37184 Infrastructure Strategy Cross-sectoral issues Vietnam's infrastructure challenge As Vietnam becomes richer it faces challenges in adapting its infrastructure policies and institutions. While the old challenges of providing basic services to all remain, new challenges are emerging, such as accessing new sources of finance, refining planning processes, preparing for rapid urbanization, improving the efficiency of infrastructure service providers, developing stronger institutions to encourage private finance of infrastructure or direct private provision of infrastructure, and developing more targeted approaches to poverty alleviation. This report on Infrastructure Strategy - Cross Sectoral Issues is one of six volumes dealing with Vietnam's Infrastructure Challenge. It deals with cross- sectoral issues that are common to all infrastructure sectors, and provides an overview of recent achievements and emerging challenges. Other volumes deal with Water and Sanitation, Electricity, Transport, Telecommunications, and Urban Development. The work for these reports was carried out between 2004 and 2006 by World Bank staff and consultants, under the direction of Klaus Rohland, Country Director for Vietnam, and Christian Delvoie, Sector Director for Infrastructure in East Asia and the Pacific. The reports have been revised to take account of comments made by the Government in workshops during May 15-17, 2006. The principal author of this volume was Michael Warlters. The comments of numerous colleagues from the World Bank, the United Kingdom's Department for International Development Bank, the Asian Development Bank, and the Japan Bank for International Cooperation are gratefully acknowledged. Abbreviations ADB Asian Development Bank BCC Business Cooperation Contract BOT Build-Own-Transfer CPRGS Comprehensive Poverty Reduction and Growth Strategy DAF Development Assistance Fund EVN Electricity of Vietnam GSO General Statistics Office of Vietnam HIFU Ho Chi Minh City Investment Fund for Urban Development IBRD International Bank for Reconstruction and Development (the World Bank) ICOR Incremental Capital-Output Ratio IDA International Development Association (the World Bank) IPP Independent Power Producer ITU International Telecommunications Union JBIC Japan Bank for International Cooperation LDIF Local Development Investment Fund MARD Ministry of Agriculture and Regional Development MCF Marginal Cost of Public Funds MOF Ministry of Finance MOT Ministry of Transport MPI Ministry of Planning and Investment MTEF Medium Term Expenditure Framework OBA Output Based Aid ODA Official Development Assistance PER-IFA Public Expenditure Review and Integrated Fiduciary Assessment PIP Public Investment Program PPI Private Participation in Infrastructure SEDP Socio-Economic Development Plan SOCB State-Owned Commercial Bank SOE State-Owned Enterprise VHLSS Vietnam Household Living Standards Survey VITRANSS Vietnam's Transport Strategy Study VND Vietnamese Dong VNPT Vietnam Post and Telecommunications Corporation VRA Vietnam Road Administration WDI World Development Indicators Table of Contents ABBREVIATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .i EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .vii Cross-Sectoral Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .viii Sectoral Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xvii Reform Prioritization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xxvi 1. ACHIEVEMENTS AND CHALLENGES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 1.1. Growth and Poverty Reduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 1.2. Improved Access . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5 1.3. Changing Circumstances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 1.4. Shared Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15 2. FINANCING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17 2.1. Level of Infrastructure Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17 2.2. Who Pays for Investment, and When? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20 2.3. Financing Institutions and Mechanisms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21 2.4. Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39 3. PLANNING AND COORDINATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .43 3.1. Prioritizing Investment Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .43 3.2. Coordination of Planning Across Ministries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46 3.3. Allocation of Responsibilities Across Tiers of Government . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51 3.4. Urban Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54 3.5. Environmental and Social Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .56 3.6. Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60 4. EFFICIENCY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63 4.1. Current Efficiency Levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63 4.2. Reforming Public Infrastructure Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67 4.3. Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .70 4.4. Private Participation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71 4.5. Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78 4.6. Addressing Corruption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .81 iii 4.7. Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .84 5. POVERTY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87 5.1. Rural Poverty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87 5.2. Urban Poverty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .90 5.3. Designing Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .91 5.4. Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95 6. REFORM PRIORITIZATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 6.1. International Competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 6.2. Estimates of Reform Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98 6.3. Capacity to Manage Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .101 6.4. Principal Reform Priorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .101 Annex 1 - Scope for Greater Competition in Infrastructure Sectors . . . . . . . . . . . . . . . . . . . . . . . . . . .104 Annex 2 - Infrastructure Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .108 Boxes Box 1.1: The Hanoi-Hai Phong northern transport corridor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4 Box 2.1: The Marginal Cost of Public Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 Box 2.2: Vietnam's Financial Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27 Box 2.3: Ho Chi Minh City Investment Fund for Urban Development (HIFU) . . . . . . . . . . . . . . . . . .30 Box 2.4: Using Pension Funds to Finance Infrastructure in Chile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34 Box 3.1: Common Weaknesses of Vietnamese Feasibility Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . .44 Box 3.2: Development Planning in Malaysia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45 Box 3.3: A Medium Term Expenditure Framework (MTEF) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .49 Box 3.4: Weaknesses in the Coordination of Road Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53 Box 3.5: Strategic Environmental Assessment in Bali . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57 Box 3.6: Resettlement and Land Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58 Box 4.1: Phu My 2.2 Project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74 Box 4.2 Gujarat Infrastructure Development Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78 Box 4.3: Forms of Price Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79 Box 4.4: Discretion in the Regulation of Private Infrastructure Enterprises . . . . . . . . . . . . . . . . . . . . .80 Box 4.5: Bangladesh Rural Electrification Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82 Box 4.6: Opportunities for Corruption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83 Box 5.1: Road Investment-A Case for Further Expenditure Redistribution . . . . . . . . . . . . . . . . . . . . .89 Box 5.2: Targeting Effectiveness of Increasing Block Tariffs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .92 Box 5.3: Output-based Aid: Tying Subsidies to Service Delivery for the Poor . . . . . . . . . . . . . . . . . . .95 Box 6.1: Modeling the Benefits of Reform in Australia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100 iv Figures Figure 1: An Emerging Gap between Investment Plans and Available Financing . . . . . . . . . . . . . .viii Figure 1.1: Growth of GDP per capita 1990-2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2 Figure 1.2: Growth and Infrastructure Investment, as percent of GDP . . . . . . . . . . . . . . . . . . . . . . . . . .3 Figure 1.3: Percent of Population Living in Poverty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4 Figure 1.4: Access to Infrastructure Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 Figure 1.5: Foreign Aid in US$ million . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7 Figure 1.6: Urbanization in East Asia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8 Figure 1.7: Vietnam's Incremental Capital Output Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11 Figure 1.8: Rural/Urban Poverty Levels and Changes (1993-2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . .12 Figure 1.9: Regional Poverty Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12 Figure 1.10: Evolution of Contribution to Poverty (percentage points) 1993-2002 . . . . . . . . . . . . . . .13 Figure 1.11: Access to Clean Water, by Income Quintile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13 Figure 1.12: Access to Hygienic Latrines, by Income Quintile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14 Figure 1.13: Households living in rural villages with road access, by income quintile . . . . . . . . . . .14 Figure 2.1: Infrastructure Investment Financing Mechanisms (% of Investment Finance) . . . . . . . . .20 Figure 2.2: Spending on Energy Services (% Household Expenditure) . . . . . . . . . . . . . . . . . . . . . . . . .22 Figure 2.3: Average Electricity Tariffs (US$/kWh) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 Figure 2.4: Operating Cost Coverage for 61 Vietnamese Water Utilities . . . . . . . . . . . . . . . . . . . . . . . .24 Figure 2.5: Household Spending on Water Services (% Household Expenditure) . . . . . . . . . . . . . . .24 Figure 2.6: Average Water Tariff (US$/m3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25 Figure 2.7: Average revenues for water (US$/ m3) in 60 utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25 Figure 3.1: Gini Indexes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46 Figure 3.2: Transport Central Government Recurrent versus Capital Expenditure . . . . . . . . . . . . . .50 Figure 4.1: Non-Revenue Water (%) in Asian Cities (2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64 Figure 4.2: Unaccounted Water (%) in Vietnam . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64 Figure 4.3: Water Utility Staff Ratio (Staff/1000 Connections) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 Figure 4.4: Staff per 1000 water and waste water connections in Vietnam . . . . . . . . . . . . . . . . . . . . . .66 Figure 4.5: Telephone Mainlines per Employee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .66 Figure 4.6: Transmission and Distribution Losses (% of Electricity Generated) . . . . . . . . . . . . . . . . . .66 Figure 4.7: Road Maintenance Expenditure (% Total Road Expenditure) . . . . . . . . . . . . . . . . . . . . . . .67 Figure 4.8: Transparency International Corruption Perceptions Index (2000-2004) . . . . . . . . . . . . . .81 Figure 5.1: Percent Population with All-Weather Access to Rural Roads (2002) . . . . . . . . . . . . . . . . .89 Figure 6.1: Percentage of firms ranking transport a severe or major constraint . . . . . . . . . . . . . . . . . .98 Figure 6.2: Businesses' Problems with Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98 v Tables Table 1.1: Investment in East Asia (% of GDP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 Table 1.2: Present value of repayments on a $1 loan from the World Bank Group . . . . . . . . . . . . . . . .7 Table 1.3: Urbanization Forecasts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 Table 2.1: Vietnam's Recent Investment in Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18 Table 2.2: Infrastructure Investment Financing Mechanisms (% of GDP) . . . . . . . . . . . . . . . . . . . . . . .19 Table 2.3: Private Investment (Contractual Commitments)-US$ millions . . . . . . . . . . . . . . . . . . . . . . .37 Table 4.1: Private Participation Contracts in Vietnam . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73 Table 4.2: Responsibilities under the Main Private Participation Options . . . . . . . . . . . . . . . . . . . . . .76 Table 6.1: Benefits of Possible Reforms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .99 vi Executive Summary O ver the past decade Vietnam has made become increasingly difficult to obtain as spectacular progress in GDP growth and Vietnam's GDP per capita exceeds donor poverty reduction. Annual per capita thresholds. In all infrastructure sectors, there is growth has averaged 5.9%, the eighth highest in a need to develop new sources of long-term the world over the decade. Since 1990, poverty finance as alternatives to ODA. Much of that measured at the $1 a day threshold has fallen finance will need to come from financial from 51% of the population to just 8%. markets or direct private finance, requiring A critical part of this success has been a high reforms of consumer pricing, enterprise level of investment in infrastructure. Around 9- restructuring, and revised regulation to 10% of GDP has been invested in transport, establish the credit-worthiness of infrastructure energy, telecommunications, water, and enterprises. sanitation in recent years, a very high level of Urbanization is adding a million people per infrastructure investment by international year to Vietnam's urban centers, providing not standards. Microeconomic studies provide only a financing challenge to meet their evidence of a strong link between this infrastructure needs, but also a planning infrastructure investment and Vietnam's challenge to ensure that infrastructure growth and poverty reduction. provision is timely and avoids the need for The road network has more than doubled in expensive retro-fitting after urban areas are length since 1990, and its quality has improved already settled. substantially. All urban areas and 88% of rural In past years, Vietnam could be reasonably sure households have access to electricity. The of high social returns on public investment by number of fixed and mobile phones per 100 connecting consumers without access to people has multiplied nine-fold since 1995. infrastructurenetworks.Butasaccesslevelsincrease Access to improved water grew from 26% of the it will become more difficult to find investments population to 49% between 1993 and 2002, and with high rates of return, necessitating more refined during the same time access to hygienic latrines planning systems. And as infrastructure networks grew from 10% to 25% of the population. expand the cost savings available from more Vietnam's existing infrastructure strategy efficient operation will increase, placing greater has been a success. And yet, the strategy needs emphasisontaskssuchasrestructuringstate-owned to evolve and adapt as new challenges emerge. enterprises, equitization, or the introduction of Over the next five to ten years, official greatercompetition,toprovidestrongercommercial development assistance (ODA) is unlikely to incentives.Theeliminationofcorruptionwouldalso grow at the same pace as the economy, and will have a significant impact on the costs of thus occupy a smaller part of total infrastructure services. infrastructure investment. Grants and the most Vietnam's approach to the reduction of concessional forms of donor financing will poverty has been one of general reliance on vii growth, but with investments being the themes of financing, planning, service geographically spread to ensure that all regions efficiency, and poverty. Chapter 6 concludes participate in that growth. Increasingly poverty with a discussion of reform prioritization. is focused in remote rural areas, ethnic minority The report is accompanied by five further communities, and new areas of urban poverty volumes dealing with transport, electricity, arising from migration. As general poverty levels telecommunications, water and sanitation, and fall and infrastructure access increases, the urban development. This executive summary existing approach to poverty reduction will need presents the main findings of all six volumes. to be supplemented with approaches which more directly target individual households CROSS-SECTORAL ISSUES Careful review across infrastructure sectors is 1. Investment Needs and Financing required to determine how existing subsidies could be better targeted to address these new Infrastructure investment in 2002 represented concentrations of poverty, without wasting about 9.4% of GDP. Looking to the future, poverty alleviation funds on the non-poor. sectoral plans and forecasts suggest future This report deals with cross-sectoral annual infrastructure investment summing to infrastructure issues. Chapter 1 sets out the 11.4% of GDP, an increase of 2% of GDP over emerging challenges that will require a revised recent levels:1 approach to Vietnam's infrastructure strategy - In September 2005, the Ministry of a reduction in ODA as a proportion of GDP, Transport estimated future financing needs urbanization, the challenges of managing more in a Medium Term Expenditure Framework, extensive infrastructure networks, and changes which matched proposed investment with in the nature of poverty in Vietnam. Chapters 2 potential financing sources. The proposals to 5 set out the reform agenda required to for capital spending in 2006 to 2008 address these new challenges, organized under amounted to VND 69,186 billion (US$ 4.3 Figure 1: An Emerging Gap between Investment Plans and Available Financing Source: For investment in 2002 see Table 2.1, for investment plans in 2010 see text in section 2.1, for financing sources in 2002 see Table 2.2. Financing sources for 2010 assume that ODA grows at 2% p.a., while government and user financing (retained earnings) grow at the same pace as GDP (7% p.a.) from their 2002 levels. 1. In 2005, 2% of GDP was about VND 15,250 billion (US$ 966 million). Estimates of investment as a proportion of GDP assume that GDP grows at 7% annually. viii billion) over the three years, and averaged yield high returns. Failure to keep pace with the 4.1% of GDP per year. growth of demand for electricity would likely In the electricity sector, investments required have high economic costs. And the transport to meet the Fifth Power Master Plan amount investment proposals have already been to VND 215,078 billion (US$ 13,743 million) prioritized to match existing sources of finance. in the years 2005-2010, or about 3.9% of GDP. So, for purposes of thinking about finance This figure is now regarded as an mobilization, a figure of about 10-11% of GDP underestimate, because of higher than seems reasonable. Nevertheless, a more expected demand growth in recent years. definitive appraisal of the appropriate level of The financial model used by EVN to plan investment would require a concerted effort to future investments suggests that during monitor investment and maintenance activities 2005-2010 capital expenditure will amount to and evaluate their financial and economic VND 237,246 billion (US$ 16 billion), which returns. in annual terms is about 4.7% of GDP. Figure 1 illustrates the financing challenge In the water and sanitation sector the implied by this increase in investment. The Government has set coverage targets to sources of finance in 2002 are summarized in achieve its 2010 development goals. The four categories, with the category "Government" targets are 85% for urban water and incorporating budget funding, government sanitation, and 75% for rural water and bond issues, as well as financing by State- sanitation, which would require investment Owned Commercial Banks. The category of VND 57,547 billion (US$ 3.62 billion) "Users" incorporates the retained earnings of during 2005-2010, or 1.2% of GDP annually. infrastructure enterprises as well as community In the telecommunications sector, in October financing of facilities such as small-scale rural 2005 the Ministry of Post and Telematics water systems. The illustration supposes that the adopted a target of 32-42 total telephone financing contribution by Government and lines per 100 population by 2010. To achieve Users will grow with the economy, at 7% p.a., 35 lines per 100 population would require but that ODA will only grow at 2% p.a. Under about VND 57,000 billion (US$ 3.6 billion). these assumptions, ODA, Government and User Spread over the period 2006-2010, this financing combined would fall short of the total would amount to around 1.4% of GDP planned/needed investment in 2010 by US$ 3 annually. billion, or 5.1% of GDP. In order to meet the The forecasts should not be interpreted as an Government's infrastructure goals, this endorsement of sectoral investment proposals. financing gap will need to be filled with Closer analysis of the individual sector plans expanded Government financing, higher user may find ways of economizing on investments, tariffs, or an expanded role for the private sector. increases in user tariffs could reduce demand An important source of this financing and hence defer investment, and budgeting challenge lies in the likely relative decline of decisions could result in indefinite deferral of ODA as a proportion of GDP. The assumption some investment proposals. Nevertheless, that ODA will grow at 2% of GDP, is purely investments dealing with electricity, water, and illustrative, and is by no means clear. telecommunications access targets are largely Nevertheless, as discussed in Chapter 1, some unavoidable if the government's stated time druing 2010-2013, Vietnam is likely to begin objectives are to be met and should generally a "graduation" process in which it moves from ix concessional IDA financing, to more expensive treatment, and solid waste management, the IBRD financing. Internationally, the experience ability to raise revenues is constrained by has been that when countries graduate, they consumers' willingness to pay. The social tend to rely much less on ODA financing, and to benefits of these services typically exceed rely more on private financial markets. private willingness to pay, so a level of budget While the levels of ODA in the future cannot support is appropriate. In these sectors the be predicted precisely, the overall nature of the key to mobilizing alternative financing is to financing challenge is clear. Vietnam must use provide clear and predictable rules for the the coming years to develop financial institutions allocation of budget support, so that the capable of providing long-term finance for future public revenue stream provides