplied by the · Develop systems for monitoring the risks (and private sector, is separated from distribution. thus the off-balance-sheet commitment and Rather than allowing ad hoc PPI projects to re- contingent liabilities) the government continues define the market structure of the sector, the to bear in private power projects. government is encouraged to establish a clear · While the development of toll roads on a BOT policy toward market reform and restructuring in basis is substantially complex due to problems which the sector is viewed on an integrated basis of traffic forecasts, the Government should and where a range of options are considered with a explore alternative models where existing view to maximizing the benefits from private operations can be bundled with new investment participation. requirements to facilitate the financing of such Although vertical unbundling offers benefits road projects. such as more transparent costs in each segment of the industry, possibilities for increased benchmark competition and the separation of processes with differing environmental challenges, it also has some significant drawbacks. These include higher contracting and coordinating costs between independent buyers and sellers and the loss of economies of scope in operations. Most importantly, a move toward vertically unbundled market will fail to address the main problem currently facing the water sector in Vietnam, i.e. inefficiencies in the distribution system. Private sector participation confined to bulk supply alone 76 Part A may in fact exacerbate system inefficiencies by for example, a long-term concession contract for raising unrealistic prospects of new BOTs "solving" an urban area. Equally, recent discussions with the water supply shortage problems. This is private sector investors and lenders in the particularly important since Government's aftermath of the East Asia Crisis suggests that some medium-term policy focus should be on project sponsors and lenders are dubious about the improving management systems and commercial real value of guarantees associated with project pricing in the distribution system down to the financed projects. Indeed, some investors have service level. Without improving distribution indicated that they would prefer to enter into long- operations, maintenance, metering, human term franchises or concessions where there is some resources and institutional strengthening, more control by the private operators over the customer than 50% of new production in some cities will be base at the service level than relying on guarantees lost - it will literally disappear "down the drain". from government utilities under BOT contracts. Under franchise or concessions structures, the In addition, given Vietnam's limited track private operator is more concerned about record with PPI, potential private investors in Government support for the enforcement of BOT bulk water supply are likely to require the customer obligations to pay for services rather than Government to bear significant risks through the direct guarantees of demand. The Government provision of guarantees to the private sector for should therefore carefully consider promoting demand and foreign exchange risk through take- private participation in an integrated system. or-pay contracts linked to hard currencies. In the Options for ownership reform are discussed in the absence of a careful policy which identifies, prices following sections. Box 3. PPITrends in Water and Sewerage Sector in Developing Countries By the end of 1997, nearly 100 water and sewerage PPI projects have been implemented in developing countries. Of these, concession contracts account for 50% of all water and sewerage projects, and 80% of all private capital investment with total investment commitment of US$20 billion. This trends reflect the reality the water sector in developing countries. Most developing countries not only need to expand capacity and distribution networks, but also face high levels of unaccounted for water and inefficient services. While the creation of new capacity detached through BOTs from the management of distribution networks can exacerbate system inefficiencies, concessions can encourage improved management and maintenance of whole network. and charges for these guarantees, there is the risk 3.2. Financial Discipline that the Government may be assuming It is recommended that the Government of unnecessarily large contingent liabilities. Vietnam adopts a clear policy which would lead to There is widespread evidence based on the application of full-cost recovery tariffs in the international experience, that Governments can water sector. This policy is important for a number adopt a range of strategies to maximize the benefits of reasons. First, the present situation where water from private participation. These might include is sold at levels well below full-cost leaves the WSCs pursuing more fundamental market reforms which in a financially weak position with unclear allow Government to shed market risks through, incentives for the management responsible for day- 77 Part C to-day operations. It is evident from the statistics general through taxation. The alternative is on high levels of unaccounted for water in the widespread inadequacies in infrastructure which urban systems that there are insufficient funds leave many who are willing to pay for services from retained earnings for the WSCs to finance the without access to these services. maintenance of the current distribution system let Equally, there is growing international evidence alone allow for much needed capital investment in to support the claim that subsidizing utility services new capacity. As such, WSCs must rely on such as water and electricity for broad consumers increasingly constrained Government budgets or groups is a crude and inefficient way of attacking ODA sources to fund much needed expansion. poverty reduction for the poorest groups in society. Second, most investors will not be willing to make The issue of targeting subsidies as an interim large investments in infrastructure unless measure in the move towards cost-recovery tariffs is governments commit to charging tariffs for services a topic which should be examined in more detail which allow the full recovery of costs. Finally, by the Government in the coming months. Issues heavily subsidized tariffs can encourage over- to be examined might include: the identification