infrastructure, and must reform its infrastructure sufficient security to mobilize investment. It is businesses to become credit-worthy enterprises possible to combine user payments with capable of borrowing long-term. budget revenues to meet the costs of service by means such as competitive bidding for service delivery on a least-subsidy basis. Need to Increase Cost Recovery A prerequisite for alternative financing Other Sources of Finance mechanisms is cost-covering tariffs. Ensuring full cost recovery through tariffs opens up a Wide-ranging reforms are required to develop range of financing options that are otherwise stronger institutions for infrastructure finance. generally impossible. The proportion of costs Governance reforms are needed for the recovered differs from sector to sector, and only state-owned commercial banks to eliminate in some sectors can it be increased. informal pressures for "policy-lending", The principle is well established in otherwise known as lending to projects that are telecommunications and electricity. not commercially justified. In any case, direct Charges associated with road transport, lending by banks is likely to play a relatively such as vehicle registration and petrol tax, small role in infrastructure financing, because of more than cover road maintenance costs, the mismatch between short-term deposits held but do not cover the full cost of capital by the banks and the long-term needs of invested. There is scope to increase these infrastructure. charges, and there are many possibilities for Bonds are a useful form of financing for revenue to be raised from toll-roads. infrastructure, since they can provide long-term In the water sector, cost-covering tariffs have financing. The Government is making good been embraced in the water sector in Ministry progress in this area, but more needs to be done of Finance guidelines for water tariffs, and the in the way of information disclosure concerning principle is being considered for the ability of public authorities to repay debt; implementation in a draft Government decree. and to increase the secondary activity and But current water tariffs typically only cover liquidity of the government bond market operational costs, while capital costs can through enhancements to the legal framework, occupy 80% of total costs of a water utility. improved debt issuance and management by Considerable tariff increases would be required the Treasury, and strengthened intermediary in the sector to achieve full cost recovery. functions. As a means of limiting fiscal risks it In areas such as sanitation, waste water would be desirable for the Government to shift x from general obligation bonds (backed by other public finance rationale, and taxation powers) to revenue bonds (backed by according to objective criteria. infrastructure revenues) where possible. Equitization is a potential means of raising a Decentralization has shifted greater limited amount of infrastructure financing. investment responsibilities to provincial Equity inputs can be used to increase governments. The extent to which these investment, or to retire public capital for use governments have the financial resources to elsewhere. But the highest financing benefits meet their new responsibilities is unclear. The will not be realized if investors discount the system of transfers from the central government price they pay for the risks arising from should not undermine the incentives of local inadequate disclosure of accounting governments to raise their own revenues. information, or if investors are unable to obtain Limits on their borrowing should be assessed management control rights. based on their ability to repay debt, rather than There is great potential for more private the current limits based on investment budgets. investment in infrastructure. But taking An expansion of property taxes could serve as a advantage of this potential requires careful useful tax base to efficiently consolidate a transaction preparation and sound regulatory variety of existing charges, and to provide a environments. Vietnam should experiment reliable source of local government revenue. more with private financing than it has in the Both central and provincial governments have past, developing a number of transactions established specialist investment institutions, across sectors, using competitive bidding, and with an emphasis on infrastructure investment: carefully monitoring the lessons learned. the DAF and the 13 local development Allied to the use of private financing, investment funds (LDIFs). Rationales for these Vietnam should develop a risk management institutions include pooling finance from a framework that permits the appropriate use of variety of sources (reducing the risks taken by the contingent liabilities (such as guarantees) in individual financing sources), and providing attracting finance, but monitors and limits the centers of technical capacity for developing government's exposure. infrastructure financing schemes. But: Finally, efficiency improvements in Theyalsoexposethegovernmentstofiscalrisks procurement and operation of infrastructure in the event of financing defaults. Measures are services can be thought of as an alternative to needed to distance these institutions from the the mobilization of finance. Improvements in governments through clearer governance efficiency can increase output from existing and arrangements, and to install professional proposed facilities, and thereby lessen the need management practices to reduce risks of for new investments. default. Improved reporting is required to ensure that the institutions' liabilities are taken 2. Planning and Coordination into account in assessments of the government's fiscal position. There is room for improvement in many aspects In the case of the DAF, on-lending occurs at of Vietnam's planning processes. As a result of subsidized rates. If investment subsidies are success in increasing levels of access to to be offered, differing levels of subsidies infrastructure services, it is becoming should be offered to different sectors in increasingly difficult to select investment accordance with the extent of externality or projects with high economic returns, requiring increased emphasis on economic considerations xi in project selection. Rapid urbanization requires Reduction and Growth Strategy (CPRGS) have improvements in both the speed of urban been integrated into the Socio-Economic planning processes, and also its responsiveness Development Plan for 2006-2010. But the link to local conditions. In addition to these reforms between Vietnam's socio-economic addressing emerging challenges, there are long- development goals and investment planning standing needs to improve coordination could be improved with the use of a results between spatial and sectoral master plans, to framework which specifies goals to be achieved develop tools to achieve national objectives in (e.g. improve access to hygienic sanitation), provincial and municipal projects, and to strategies for achieving these goals (e.g. integrate environmental considerations into investment in sewerage systems in urban areas) broader investment planning. and key performance indicators measuring progress towards the goals (e.g. number of urban households with sewerage connection). Integrating Economic Criteria into Project The goals should be comprehensive, and Selection projects would only be approved if they The importance of economic criteria for mapped into the strategies. An increased choosing between investment projects will emphasis on monitoring project outcomes is increase as the infrastructure stock increases. also required, to inform future feasibility Identifying high return projects was easy when studies about the likely impact of different much of the population lacked access to types of investments, and to ensure that infrastructure services. As the access rollout progress towards development goals is really advances, choosing between investments will being made. become more difficult. For example, it is not With improved criteria for distinguishing easy to compare the social returns between between projects, a framework within which to providing new connections in high cost consider projects' potential contribution to locations or providing improved service quality development goals, there will then be a need for in areas already connected. a governmental process that is capable of Better processes need to be developed for allocating funds to the highest priority projects, assessing investment priorities across sectors with lower priorities receiving funding only to and across projects. Ideally this would entail the extent of available funding. Projects that estimation and monitoring of rates of return, could be financed privately should be given low permitting an ordering of projects that could be priority for receiving public funding. achieved within financing constraints. A serious Budgeting processes need to be better effort to build capacity in assessing economic integrated with investment planning. There has and financial rates of return will take time. In been a problem with budget discipline in the the short term, a high priority should be to past, with transport projects being commenced improve the quality of feasibility studies, without budget financing authorization. providing decision-makers with better Questions are also raised about whether an information about the relative merits of appropriate balance is being struck between proposed projects. new investment and maintenance, particularly Progress is being made in relating in the transport sector. The Transport Ministry's investment plans to development goals - the recent experience with preparation of budget principles of the Comprehensive Poverty proposals within a medium-term expenditure xii framework (MTEF) has been a useful their potential to provide infrastructure more development in terms of fitting proposed efficiently and in closer synchronization with investments within the available financing community needs. envelope and giving greater consideration to The need for more refined appraisals of maintenance costs. The MTEF experience should rates of return to different investments extends be developed to extend to non-budget finance to an assessment of the spatial balance of sources, and to provide better information about investments. Vietnam has done well over the the trade-off between new investment and past decade, balancing high-return investments maintenance (ie the relative rates of return in major centers of economic activity with rural earned by spending in these areas). investments aimed at reducing poverty, and achieving high aggregate growth with only a slight increase in inter-provincial inequality. Planning for Urbanization But migration to major urban centers has been Vietnam's urban population is growing by about important in restraining inter-provincial one million people per year, with much of that inequality. Continued migration may growth concentrated in Ho Chi Minh City and overwhelm planning capacities in the major Hanoi. It is likely that growth of Vietnam's rural centers resulting in congestion, inadequate population will level off in the next five to ten provision of basic services, and environmental years, with all new population growth being degradation. One response would be to expressed as larger urban populations. Based on provide much more resources to urban China's example, urban growth will present a planning in the major cities. An alternative range of new problems including traffic would be to divert migration to mid-sized congestion, pollution, and the need to roll out cities, but this would require wide-ranging infrastructure services quickly. It is much more policies extending beyond mere spatial and expensive to provide infrastructure services after sectoral master plans. Assessing whether such Urban planning is poorly managed at policies might be worthwhile would require present. Centrally prepared spatial plans set much better information about the relative unrealistic standards, and partly for this reason social rates of return across different urban are frequently ignored in practice. There needs areas. to be more flexibility in centrally developed spatial plans, and more enforcement of those Other Planning Challenges plans at the local level. Ideally spatial planning should be devolved to a more local level, to There are general problems of coordination enable greater responsiveness to local across government ministries. The need for communities' desires and market better coordination between the Ministry of developments. Arrangements under which land Planning and Investment and the Ministry of is provided to property developers in return for Finance is a key area for better coordination, but infrastructure provision should be carried out there is also a need to better coordinate spatial through more transparent procedures involving plans and sectoral master plans, particularly in competition to mitigate potential risks for urban areas. corruption, land speculation, or wasted Greater effort needs to be made to integrate investments. Revised tax and fee instruments, environmental issues and assessments of social such as property taxes, should be studied for impacts (particularly resettlement issues) into the xiii overall planning environments. While on the commercial objectives of increasing environmental impact assessment may occur for revenues and reducing costs. Internationally, a individual projects, plans for a series of typical first step towards improving investment projects similarly need to be subject to commercial incentives is "corporatization" of assessment. While individual projects may have business enterprises - subjecting them to only marginal impacts, and thus be approved, the private corporations law. In Vietnam, aggregate effect of a series of projects may be subjecting infrastructure enterprises to the much larger, and require modification of proposed Unified Enterprise Law may help to investment plans. Recent legislation requiring install the basics of corporate governance and strategic environmental assessments - should be a minimum step. Additional assessments of the most critical environmental possible measures include specific statements issues in particular areas - is a positive step, of corporate objectives, and additional The process of decentralization is ongoing, reporting beyond that required by the with a gradual reallocation of spending and Enterprise Law. Governments typically have investment planning responsibilities from the additional non-commercial goals for their national government to provincial and local infrastructure enterprises, and these can be governments. Decentralization brings various achieved by explicit contracting between the risks of failure to coordinate between lower level Government and the enterprises, with governments (eg failure to take account of payment for particular services provided. environmental effects on neighbors, or failure to Equitization, the sale of shares primarily to coordinate investments). There is a need for the workers and managers, has been used as a tool central government to develop fiscal tools (such for efficiency improvement in many state- as matching grants) that would help to coordinate owned enterprises in Vietnam. However, the sub-national decisions with national objectives. worker motivation incentives that have been effective in smaller enterprises may be weaker 3. Efficiency in large infrastructure enterprises, where there are greater possibilities to profit from the efforts In general, Vietnam's infrastructure services are of others (free-riding). Accordingly, it is provided relatively efficiently. But as in all important that equitization of infrastructure countries, there is room to reduce the costs of enterprises should involve sales of controlling service. Internationally, experience has been that interests to general investors, and that it be the key to lowering costs is to increase the supplemented by mechanisms to provide commercial focus of infrastructure business entities stronger management incentives, such as stock - through reform of state-owned enterprises or exchange listing. direct private investment - and the introduction of The agenda for state-owned enterprise competition. The sorts of reforms necessary to reform varies across sectors. For example, improve commercial focus are also the sorts of the Ministry of Transport has over 200 SOEs, reforms needed to increase infrastructure of which over 100 are engaged in enterprises' access to financial markets. construction. Many of these enterprises are excessively indebted. Competition between these enterprises results in low "survival" State-Owned Enterprise Reform bids to secure contracts, a practice which Central to improving efficiency is a ultimately results in low quality works and governance structure that improves the focus delayed implementation. In a fully xiv developed market economy, this situation competition. Several new entrants have been might be resolved by bankruptcies of the authorized to compete with VNPT in fixed line least efficient enterprises. But state- and mobile services, but VNPT remains ownership tends to delay such politically dominant. Effective regulation, in particular difficult decisions. MoT has plans for spectrum management and resolution of equitization of SOEs, but these need to be interconnection disputes, will be important in accompanied by clear guidelines on debt facilitating the progress of the new entrants. accounting, and criteria under which certain Faster progress could be made by allowing the enterprises might be declared bankrupt. entry of foreign firms. In this respect, the United In the electricity sector, in contrast, the States has obtained an early advantage, obtaining reform of state-owned enterprises is focused on preferential access for its firms under a Bilateral the transition to a future competitive market for Trade Agreement. But even these advantages electricity. EVN will need to be broken up into limit foreign ownership to 49% and 45% in the truly separate corporations. Decisions on the mobile and fixed line services markets. These size, structure and operational scope of newly limits may unnecessarily inhibit market entry. formed shareholding companies need to ensure The 2004 Electricity Law and 2006 Road Map adequate competition in different market for Power Sector Reform set out plans for a segments, but also adequate resources to ensure phased transition over 20 years to direct financial viability. Distribution companies, in competition in electricity generation, with particular, need to have sufficient financial eventual choice of generators for consumers. strength and managerial capacity to be There are various obstacles to the implementation perceived as credible and make long-term of these plans, including the difficulty of contracts with generating companies. encouraging private investment in IPPs (a major In the water and sanitation sector, the sectoral priority) when the future market agenda for SOE reform needs to focus on structure is uncertain. Managing the transition to preparing the utilities to access financial a competitive electricity sector will be one of the markets. For example, financiers are likely to most difficult policy challenges in infrastructure. have more confidence in the credit-worthiness of water utilities if their accounts are prepared Private participation according to international accounting standards and are independently audited. In most other infrastructure sectors, competition can only be introduced in the form Competition of "competition for the market": competitive bidding among private investors for a the right Competition is the economic force most likely to to provide an infrastructure service over a fixed deliver sustained efficiency improvements. But period of time. Done well, with well-prepared the possibility to introduce competition is competitive bidding and appropriate limited in most infrastructure industries. regulatory environments, concessions, leases, Telecommunications and electricity generation and management contracts can be strong tools are exceptions. for performance improvement as well as In telecommunications international investment financing. experience strongly suggests that the speed of Vietnam already has experience in the use network rollout is accelerated by greater of BOTs, but at least some of the existing xv BOTs have been negotiated with a preferred or electricity distribution operations. Greater operator. Competitive bidding would provide attention to international benchmarking could a higher probability of minimizing also be used as a spur to improved procurement costs. A number of BOTs have performance. been negotiated with state-owned More generally, performance standards and construction companies. While local financing regulated prices, in addition to their has advantages in terms of foreign exchange implications for investment and financing, can risks, the use of foreign enterprises with be used as tools to improve infrastructure specialist infrastructure experience could service performance. This is more likely to be provide more ideas for management effective in infrastructure enterprises with improvement and utilization of new stronger commercial focus, such as private technology. And a difficulty with state-owned firms. Getting prices right is a complex task, enterprises is that weak governance requiring specialist skills. structures may provide weak commercial Regulatory institutional and capacity building incentives. There is scope for greater is required, especially in the areas of cost auditing openness toward foreign private enterprises and economics (to set prices at efficient levels). A in infrastructure investment. Vietnam is high priority is support for the newly established currently revising its BOT decree. A revised Electricity Regulatory Authority, since lessons decree should entrench a requirement for learned here will have implications for other careful preparation and competitive bidding sectors. In the telecommunications sector, the of BOT contracts. Ministry of Post and Telematics' ownership of Beyond the construction of new facilities, VNPT creates a conflict of interest in its various forms of public-private partnerships regulation of the sector, for example in the can help to improve efficiency of existing resolution of disputes over access to VNPT's facilities. Vietnam should conduct pilot projects network by new operators. An agency across different sectors to gain experience in the independent of the Ministry would be desirable. use of public-private partnerships other than BOTs. An effective process would entail a Addressing Corruption pipeline of projects, and a dedicated unit associated with the development of public- Corruption raises the final costs of private partnerships. infrastructure services, and is a source of inefficiency. Opportunities for corruption arise Regulation at most stages of the infrastructure project cycle. In recent years Vietnam has been making One form of light-handed regulatory pressure greater efforts to address corruption. Recent for efficiency improvements is benchmarking. reforms