of consumption of scarce resources and send the poorest target groups and how the subsidy misleading signal to infrastructure providers. might be implemented. Box 4.Targeting Subsidies and Full-Cost recovery: Guinea and Chile Raising prices to cost-covering levels can be politically difficult for many governments and Vietnam is no exception. However, some countries have developed programs to augment consumer prices to full recovery levels gradually over time, while making up the difference to operators through partial subsidies (e.g., a water distribution lease in Guinea). There are legitimate social goals regarding the provision of basic services to the poor which may be addressed through specifically targeted subsidy schemes. In Chile, for example, a comprehensive subsidy scheme has been developed for low-income users of public services. A survey of households identified those which qualified for subsidy assistance to ensure that spending for certain basic services, such as water, do not consume more than a certain percent of households' income. However, households failing to pay their share of the bill have their subsidies suspended. Such a scheme carefully targets the neediest, whereas broad subsidies to the sector in general often benefit the better-off who already have access to service, while the poorest lack access entirely. However, tariff reforms and re-balancing may Sustainable action by the Government to give rise to charges that, in low income countries, address losses in the water sector also requires a many users cannot afford to pay the full cost for hard look at institutional structures and services. This is a particularly important and incentives. Even under the present public sensitive issue in Vietnam. Nonetheless, that cost ownership arrangements, the corporate and recovery tariffs would deprive the poor is a misled management structures of water supply conviction, and the governments must face the institutions should be reformed to provide reality that there is no way out of this financing incentives for minimizing costs. Haiphong WSC, dilemma. Either costs must be recovered from for example, operates on an incentive consumers who make use of the service through management system with competent cost-covering charges, or from the population in management team and the percentage of water 78 Part A loss is relatively low ranging from 15 to 20%. reviewing tariff rates, monitoring water quality and Similarly, good accounting systems are essential other performance obligation, and conducting for the tariff guidelines to be meaningful. New public hearings with customers. accounting standards were introduced recently The regulatory issues are particularly acute in with the help of international assistance and these the water sector because of the critical nature of programs are now focusing on training of piped water to the social and economic well being accountants in the sector. of customers, which naturally increases the Finally, a related element of financial discipline pressure on political authorities to keep tariffs low. in the sector will be the need for a clear and Investors have legitimate concerns about regulation consistent policy towards Government guarantees since they are often required to make investments for BOT projects. In the near-term, it may not be that are both long-term - often with asset lives of possible to eliminate the need for sovereign over 50 years - and irreversible. Once pipes are laid guarantees in all cases. Where guarantees may be in the ground, investors cannot respond to tariff required, the Government should recognize, value cuts by digging the pipes up and starting business and price them and manage these commitments somewhere else. In addition, it is important to on a commercial basis. clarify which projects need approval, by what 3.3. Regulatory Reform agencies, and who has legal right to sign the contract. In Vietnam these matters have been very Although there is little private participation in complex and often difficult to resolve. the water sector to date, it is recommended that the Government uses the coming months to address 3.4. Ownership Reform some of the fundamental issues associated with the Vietnam has yet to consider any model in regulation of the sector drawing, as appropriate, on transferring ownership-and therefore risk-from the best international practices. public to the private sector. However, in the case of Private investors in the water sector will need to the water sector, it is lagging behind the PPI be sure not only that current tariffs are sufficient to reforms being considered and implemented in the cover the costs of an efficiently run firm but that Region and in other developing countries. With tariffs will be allowed to increase if costs increase the Government's target of doubling the access to because of factors outside their control. As in other safe water up to 70% of the population, there is sectors, the Government should develop a clearly a large role for the private participation in regulatory system that facilitates tariff adjustments the sector. that are fair to investors, as well as to customers. In theory, there are many private scheme For example, in the case of the Manila water options that the Government can consider concessions awarded to two private sector consortia including: service contracts; management of local and international companies, the private contracts; leasing contacts; BOTs, concessions; and companies are anticipated to make up to US$7 full divestiture. In practice, a concession or full billion investment over the life of concession. In divestiture may offer the best choice overall. While this case, responsibilities of the Regulatory Office all forms of PPI promise some benefits, the more include enforcing the concession agreements, ambitious options such as concessions or 79 Part C divestiture present the widest range of advantages It is recommended that the Government adopt since most risk is transferred to the private sector a twin-track strategy for ownership reforms in the and the operators have strong financial incentives sector involving limited BOT projects in the short to maximize efficiency. term and more fundamental reforms in the Looking ahead, the diagram above may be a medium term. useful tool for the Government to analyze some of First, since the Binh An Water Corporation's its policy options for the sector. Cote d'Ivoire BOT in HCMC is at an advanced stage but has provides an example where gradual transition was not yet reached financial closure, it is necessary because of private firms' unwillingness to recommended that the Government and the commit their capital. The detail of the case is set sponsors and financiers work in good faith to out in the box below. implement this project in a timely manner. Box 5.The Water Lease in Côte d'Ivoire Original arrangement: SODECI is, an Ivorian company owned 48 percent each by local interests and a French company, started operations of the water supply system in urban and rural centers a few decades ago. The government was in charge of elaborating and implementing the investment program. While SODECI did not have to be consulted it was obliged to maintain and operate any additions made to the existing system. SODECI was however guaranteed compensation if the amount of water actually consumed was less than forecast. Problems: In urban areas, the percentage of the population with access to drinking water rose rapidly (to reach 87 percent in Abidjan and 60 percent in other urban centers); efficiency also improved (leakage of only 12 percent; collection rate of 98 percent from private customers; less than eight employees per 1000 connections). However, the financial situation of the sector progressively deteriorated, partly because of macro-economic problems in the country and partly because of problems in the regulatory framework. Investment decisions, made without consulting SODECI, were based on extremely optimistic consumption forecasts and required extensive borrowing by the authorities. When the forecasts failed to materialize, SODECI's revenues were protected by allowing the company to retain some of the funds intended for the construction fund. In 1986 the financial crisis was such that no investment could be made. New arrangement: A new contract was signed in 1987 in an attempt to address these problems. To improve coordination between investments and operating needs, SODECI was given responsibility for submitting investment plans to the government for renewals, extensions and social connections. SODECI's revenue guarantee was canceled to give SODECI stronger incentives to perform well. Today, SODECI provides service close to the standards of industrial countries at a cost to consumers which is no higher than in neighboring countries with similar economic conditions, where tariffs do not cover costs and service lags behind. Unaccounted-for-water is about 17%, collection from private customers remains around 98%, and there are now only 3 staff per 1,000 connections. Remaining challenges: Some problems remain however. Public users do not pay their bills, and, as a result, SODECI seeks compensation by keeping the share of the tariff that should be allocated to debt payments. Also, investment and maintenance decisions are still complicated by the separate between the responsibilities of the Government and the company. And because the Government retains financial responsibility for some investments, it bears financing risks that in full concessions are transferred to private parties. 80 Part A However, with future BOTs the Government public financing and then is turned over for should be careful to accept as little of the business commercial operation to private operators who risk as possible bearing in mind the assume the market and commercial risks associated recommendations on contingent liabilities set out with the business. The Government on the other in the section on Financial Discipline above hand must ensure the de-politicization of tariff and Second, it is recommended that serious allow the private operators to run the business consideration be given to more far-reaching within specified and agreed rules of the game. This changes in the sector by pursuing options that model, if successful, could then be graduated to a tackle the service level problems of operations to full concession, whereby investors would commit improve efficiency. Ideally, this should be their own financing to the operation as greater undertaken through a concession or divestiture. confidence on the regulatory framework is However, if the private sector is not yet ready to developed. Bulk water BOT should not be pursued invest its own capital in the sector except for bulk further unless there is a commensurate BOTs, a pilot lease agreement may be more feasible strengthening of the service level, particularly in in the short term. This approach, which falls short setting tariffs that fully cover costs and in the of full divestiture, gives the private partner reduction of unaccounted for water. increased responsibility for the operation of the In the case of the Buenos Aires water utility. In Vietnam's situation, it may well be that concession, the private operators have a firm private sponsors and financiers may view the commitment to invest $4 billion over the life of the investment and financial risks to be extraordinarily 30-year contract. Average tariffs have been reduced high and as such, there may be little inclination on by 17% while the Government received $8.3 m in their part to commit investment and finance tax revenues in the first year of operation. After 18 capital without substantive political and risk months of operation, water production capacity coverage from the Government. In such increased by 22%, water losses had fallen by 37% circumstances, the Government may wish to and the population served under the concession explore leases in parallel with public financing and had risen from 6 million to 6.6 million customers rehabilitation of the system as it is being presently - an increase of 10%. done in the Philippines in rural towns. Under such The Box below also highlights some of the an arrangement the system is rehabilitated with details of the Manila Water Concession. Box 6.The Manila Water Concession Background: Before privatization, Metropolitan Waterworks and Sewerage System (MWSS) in Manila faced several operational deficiencies: as of July 1997, a month before the privatization, non-revenue water was as high as 60%, about 80% of which was estimated to be due to leakage and the remaining 20% due to metering errors and unregistered or illegal connections; due to the poor billing and collection, gross accounts receivable had remained about 6 months' sales; water supply and sewerage coverage were 65% and 7% respectively of the 11 million service