have focused on detection and Vietnam has made significant progress in punishment, but have been of general benchmarking water utilities, encouraging application. Closer review could identify better performance by highlighting well particular infrastructure activities at risk, and performing companies that serve as examples develop appropriate responses. Reforms to for others. This experience could be copied in increase competitive pressures in infrastructure some other infrastructure sectors, for example are likely to complement measures against urban environment companies, port operators, corruption, but should be buttressed by anti- xvi collusion measures. SECTORAL STRATEGIES 4. Poverty 1. Transport Financing Road and water investments are good means of targeting particular provinces in which Transport expenditures reached 4.5% of GDP in rural poverty levels are high, suggesting a 2002, although 35% of this expenditure was not need to maintain high priority for these allocated budget funding and this in turn led to investments. problems of indebtedness in the sector. In Urban poverty is likely to increase in coming years, transport expenditure is expected coming years. Because of the pace of migration to be reduced to the order of 3.5-4.0% of GDP, and urban development, addressing emerging although in a rapidly growing economy this urban poverty issues will require implies continued increases in the absolute level improvements in the local planning process to of transport expenditures. ensure that infrastructure networks are ODA currently finances 37% of central installed "just in time", and in the right places. transport expenditures. As in other sectors, the There are many different ways of subsidizing expectation that ODA financing will not grow at use of infrastructure services by the poor: the same pace as GDP means that growing Currently, Vietnam uses increasing block sector expenditure will need to be paid for by tariffs in water and electricity. While the either consumers or the Government. The scope details need to be studied carefully, such for direct user payments differs across sectors, schemes typically provide greater subsidies but toll-roads are an obvious possibility for to the relatively well-off, rather than the greater direct payments. Fuel taxes (reduced poor. subsidies) would be a means of generating It would be useful to refocus subsidies additional government revenue in a way that is on connection, rather than consumption, related to use of infrastructure facilities. Another since those with connections are avenue would be to use land taxes to capture a typically less poor than those without proportion of the increase in land value connections. associated with infrastructure improvements. Output-based methods for subsidy delivery To ensure affordability of transport projects, should also be explored. A classic output- the financing burden can be shifted to future based scheme involves competitive bidding generations through government borrowing or among private operators for the right to by direct private investment. Around 30% of the provide a service (encouraging cost Ministry of Transport's projects between 2001 reductions in service provision), and and 2005 were financed by government bonds, payment of the subsidy only when the and local development investment funds requisite outputs have been achieved (LDIFs) are also using bond financing to (transferring the implementation risk to the provide transport projects in some provinces. private sector). The private sector could play an expanded role A general subsidy strategy should be in financing highways, ports and airports. developed for infrastructure services, identifying whether subsidies are to be Planning and Coordination delivered to the poor, and if so, how best to maximize the benefits of those subsidies. All of the problems of planning and xvii coordination affecting infrastructure in general outcomes in the sector. Frequently the can be found in the transport sector. There tends Ministry's SOEs are over-indebted and deliver to be a gap between broad government low quality and delayed work. An equitization strategies and detailed sectoral plans, and little program should be designed to close non-viable coordination between spatial and economic enterprises, to establish clear lines of development plans. Poor budget discipline has accountability and improved commercial been the source of unfunded expenditures, incentives for the remaining enterprises, and to giving rise to severe debt problems in the provide clear separation between Ministry transport construction industry. There is finances and enterprise finances. A further misallocation between new investment and possibility would be to remove ownership of maintenance; among modes, with inland shares in the SOEs to a separate ministry, such waterways receiving a significantly smaller as the Ministry of Finance, to ensure no conflict share of funding than is commensurate with of interest between the Ministry of Transport's their important role; and in the selection of policy role and the profit motives of share investments within each sub-sector. ownership. The introduction of a results-oriented planning Another important source of inefficiency is process at both the national and provincial levels inadequate attention to road maintenance. would help align expenditure planning with the Currently maintenance expenditures are at about desired development goals. The ongoing Medium 50% of the necessary levels. If expenditures on Term Expenditure Framework (MTEF) pilots national road maintenance remain at their current could help remedy many of the problems in the levels over the next ten years, the condition of the planning process by strengthening integrated network would substantially deteriorate, with planning and developing investment plans within about 34% of national roads being in poor the envelope of available resources. Building on condition, including 55% of the high traffic the progress already made with the MTEF pilots is volume network. an important priority for the sector. Planning Currently decisions about whether to pave across transport sectors needs to be better provincial and rural roads are distorted by bias integrated, to ensure the development of multi- in the Government budgetary system against modal transport systems. maintenance. Knowing that regular budget Rigidities in the planning system and the allocations are unlikely for ongoing lack of metropolitan or regional institutions that maintenance, many local governments prefer to can coordinate development across construct paved roads which require less jurisdictional boundaries are obstacles to the ongoing maintenance than gravel roads but development of effective urban transport which, depending on local circumstances, may systems. Planning processes should encourage involve higher total costs over the life of the growth of high density corridors, and establish road. The budgetary system should be revised public transport systems to complement to ensure that decisions on road types can be investments in road infrastructure. based on total life cycle cost - ie if on this basis a gravel road is cheaper, then the necessary Efficiency maintenance budget should be provided. There are many negative impacts of Reform of the Ministry of Transport's State- transport, such as congestion, pollution, and Owned Enterprises is central to improved high accident rates, which need to be better xviii managed to improve the transport sector's demand growth projected at 16% per year contribution to aggregate welfare. Efforts to during 2006-2010. While demand-side control congestion by limiting vehicle management must be pushed as hard as ownership or registration in Hanoi and Ho Chi possible, the main solution lies in a large-scale Minh City are not working. Alternative medium-term capacity expansion program. In instruments, such as higher parking fees, and 2004 it was estimated that generation capacity the promotion of public transport systems may would need to expand from 11,000 MW at the prove more effective. Linked to congestion, time, to 24,000 MW by 2010. More recent both Hanoi and Ho Chi Minh City have air forecasts suggest this was an under-estimate. quality problems which could be at least Annual power sector investment requirements partially addressed with improved vehicle during 2005-2010 are expected to cost over US$3 inspections for emissions. A few relatively billion. simple measures, such as improved road The three main financing options for the design and signage and police enforcement of sector are self-financing by EVN using retained rules of the road, particularly the requirement earnings, different types of borrowing, and for motorcyclists to wear a helmet, could independent power investment. EVN exhibited significantly improve road safety strong financial performance during 2002-2004, permitting a substantial self-financing contribution to the investment program. EVN is Building Capacity also making extensive use of borrowing, from A long term capacity development framework donors and by issuing bonds. should address needs at three main levels: the But increases in average retail tariffs are policies and laws governing the sector (building required to ensure an expanded contribution on the findings of a recently completed from self-financing and borrowing. Recent cost regulatory review); organizational increases, stemming in part from power development (including stronger separation of shortages in 2005, of themselves would require responsibilities for policy development, tariff increases. The massive borrowing needs enforcement of rules, implementation of will also require counterpart funds from EVN to projects, and operation of services), and human be generated in the next few years, through resource development (training). tariff increases. Implementation of project works has often EVN's purchase of power from sources suffered from inefficiency and low quality. currently independent of EVN, including both Recent events have also highlighted problems IPPs and imports, is expected to account for more than -half of new power production of governance in relation to project during 1995-2010. New IPPs wholly owned by management units (PMUs). The respective roles foreign or private firms are expected to provide of PMUs, contractors, and supervision several thousand megawatts of new build-own- consultants need to be reviewed. transfer (BOT) IPP capacity. Use of competitive bidding is strongly recommended as the 2. Electricity standard method for awarding new IPP power Financing purchase agreements. International experience has been that prices and terms awarded The capacity of Vietnam's electricity system through competitive bidding have provided needs to double in just five years, to meet lower costs than negotiated deals. xix approved sector Road Map set the direction for Planning major efficiency improvements through the Vietnam has established a good foundation for introduction of competition in the power the coming massive capacity expansion program industry. The reform process is expected to with the development of the Sixth Power Master span twenty years, proceeding through (a) Development Plan, covering 2006-2015, with a operation of a competitive market for supply view to 2025. The basic institutional from generators to a Single Buyer (EVN); (b) arrangements, analytical capacity and analytical introduction of a wholesale market, allowing tools being used are fundamentally sound. bilateral between large consumers and The new Plan emphasizes expansion of all generators; and finally (c) introduction