population; the service was available 16 hours per day; and the system was between two to four times overstaffed. Concession Process: Government objectives of the MWSS concession were threefold: (i) improved quality and coverage of the water and sanitation; (ii) increased operating efficiencies; and (iii) reduced government capital expenditure. The 81 Part C transaction was done through competitive bidding for a 25-year concession in 2 service areas.The original MWSS service area was divided into East and West zones to secure (i) independent benchmarking and (ii) balanced negotiating power between concessionaires and regulator. The bidding process had two stages, and only those who passed the technical (first) bidding stage were invited to the financial (second) bidding. The companies that offered the biggest reduction in the current average water rates were to be awarded the contracts, and no one company was to be awarded concessions in both areas. Bidders are not allowed to change the structure of the tariff for the first 10 years of concession. Concession Structure: The concessionaires are required to meet service targets and pay concession fees sufficient to make MWSS's debt-service payments of $100 million per year. The required total capital investment over the concession period is estimated to be about US$7 billion. After the privatization, what remained of MWSS was split into the MWSS Regulatory Office and the MWSS Residual Office. The MWSS Regulatory Office monitors and enforces the Concession Agreements and reviews water supply and sewage rates while the MWSS Residual Office implements remaining MWSS projects. Performance and Tariff Improvements: The terms of the bid resulted in large decreases in consumer tariffs - a 74% fall in the East and 43% in the West. After the first year of operation, there has been a 5% increase in the population served and a 7% increase in water distributed. 3.5. Summary of Policy an urban area with the possibility of transferring Recommendations this to a concession contract at some point in The key policy recommendations for the Water the future. sector in Vietnam are as follows: · Accelerate efforts to corporatize and improve efficiency and financial performance of existing state-owned WSCs; · Move on a step-wise basis towards increasing tariffs to near cost-recovery levels. At the same time, consideration should be given to designing targeted subsidy schemes for the poorest consumers; · Where guarantees for BOTs may be required in the short term ,the Government should establish a clear and consistent policy for valuing, pricing and managing these commitments; · In anticipation of increased private participation, efforts should begin at establishing a transparent regulatory framework for the sector; and · The Government should begin the process of designing a competitive bid for a pilot lease in 82 Part A 4. TELECOMMUNICATIONS which US$12.6 billion or a little over 30% was Over the past fifteen years of extensive raised in East Asia. Telecom sector counting for international experience with PPI across all of about 30% of total revenue from all infrastructure, telecommunications stands out as infrastructure divestiture in developing the sector where the involvement of the private countries. sector in terms of management, financing and There is a great deal of evidence to indicate that, ownership has been both the easiest and the most where governments have disengaged from the successful in terms of global coverage. telecommunications sector, considerable benefits The following figures highlight the extent of through competition and increased investments PPI in telecommunications over the period flow to users by way of improved service, a wider 1990-97. product range and lower costs (see Box below). Governments also benefit by not having to find the · Total investment in telecom PPI (divestiture, large amounts of capital such industries require. greenfield, concession and O&M) since 1990 Instead the privately owned telecom enterprises reached $145 billion, of which US$43 billion generally generate considerable tax revenues for the or 30% was raised in East Asia. The telecom governments. Increasing private participation in sector attracted a little over 40% of total the telecommunications sector has proved to be a investment to PPI projects in developing fruitful way of achieving real and sustainable countries. efficiencies. This is highlighted in the case of Chile · Over the same period, the total revenue from summarized in the Box below. telecom divestiture was about US$40 billion, of Box 7. Benefits of privatization and competition in Chile's telecommunication sector Chile launched one of the world's first telecommunication service privatization in late 1980's. The Telecommunication Law was passed in 1982 (with two amendments in 1989 and 1994), and during the crucial period between 1987 and 1990, the two largest telecommunication companies (one local services and the other long distance company) were sold to private investors. By 1990 the government had no participation in telecommunication companies. The telecom law does not allow exclusivity, and competition has been active in almost every service: 9 companies offer local service, 7 offer long distance service, and 4 offer mobile service. Positive results of the privatization include improvement of service both in terms of quality and quantity. For instance: · Annual investment in telecom has been between US$500 million and US$1 billion every year. · The number of lines increased from about 700,000 to 3 million between 1989 and 1998. · The number of lines/100 person increased from 5 to17 between 1989 and 1998. · The waiting time decreased from years to a couple of months and waiting list decreased from 236,000 to 58,000 between 1989 and 1998. · Productivity (lines/employee) has increased 16% annually between 1990 and 1996. · LD tariffs have decreased by 21% (domestic) and 31% (international) since competition started. Reduction of tariff has been ostensibly stronger in long distance services, where competition is more active. · Local service tariff increased by 16%, but it ended cross-subsidies. In addition, the installation fee once as high as US$2,000 has been almost eliminated. 