of three electricity generation subsectors - hydro, competition at the retail level. coal, and gas. Imports from China and other To implement these reforms, EVN will need neighbors are expected to increase considerably in to be broken up into truly separate the future. Demand-side management should play corporations. The model of EVN as a holding a greater role than in the past - for example shifting company for assets in generation, transmission, consumption from peak times can significantly and distribution cannot be retained if true reduce system capacity requirements. competition is to be achieved. The corporate Ongoing work will be required to ascertain restructuring and equitization involved will of the optimal balance between coal-fired and gas- itself be a significant challenge. Resulting fired power plants. A central issue is the relative companies need to be strong enough to be economic costs of coal and gas - in particular, the active market participants, but should not wield excessive market power. In particular, current price of coal in Vietnam appears to distribution companies need sufficient scale to diverge substantially from its economic value - be reliable revenue collectors and power and this should be carefully reviewed before purchasing agents. significant investment in either sector. Greater A further implication of the reforms is that investment in exploration for gas and gas field greater flexibility in retail pricing will need to be development will be needed in the longer term, introduced over time, including mechanisms and it is critical for Vietnam to further develop which allow changes in costs to be passed the framework for investment to ensure it through to consumers, and for consumers to remains attractive for international companies respond. More attention needs to be given to social and The approved reforms could be improved by environmental issues in the planning process. bringing forward at least some direct For example: major hydro developments can contracting between generators and large involve significant resettlement and social consumers and/or distribution companies. It is dislocation; the choice between coal- and gas- this form of competition which is likely to yield fired power plants has implications for carbon the main efficiency gains. emissions; and siting of power plants and A major challenge to the reform will be the transmission facilities must be planned with existing tight reserves in the system. In a market regard to local environmental effects. system, supply shortages lead to high prices, as signals to induce more investment. It can take Efficiency several years for new capacity to come on line and lower prices, during which political The Electricity Law of 2004 and the recently support for reform could be undermined by the xx high prices. Alternatively, if prices are kept low of a clear work program; (c) staff training and by regulation, additional investment may not be development; (d) agreement with industry forthcoming from the private sector. participants on arrangements for information A linked challenge is the need to expand collection and monitoring; (e) definition of private investment. With Vietnam's limited ERAV's enforcement powers; and (f) definition experience of international investment in IPPs, of mechanisms for resolution of disputes. there is a need to offer great certainty to potential investors about their future returns. 3. Water and Sanitation Uncertainty over the nature of future market Financing developments will increase the perceived risk of IPP investments. The key here is to design the Investment needs to meet the Vietnam power market to mitigate these concerns. For Millenium Development Goals in rural and example, emphasis may be given in the market urban water and sanitation by 2020 are design to cover load primarily with contracts, estimated at US$ 600 million annually, which is and limit spot trading to non-contracted roughly four times the annual investment in the surpluses and to clearing differences. last ten years. Allowance can be made for a growing economy, but even as a proportion of GDP investment in the sector would need to Building Capacity double, from 0.6% to 1.2%, by 2010. Moreover, Existing planning strengths need to be nearly 85% of past investment in the sector has supplemented with greater institutional come from ODA, which is unlikely to expand capacity in demand-side management. significantly in coming years. Managing the task of competitive Meeting the Government's development procurement of a large pipeline of IPP projects targets will require greatly expanded financing will pose considerable challenges for the from either the government or through Ministry of Industry, requiring much learning borrowing in the capital markets. For from international experience and building up borrowing to occur, the utilities would need to of capacity in preparing 'bankable' transactions. generate operating surpluses to meet Experienced international advisers will be a repayment obligations, which would in turn necessary element of this program, but there is require increased user fees and increased a corresponding need for capacity on the efficiency of service providers. Government's side to manage these advisers. One of the keys to the success of the sector is Linked to the reform program, there is a higher but realistic and affordable tariffs. Joint need for an expansion of regulatory capacity. Circular 104 of November 2004 requires that The Electricity Regulatory Authority of tariffs be set to fully recover costs, which is an Vietnam was established recently. It needs to be important step in the right direction, but an objective institution, charged with enforcement of the Circular remains an issue. implementation of the country's laws, with a The possibility of automatic indexation of tariffs mandate recognized by all parties, and to match cost increases should be considered. operating as an agency separate from the For wastewater, the Government should review Ministry of Industry's regular business Circular 67 (2003), which is perceived by local departments. Some areas for ERAV's early governments as a cap on wastewater fees at 10% attention include: (a) establishment of itself with of water tariffs. Wastewater operations and a distinct identity; (b) definition and publication investment typically cost more than equivalent xxi water services, and the need for cost-covering CERWASS should be more clearly separated tariffs in the sector is the same. from its role as service provider. As the creditworthiness of the sector improves, access to longer term local financing Efficiency will become important. A staged progression could be envisaged over the next 10 years from Overall, Vietnam's water utilities are current reliance on ODA, through mixed performing well by developing country financing, to a sector built on local capital standards. But there remains wide variation markets. Greater access to ODA funds could be between utilities in the costs of service and provided to utilities that are able to borrow commercial performance, suggesting significant from financial markets, as a means of room for improvement for many utilities. encouraging additional finance into the sector. Possible measures for improving performance Pilot projects will be required to develop credit- of the utilities include: worthy utilities, and to develop capacity on the More widespread knowledge about the top part of banks or other financial institutions for performing water companies and loan appraisal. The Government or benchmark capital and operating costs. The international financial institutions could play a existing benchmarking system could be role initially in providing some form of improved and made available more widely, guarantee to early commercial loans to the to be used by provincial governments and sector, in order to build confidence, but such potential private investors for cross-sectoral guarantees should not be seen as a permanent comparison, and by utility managers to feature. highlight areas for improvement. Importantly the Government should Policies to provide incentives to water consider how best to utilize ODA. Gradually companies to achieve higher levels of ODA should move away from production to performance. A system of incentives distribution, from water supply to sanitation requires a strict evaluation of performance and from investment funding to leveraging and the use of rewards and sanctions which local capital. Better targeting of ODA to reduce affect both the utility and its owners. As a poverty will be important and Output Based first step, performance contracts could be Aid (ODA) should be considered as a established between individual Provincial mechanism for the use of grant financing for Peoples Committees and their service poverty interventions. providers, with rewards/sanctions for performance against agreed targets. In the case of poorly performing water service Planning and Coordination companies, PPCs could choose to Over the long term the government should competitively bid unserved district towns to consider rationalizing into one entity the new water supply service companies. various line agencies that are currently Competition between water service responsible for policy and oversight of water companies could be also simulated, with and sanitation in the urban and rural areas. In rewards (eg greater access to Ministry of the meantime the existing legal framework Construction finance, or donor finance) needs to be upgraded to support the National for companies that meet agreed Rural Water and Sanitation Strategy. In performance targets, or are the best addition the sector policy/regulatory role of performing companies in the country, or xxii that show the greatest improvement in Building Capacity performance. The country should continue to encourage The provision of incentives to service providers the involvement of the private sector as a will only be successful if there is adequate spur for efficient service delivery, and information about the sector, and there is possibly as a source of investment financing. adequate capacity to respond to that The national private sector has a distinct role information in both service providers and to play in providing services to smaller oversight agencies. In particular a sanitation towns and in the rural setting. study is required to develop and keep updated Improved regulation. At present provincial comprehensive and reliable data. governments are effectively both tariff The Government needs to be more active in setters and owners of water service compiling, analyzing and disseminating sector companies, creating a conflict of interest data. Through such activity the Government between the goal of keeping tariffs can build its capacity to improve policy affordable for consumers, and the goal of development and the targeting of ODA funds. profitable operation of the companies. A The Peoples Committees need to improve national oversight agency (nascent their understanding of the opportunities for regulator) could be established to provide sector development and how they can benefit. advice/guidance to Peoples' Committees on National agencies should take a lead in the design of performance contracts, and provision of training in introducing and expected performance of water service maintaining commercial relationships, and companies. effective corporate governance and oversight. Focusing on core businesses. Water service The Vietnam Water Supply Association companies should divest their construction could play a bigger role in building technical and other services