83 Part C In the case of Vietnam, it is recommended that 4.1.1. Re-organization of VNPT the Government gives serious consideration to It is recommended that consideration be given more widespread reforms in the telecoms sector to to restructuring VNPT as a starting point for more take advantages of the role of the private sector in fundamental participation by the private sector. At the management, financing and ownership of the the present time, it is clear that VNPT is a large sector. It is recognized that some of the broad bureaucratic organization that is trying to fulfil recommendations will require considerable multiple roles. Once restructured and separated elaboration both in terms of policy and from each other, VNPT companies will be able to implementation - including the need for a have a clear focus on their core business without transition period for many of these initiatives. internal conflicts of interest. However, the main policy recommendations for promoting PPI in the telecoms sector are set out The most common and obvious example of this below under the following broad headings: type of restructuring is the separation of the postal services from the telecommunications business. · Market Structure Reform This decision should be a addressed as a priority · Regulatory Reform; matter by policy makers in the Government. · Ownership Reform; and · Summary of Key Policy Recommendations Box 8. New Zealand:The Separation ofTelecom and Postal Services The Labor government in New Zealand successfully separated telecommunication and postal services in 1987. Until that date it was an inefficient part of the Post Office, which, like VNPT, also provided telecommunications and banking services. The postal service was heavily subsidized by the more profitable telecommunications business, to the detriment of telecommunication customers, through high prices and constrained access to capital. Within a year of being separated into an autonomous company, New Zealand Post became a profitable enterprise, markedly improving its services and efficiency until today when it now wins contracts around the world to help other postal organizations to achieve the same results. Over the period it also lost all of its monopoly services, including the 'standard letter' so that it now has to compete with a number of mail and courier companies. The formula for these successes include: (i) separating the business so that it can concentrate on its core activity; (ii) providing a clear framework of rules and regulations to work in; (iii) setting commercial goals; (iv) providing commercial governance. 4.1. Market Structure Reform In addition, experience in other countries indicates that, if the incumbent operator is This section of the Report highlights some of allowed to remain in a dominant position after the core elements of market structure reform liberalization, the ability for competitors to designed primarily to maximize the benefits of develop is severely constrained, even with a competition in the sector. These are discussed strong regulatory environment. It is therefore under the following headings: recommended that the Government also · Re-organization of VNPT consider unbundling VNPT to create several · New Entry; and autonomous companies, some of which would · Cross-Ownership. eventually end up competing against each other. 84 Part A Fortunately its current structure makes this services allow the economic development of reasonably easy to achieve. competing services. Some countries have opened Dis-aggregation of the VNPT would be a even the local fixed line segment of the complex undertaking and would require telecommunications sector to competition, as is considerable planning. However, if well conceived the case in Hong Kong, for example, where the and thoughtfully implemented this type of reform monopoly of Hong Kong Telecom on local service would have a number of benefits including: (i) ended in mid 1995 when three new competitors focussing each business on its 'core' activity; (ii) entered the market. Box 9. Introduction of competition in long distance services in Chile and Mexico The Chilean government dismantled legal barrier to competition in long distance and international services in 1994 and launched multi-carrier system. This system allowed customers to choose from among eight carriers for each call they make by dialing a specific three-digit number. The cost of a phone call to the US has since plummeted from US$1.5 per minute too less than US$ 0.40. In Mexico, the introduction of competition in the long distance and international market is resulting in lower prices and increased investment. There, the threat of competition, even before the start of actual competition, began to produce results as Telmex, the incumbent operator, tried to strengthen it position in anticipation of competition. eliminating hidden costs and removing cross- 4.1.3. Cross ownership subsidies; (iii) removing many bureaucratic layers Looking further ahead, rules on cross of management; (iv) immediately increasing ownership should be established to ensure that re- competition; (iv) giving the regulator greater aggregation which hinders effective competition influence as well as market knowledge through does not take place. These regulations can be set benchmark competition; and (v) setting up a through broader anti-competitive or anti-trust market structure which would be suitable for 'local' laws, or through contractual arrangements. They as well as foreign investment. would define the shareholding that one company 4.1.2. New Entry may take in another in the same line of business. If the government is serious about introducing Ownership outside a particular service, however, competition into the sector, the design of the sector should be possible. must ensure that no one operator is dominant. 