from the water business. and managerial capacity in service providers. A This would provide the basis for the coordinated action to reduce non-revenue water development of a competitive market for and improve energy efficiency could yield construction services and reduce the significant benefits. Training for small-scale opportunity for hidden cross subsidies. providers should be offered to enhance their Progress on sanitation services is lagging management and financial capability, and well behind water services. Establishing capacity for quality control, contract and business entities responsible for the provision contractor management. of sanitation services is the immediate priority in sanitation reform. Merging wastewater 4. Telecommunications activities into the business of urban water Financing service companies, to take advantage of operating and administrative synergies, should In October 2005 the Ministry of Post and be considered in all but the largest cities, where Telematics adopted a target of 32-42 separate wastewater companies may be telephone lines (fixed plus mobile) per 100 appropriate. The Government should continue population by 2010. The investment required to support soft interventions which highlight to meet this target, given the current level of the linkages between sanitation, improved about 20 per 100 population is about VND 57 hygiene practices, and health outcomes, and trillion (US$ 3.6 billion) spread over five build demand for investments in sanitation. years. This compares with a total investment xxiii budget for VNPT in 2003 of around not well-thought-out mechanisms using policy US$ 313 million. changes that reflect international best practice. VNPT's main sources of profits - highly There is a need for more policy planning and priced leased lines and international calling - linking processes and policy changes to will be reduced as competition is increased, so anticipated results. Part of this process should self-financing of investments will be reduced. be the development of a modern New sources of finance will need to be telecommunications law that the WTO, developed. Possible sources of finance could international best practice, and investors would include bonds or issuance of shares. Current recognize as a model. business cooperation contracts (BCCs) with One area where market forces could foreign telecommunications companies potentially be supplemented with central generate hundreds of millions of dollars of planning is rural access. On this subject, regard investment, but the restrictions on this sort of should be had to the WTO Reference Paper, investment (such as the absence of management which states that although WTO members may rights for the foreign investor) means that undertake any universal service obligation billions of dollars of private investment through (USO) regime they like, the USO scheme must BCCs is unlikely. A move to true joint ventures, be administered in a transparent, non- desirably with the possibility of majority discriminatory and competitively neutral private ownership, management control rights, manner. and equity returns, would be likely to generate higher levels of investment. Improving Access and Efficiency Following international experience, there is great potential for increased direct private The major priority for the sector should be to investment, domestic and foreign, in the sector, intensify and entrench competition in the sector. but this would require major improvements in Competition provides positive incentives for the regulation and operation of the sector. The increased productivity and responsiveness to reforms required to encourage private customer needs. Internationally, stronger investment are broadly the same as those competition has also been linked to faster required to increase access and improve expansion of access to telecommunications efficiency. services. Many elements are needed to promote competition. A clear vision of a future industry Planning structure needs to be devised and disseminated. Market forces, appropriately regulated, could This structure should have several viable achieve most of the government's operators, each totally independent of each telecommunications objectives, without the other, and all subject to impartial regulation. need for detailed planning of investments and VNPT's multiple ownerships in every market operations by the Government. To arrive at segment, particularly mobile telephony, should such a position a wide range of policy reforms is be eliminated. VNPT's equipment required to increase access and improve manufacturing, postal and postal giro efficiency. businesses should be separated from the At present there is no roadmap for policy telecommunications businesses. change. Plans and decrees tend to be Another key element of achieving engineering documents or penetration goals, competition and private entry is licensing. The xxiv Government should move to a class licensing there is a growing need for enhanced capacity system that will streamline and clarify licensing in regulatory issues. While price regulation can procedures. Properly implemented, improved be relaxed in competitive market segments, policies could generate substantial revenues for issues of market dominance will remain for the State budget. some time. In these areas, complicated Enforcement of a credible and equitable regulatory issues arise such as collusion on network interconnection regime is critical to prices, development of inflation-linked price facilitate new entry as well as to provide cap formulas for maximum tariffs, dominant incentives for existing operators to make carrier abuses of pricing, and analysis of costs investments. A study of current interconnection underlying prices. A considerable investment in practices should be undertaken, identifying training and contracting-in of international carrier complaints, abuses if any, and the effects experience is required to address these topics. of VNPT's market dominance. Other regulatory tasks that are central to effective competition are 5. Urban Development Strategy rules on numbering and on spectrum allocation. A minimal step towards the promotion of Some of the most pressing issues for urban competition would be compliance with the development strategy are investments in water provisions of the Vietnam-USA Bilateral Trade supply, wastewater collection, wastewater Agreement. WTO accession could be used as a treatment and urban transport. To a large forum for further development of pro- extent, these challenges and proposed strategies competitive reforms. A telecommunications for dealing with them have been dealt with offer will be required for accession, which could above, along with the challenges of urban address issues such as opening of various planning and financing of municipal market segments to foreign participation, investment. possibly increasing private ownership above Other significant forms of infrastructure for 50% in at least some market segments, setting urban development include solid waste realistic deadlines for proposed changes, and management and housing. Safe disposal of solid meeting the Telecommunications Reference waste is becoming a major issue in Vietnam, Paper requirements. particularly in the larger cities. Sound policies Finally, supporting these pro-competitive have been put in place for solid waste policy reforms, there will be a need for management but enforcement of these policies improved regulatory processes. Consideration remains problematic. Only 17 out of 91 disposal should be given to the establishment of a non- facilities in the country are reported to be ministerial telecommunications regulatory properly designed sanitary landfills with body and the respective responsibilities of this leachate collection and treatment facilities. The body and the ministry. As a first step a Government has designated 50 waste dumps as Regulatory Committee could be established environmental hazards that should be closed as within the Ministry; with the goal of having this soon as possible. A national policy framework, Committee become the basis of a later with inspection and enforcement, is needed to Regulatory Authority. ensure that municipal governments deal appropriately with solid waste. About 25% of the urban population was Building Capacity living in substandard or temporary houses in Whatever institutional arrangements are made, 2002. The new Land Law of 2004 provided xxv incentives for property developers to build of the potential benefits of different sorts of planned developments. This created a housing reforms, and the administrative capacity of boom in major cities, with state-owned different ministries to handle reform. companies taking on the role of commercial In the central ministries of Finance, Planning developers. But the boom is geared largely to and Investment, and Construction, a major middle and upper income earners, and the priority should be the development of provision of appropriate housing for low improved mechanisms for project selection, income people remains a major challenge for monitoring, and evaluation. The central the Government. ministries could take the lead in cross-sectoral The Government is reluctant to embark on capacity building to improve the quality of subsidized state housing because it has only project feasibility studies and monitoring and recently extracted itself from many of the evaluation activities. The aim should be to problems associated with poorly managed state obtain high quality economic analyses housing provision, such as poor housing indicating expected and attained rates of management, and insufficient cost recovery for economic return. These estimates should be maintenance. Measures which could be used as central criteria in selection of projects explored include the release of land from for public financing and investment approval. Government ownership to increase the supply Chapter 3 highlights the need for a better of land in private ownership and hence lower integration of financial planning with other its price; provision of incentives to developers aspects of planning. A mechanism needs to be to invest in rental properties; and development found by which available taxpayer funds are of the housing finance market as part of broad allocated to infrastructure projects where financial sector reform. A cost effective way to necessary, by which taxpayer funds are not improve living conditions for the poor is involved where not intended, and which through urban upgrading of tertiary level provides financing alternatives for socially infrastructure (drains, sewers, water supply, profitable investments where taxpayer funding paved roads/alleys, street lighting, etc), is not required. These processes should be tied providing householders with security of tenure to results frameworks providing strategies that (land use right certificates), and micro-finance link individual projects to development goals, to enable residents to improve their houses. and which should be prepared by sectoral Research from other countries show that ministries. residents invest up to seven times in their Reforms of capital markets identified in houses what the city invests in infrastructure. Chapter 2 will require a series of reforms, many within the responsibility of the Ministry of REFORM PRIORITIZATION Finance. Among these reforms, preparing the way for private infrastructure investment is a It would be difficult for the Government to particular priority, given the proposed implement all of the recommendations importance of the private investment in the identified in these volumes