4.2. Regulatory Reform Cellular telephony, with its low fixed costs and If the Government is to lock in the long-term substantial demand, is an obvious candidate for efficiencies from private participation, it must liberalization. Many countries have also introduced ensure that the telecommunications sector is truly direct competition in the market for long distance competitive. As such, it is recommended that the and international services, often with dramatic Government should confine its role primarily to effect on prices. Even the fixed domestic network that of a regulator through a department such as need not be granted monopoly status. Recent DGPT. technological developments like fixed wireless 85 Part C 4.2.1. Redefining the Role of DGPT with as few conditions placed on them as In drafting new laws to establish the roles of practicable. However during the initial phase (say, regulator, the Government has to consider several 5-7 years) it will be necessary for each of the key issues. These include clear separation of policy- operating companies to be issued with detailed setting organization from the implementing licenses which define, among others, the organization; establishing the regulatory body performance targets, the geographical area of outside of any government ministry; choices operation, the tariff regime and the interconnect between industry-specific and multi-industrial conditions. regulation; and possible organizational reform of 4.3. Ownership Reform DGPT. Regardless of the approach adopted, the Along with market reform mentioned in the agencies set up to regulate telecommunications will section above, the Government should explore be required to set policy and administer the different options of private participation. However, following functions, some of which are now carried if these ownership changes are to have a lasting out by the DGPT. These are likely to include: impact on the performance and efficiency of the · spectrum management, including the issuing of sector, they need to be undertaken with a view to licenses maximizing the benefits of competition in and for · management of the numbering plan the market. The table below outlines a number of · arbitration of interconnect issues options that the Government can pursue - all of · tariff surveillance and setting (where there is no which will need to be undertaken only after careful competition) planning. · performance monitoring as well as imposing 4.3.1. Concession and License Contract sanctions for non-performance While there are clearly a number of options · issuing licenses where appropriate available to Government, immediate attention · ensuring adequate coverage for rural areas, should be given to reforming the BCC contracts. when necessary, through the development of To ensure ongoing success it is recommended that mechanisms for government subsidies BCCs be changed into more straightforward · promotion of a competitive environment commercial arrangements such as joint ventures, As part of the move towards establishing a concessions or licensed operations. Experience competitive telecommunications market it is from other parts of the world suggest that with a important to make tariffs cost-based as quickly as transparent regulatory environment in place, there practicable. In time such subsidies should is likely to be a strong and rapid supply response diminish, particularly if new approaches to the form the private sector to these concession options. provision of services in the rural, or border, areas However, since most BCCs involve major capital are taken. expenditure, the investors will require a clearly The recommended emphasis is to move defined environment and some certainty of towards 'light-handed' regulation as more returns. The rule of BCCs need to be changed so competition enters the market. For instance, that separate legal entities can be established.There licenses should only be issued where necessary and is good likelihood that the current participants 86 Part A B o t h approaches - equitization of VNPT and transformation of BCC contracts- are not mutually exclusive. In Hungary, for example, the n a t i o n a l company was restructured into local, long d i s t a n c e , international and value added services before would welcome the change to a clearly defined privatization. Local networks were divided into concession. over 50 local concession areas and bid out to 4.3.2. Equitization of Existing Assets private investors. National and international long VNPT has already equitized one of its many distance services were organized into a single companies and is currently planing to equitize four company that was privatized by selling a stake to more peripheral companies. A more far-reaching strategic investors; cellular services were unbundled reform might involve the equitization of some or into several different concessions that were all of VNPT's core businesses. Clearly this would awarded to separate investors. require a significant amount of effort in terms of the preparation for such a major reform. Box 10.Telecommunications Reform in Poland In 1990 the Governor of Pila, a province of Poland near the German border, decided to promote the benefits of doing business in Pila to other European countries, and further abroad. Industrialists and investors came and saw the benefits but argued that they would not invest without modern telecommunication systems. As a result, the Governor asked the state operator about their plans for Pila but was informed that it would be some years before the State sector could improve the service levels. The Governor sought and obtained a license to develop telecommunications in the area. Subsequently other areas of the country followed suit until now most of Poland has two licensed operators in each province: the incumbent state telco, TPSA, which is still struggling to provide service in the major centers; and private telcos based around smaller cities in which the local government also has a shareholding. In some areas the results have been astounding: towns that had one or two inadequate telephones now have modern telephone service with 100% penetration of all homes. The only difficulty has been underestimating the demand. 87 Part C 4.4. Summary of Policy 5.AIRPORTS Recommendations 5.1. Market Reform The key policy recommendations for the As in the port sector, the government is telecommunications sector in Vietnam are as encouraged to conduct analysis on the advantages follows: of decentralizing control in order to ease the · As soon as possible reform all existing BCC process of increasing PSP and to encourage contracts into more straightforward commercial regional development. Perhaps with even more arrangements, such as joint ventures that permit vehemence than the ports sector, Vietnam's central private operations, concessions or licensed government retains operational, financial and operations planning responsibility for the nation's airport · Initiate a project to plan and implement the system.This policy should be reevaluated given the reorganization of VNPT to provide greater Government's stated objectives of encouraging competition within the sector regional development, particularly of the central · Commence a project to define and implement region surrounding Danang. the role of the DGPT, or other appropriate regulatory agency, for telecommunications Canada has recently implemented a similar program of · Divest the government's interests (through airport decentralization in order to end federal subsidization and allow its provinces and municipalities VNPT) in: to seek efficiencies and access to investment capital - All joint venture manufacturing operations in through concessioning and public-private partnerships. telecommunications Under the privatization program, airports were first decentralized as well as the investment burdens associated - The two cellular companies that are not fully with maintaining and expanding the airports. Regional owned by VNPT. and municipal governments have been granted the authority to select the best method for increasing efficiency and many have sought private operators. 5.2. Ownership Reform The government should consider the concessioning of terminal operations and/or airside services. Although a few European countries have conducted outright sales of their airports and several countries have allowed the private sector to build greenfield air facilities, allowing private operators to manage terminal and runway at publicly owned airports is a politically viable and economically sensible alternative that has been gaining popularity over the last few years. Private sector operators have been able to modernize facilities and shift costs away from airside fees by 88 Part A developing landside business opportunities. A 6. RAILWAYS World Bank analysis demonstrates that airports 6.1. Market Reform owned by central governments average $4.88 of In railways, the government should consider landside revenue per passenger while private further restructuring of the sector through the operators average $11.14. The greater revenues unbundling of major business units. Of all of from landside services allow the airport operator or Vietnam's transport sectors, the national railroad authority to reduce airside charges, making the (VR) remains the most complex, vertically airport more competitive to carriers and cheaper integrated institution. The current market for users. structure makes it almost impossible to judge the financial viability of rail services in the country. The first step to reforming the sector should involve the unbundling of non-integral services from core operations. These include, but are not limited to: · Hotels; · Rolling stock manufacturing; · Tourism services; and · Meal manufacturing. Through the equitization of those business units and increased contracting for ancillary services, the VR can begin reducing costly internal subsidization practices. This could be followed by the commercialization of operating units and their separation into such businesses as rolling stock companies and infrastructure and signaling companies. By dividing accounts and commercializing freight and passenger services separately from track maintenance and investment, the Government can better determine where it needs to invest and where the private sector may be able to provide financing and operational expertise. While restructuring the Japanese National Railroad (JNR), the JNR established a Settlement Corporation to assist with the disposal of non-core assets including excess real estate. Sale proceeds were put against outstanding liabilities of the core businesses. By 1992, the sales had finished and the residual liabilities (over proceeds) was converted to government debt so as to 89 Part C being maintained or expanded from national or allow for the corporatization and eventual privatization of core lines of operation. regional budgets (rather than direct user fees or appropriate fuel taxes) or that waterway transport In New Zealand, corporatization of the railroad preceded privatization by nearly 10 years, allowing the government receives indirect but massive subsidization from to restructure the railroad, create separate accounts and the use of military barges and transport balance sheets for different operating units, make those equipment, a policy toward rail rehabilitation will units operational and to determine the preferred method have to consider the equity of these subsidizations of attracting private sector participation. Through the vis-à-vis the Government's contributions to VR's period of commercialization (1982 to 1990), New debt and infrastructure costs. Zealand Rail's efficiency factors improved significantly: NTK per freight staff more than doubled, cost per freight 6.3. Ownership GTK decreased about 35% and NTK per rail car nearly The government is encouraged to consider the doubled. Moreover, between 80 and 90 percent of rail users found that service quality had improved in the areas corporatization and eventual concessioning of of price, reliability, transit time, inquiries and flexibility. rolling stock operations and perhaps the separate concessioning of infrastructure services. While the 6.2. Financial Reform process of bringing the private sector into the Government policy toward transport, railroad industry in Vietnam is probably not going particularly passenger movements, has been to be a single step, several nations have pursued the motivated by social concerns about affordability. path of concessioning their rail operations in order While the willingness and ability of Vietnamese to to reduce the public fiscal burden associated with pay for transport services should remain a core rail subsidization and to improve a defficient concern of all transport policy, be it public or service. As with ports and airports, concessioning of private, the dilapidated state of transport the rolling stock operations and, perhaps separately, infrastructure, can, in part, be blamed upon the of the infrastructure (tracks and signaling) allows excessive and the unequal use of subsidizations. the government to retain ownership of this national Without massive public financial commitments to asset while benefiting from the experience and VR, rail tariffs will need to be raised to cover access to capital of private operators. current operating expenses (including infrastructure rehabilitation) and the capital costs Beginning in 1989, the new Argentinean government, associated with new investment and rehabilitation. seeking to alleviate the burden of its railroad which accounted for about 17% of the national deficit, entered Prior to or in parallel with the liberalization of into a privatization program for Ferrocarriles Argentinos rail tariffs, relative subsidies to other modes of (FA). This involved the separation of the railway into transport will have to be analyzed to assure that regional companies and the concessioning of each new rail is competing on an approximately level entity. While passenger and freight traffic has grown playing field with roads and waterways. Per km steadily since the reform process began, over the first four years of the concession program the government and point-to-point passenger or unit costs for was able to reduce its subsidy from $1.3billion to users of each of the three modes should be $300million per year. The on-going federal support was quantified along with the degree of direct and largely due to continued subsidization of commuter indirect subsidization being received by each lines and the funding of pension obligations from mode. In the case that roads and highways are redundant rail workers. 90 Part A 7. PORTS. Eventually, the port authorities themselves were 7.1. Market Reform concessioned to domestic operators as joint ventures with municipal, departmental and national governments (with In the port sector, the Government is at least 70% of share ownership transferring to the private encouraged to analyze the advantages of sector). The SPR's, in turn, have leased terminal space to decentralizing control in order to ease the process private stevedoring companies who compete amongst of increasing PSP and to encourage competition themselves within each port authority's area. among the facilities. Currently, port policy and 7.2. Financial Reform development is centrally controlled by Vina Marine, with decisions made in conjunction with The government is advised to conduct a tariff municipal planning and transport committees. review that would parallel or anticipate the However, municipalities such as Danang and Ho initiatives of sector reform. The analysis should Chi Minh City have pursued or are pursuing the focus on the decentralization of port tariffs and a equitization of their own principal general cargo calculation of the effects of cabotage subsidization facilities. To date, these efforts have not resulted in on the efficient use of port facilities. Currently, the successful inclusion of private operators at tariffs are maintained at equal levels for all ports existing facilities although two private greenfield across the nation except container tariffs which are facilities are operational in the south of Vietnam. levelized regionally (south, central and north).This A clarification of the roles of Hanoi vis-a-vis the prevents the individual ports setting tariffs to local governments, with greater freedom of the compete with each other, alleviate congestion or local governments to seek port operating even calculating their ability to cover their own efficiencies and facilities expansion through costs. Often in the region, domestic handling rates private sector investors and terminal operators receive so much cross-subsidization from would benefit the sector's performance. This, in international shipping charges that coast-wise or turn, would result in faster turn-around times and inland shipping companies have no incentive to reduced delivered freight costs. vacate berths or to move cargo through the terminals, or storage facilities. The impact of these The decentralization of national port authorities is a two tariff inefficiencies on international shipping common first step in the process of maritime sectoral rates and over-all port congestion may be so great reform. In Latin America, several nations have as to provide a net economic loss to consumers and implemented varying forms of decentralization prior to producers even when weighed with the benefits to their port privatization programs in order to encourage competition and efficiency and empower local authorities cabotage and the increased activity at ports that are to utilize their assets for maximum economic benefit. In able to charge lower than cost recovery tariffs. Mexico, regional port authorities were created out of the Moreover, unnecessary greenfield port investment national port agency, Puertos Mexicanos. These public is often sought when more efficient operations at authorities, know as API's, were granted the right to existing facilities, promoted through equitable concession their individual terminals to domestic or international terminal operators and investors. In tariff structures, could have provided the needed Colombia, the four major general cargo ports were additional capacity. named Regional Port Societies (SPR's) and granted independent status from the national port agency. 91 Part C 7.3. Ownership Reform having to concede the ownership of waterfront The government should pursue the property or underlying infrastructure. The concessioning of terminal operations for existing concession period roughly parallels the life facilities. By concessioning terminal operations at expectancy of major investments which are then existing ports, the Vietnamese or local converted back to the government for governments can benefit from the expertise and reconcessioning after the contract has been access to capital of major port operators without concluded. Several ports that have concessioned their operations for 20 to 30 year periods over the last few years have already reported a marked improvement in vessel turn-around times, cargo handling times, and even a reduction in stevedoring costs. Below are figures from Colombia's four main general cargo ports (Buenaventura, Cartagena, Santa Marta and Barranquilla) taken from prior to 1993 when the port authorities were concessioned and again in 1996: Prior to concessioning After concessioning Colombia: Avg. Vessel Waiting Time 10 days None (or in hours) Tons per Vessel per Day* 750 1700 Containers per Vessel per Day 16 25 Lift Rates per Container >$600 <$150 * = for General Cargo In Manila, the Philippine Ports Authority (PPA) has allowed two major stevedoring companies to take over almost all international container operations at two competing terminals. There participation has greatly improving handling efficiencies, reduced turn-around times, has practically removed the need for public investment in those terminals, and has allowed the PPA to become a profitable organization through its lease payments from the private operators. 92