simultaneously. electricity sector and for its potential role in Accordingly, there is a need to set priorities. financing and improving efficiency in other Factors that could be taken into account in sectors. Here the Ministry of Planning and setting priorities include the extent to which Investment will have a key role. Reform of the particular sectors act as constraints to Vietnam's BOT legal framework is one step, but much international competitiveness, simple estimates better project preparation and improved xxvi regulatory institutions will also be required. In telecommunications, the priority should Efforts to build regulatory expertise could begin be to encourage greater levels of with improved emphasis on rules-based competition through greater private sector regulation within the public sector. entry and entry by foreign firms and Among line ministries, the sectoral priorities through improved regulation, particularly differ in nature. regulation of interconnection terms and In transport, where the emphasis has been conditions. on road building, increased attention must In water and sanitation, investment targets be given to reform of state-owned will be driven by Vietnam's development enterprises and to the provision of adequate goals. A contribution to financing will come resources for maintenance. from increased user tariffs. Particularly in In electricity, the private sector will play a sanitation where user willingness to pay is large role in meeting new investment needs. lower, there will be a need to determine an Adequately preparing projects for private appropriate public contribution to investment will be the biggest challenge in investment and appropriate mechanism for the coming years. it to be delivered. xxvii 1. Achievements and Challenges V ietnam's overarching economic goals are infrastructure services are managed for efficient to promote strong economic growth and operation, and how the Government will address to ensure that the benefits of growth are issues of inequality and poverty. equitably distributed. In the infrastructure sectors these broad goals are supplemented by goals of 1.1. Growth and Poverty Reduction providing universal access to basic services. This Vietnam Infrastructure Strategy provides a set of Over the past decade Vietnam has been proposed policy reforms and actions aimed to remarkably successful in stimulating growth improve the achievement of these goals. It and reducing poverty. The average rate of GDP proposes a framework under which Vietnam can growth in the ten years 1994-2003 was 7.4%, better evaluate which investments to undertake, while average growth of per capita income was and how to finance them, how to improve the 5.9%.2 Figure 1.1 compares Vietnam's growth performance of infrastructure services, and how performance with some of Vietnam's neighbors. to target infrastructure interventions to the needs It should be borne in mind that regional of the poor. competition in terms of GDP growth is strong: At first glance it may appear odd to suggest Vietnam's average GDP growth in 1994-2003 that Vietnam's approach to infrastructure should was eighth best in the world. change. With infrastructure playing an important A key factor in this success is considerable role in Vietnam's 7% economic growth rate and in government emphasis on investment, and the reduction of poverty, the Government's investment in infrastructure in particular. As strategy over the past decade has served the seen in Figure 1.2, since 1997 infrastructure country well. Of course, no matter how well the investment has outpaced GDP growth, strategy has worked in the past, there is always boosting the economy's productivity. Table 1.1 room for improvement. But in addition there are illustrates that Vietnam's total investment and important changes under way in the economy infrastructure investment have been high that demand refinements to the strategy for the relative to other regional countries in recent years to come. Among the changes are the years (and East Asian countries have high approaching end of concessional sources of investment rates compared to the rest of the finance, increasing urbanization, an emerging world). The Government's focus on need for increased maintenance, and increasing infrastructure is illustrated by the fact that inequality between provinces. These changes between 1997 and 2002 about 44 percent of total have implications for the sources of infrastructure state investment was directed to finance, the way investments are planned, how infrastructure.3 2. Source: WDI (April, 2005). 3. Source: Government Statistics Office. State investment includes the following categories: State budget, State credit and owned outlays by state enterprises. 1 Vietnam's investment strategy has played a The linkage between large-scale crucial part in delivering economic growth. There infrastructure and growth has been confirmed in is no real doubt about this. Increasing the micro-economic studies. In 2003, the economy's capital stock boosts output. The size of Government and international donors the boost is determined by the marginal undertook a comprehensive review of large- productivity of capital and by the size of the scale infrastructure investment in the country in increase in the capital stock. Numerous micro- preparing the Comprehensive Poverty economic and macro-economic studies have Reduction and Growth Strategy (CPRGS). The demonstrated high rates of marginal productivity review examined the socio-economic impact of a of infrastructure; and Vietnam has had large number of key large-scale infrastructure increases in the stock of infrastructure by projects, including the improvements to the comparison with other countries. Even if other National Highway No. 1, the My Thuan bridge, matters were the ultimate causes of growth, lower the Hanoi-Hai Phong transport corridor (see Box levels of infrastructure would have severely 1.1) and the North-South 500 kV electricity constrained Vietnam's growth potential.4 transmission line (GRIPS Development Forum, Source: General Statistics Office (GSO). Infrastructure investment includes transportation, telecommunications, water, gas and electricity 4. In the standard Solow-Swan model of economic growth the economy is specified as a production function Y=AF(K,L), where Y is output, A is a technology factor, F is a concave function, K is the capital stock and L is the labor stock. There is a mechanical boost to output when K is increased exogenously, which in the short term shows up as growth. In the longer term, however, the growth rate is given by g = a + n: growth is the sum of the rate of technological growth plus growth of the labor force. After a short term boost to the growth rate from increased capital accumulation, the economy continues to grow at its steady state rate, g, albeit at a higher level of GDP. Issues of theoretical debate include: whether higher levels of infrastructure boost a, the rate of technological/organizational innovation, and thus the long term growth rate; and whether underlying institutions explain why some countries invest in infrastructure more than others (in which case it is institutions not infrastructure that "cause" growth). A more empiric question in Vietnam is the extent of the relative contributions to growth of capital accumulation versus other contributions, such as agricultural reform or opening up to foreign trade. But there is little doubt that infrastructure investment has played a significant role, at least in the short term. 2 2003). Overall, the study confirmed the critical role played by trunk infrastructure in opening up new business opportunities, and promoting income diversification and off-farm employment. The study also showed that trunk infrastructure facilitated the spread of economic linkages between growth centers and their surrounding rural areas, proving the vital importance of connecting remote areas with power grids, and trunk roads with feeder roads to achieve poverty- My Thuan bridge reducing growth. Strong growth has played a crucial role in lifting millions out of poverty. Among the comparator nations of Figure 1.3 Vietnam has the strongest performance in reducing poverty measured at the $1 a day poverty line, lifting 43% of its population out of poverty and reducing poverty to a forecast 8% of the population in 2005. The poverty headcount at the $2 a day level fell by 39 percentage points, surpassed among the comparators only by China's reduction of 40 percentage points. The reduction in poverty rates is particularly evident in the mid- Source: General Statistics Office (GSO). Infrastructure investment includes transportation, telecommunications, water, gas and electricity Table 1.1: Investment in East Asia (% of GDP) Investment (2003) Infrastructure (1998) Infrastructure (2003) Cambodia 22 2.9 2.3 Indonesia 16 3.1 2.7 Philippines 19 5.6 3.6 Lao PDR 20 1.7 4.7 China 44 2.6 7.3 Vietnam 35 9.8 9.9 Thailand 25 5.3 15.4 Note: Investment is gross capital formation as a % of GDP, source: WDI (2005). The source for expenditure on infrastructure is ADB, JBIC and World Bank (2005), "Connecting East Asia," Appendix A, Table 7. The infrastructure data include capital and recurrent expenditure, although in some cases some expenditure elements may not be included. See source for details. 3 Box 1.1: The Hanoi-Hai Phong northern transport corridor Hanoi (the national capital) and Hai Phong (with the (iii) improved coordination of production and sales largest international port in the north of the country) schedule.6 Many new jobs were created by the new are the two growth centers in northern Vietnam. FDI. In recent years, the provinces along the Hanoi - Moreover, growth has spread to neighboring areas, Hai Phong transport corridor have demonstrated particularly Hung Yen and Hai Duong provinces dynamic economic performance. With the (located between the two economic hubs), while the improvement of National Highway No.5 and the rural economy has experienced major transformation. expansion of Hai Phong Port, the transport corridor Rural households have diversified their agricultural has reinforced the link between the two growth production (from rice to fishery and poultry) and have centers, and has enhanced the access of Hanoi to been increasingly engaged in new business global markets by improving land and sea transport.5 opportunities. More convenient transportation has also Foreign direct investment (FDI) in major industrial spurred demand for tourism in Ha Long Bay (in effect, zones has increased significantly, particularly since there is now a Hanoi-Hai Phong-Ha Long 2000, driving industrial and export growth in the development triangle). north. An interview survey with over 70 FDI firm As a result, most of the provinces in the Hanoi-Hai managers suggests that nearly 90 percent of new Phong corridor achieved faster growth in per capita investments would not have been realized without the income and reduction in the number of poor improvement of National Highway No. 5 and the Hai households, compared to the average for the Red River Phong port. The survey indicates that those managers Delta or the whole country. were attracted by the benefits, such as (i) cost Source: GRIPS Development Forum (2003). reduction in transporting imported inputs, (ii) time- saving in delivering raw-materials and final products, Source: World Bank (2004). "East Asia Update, November 2004". Missing data have been interpolated. 5. Improvement of National Highway No.5 and the expansion of the Hai Phong Port was financed by Japan (JBIC) and Taiwan. The parallel improvements in rural feeder roads were financed by the World Bank, DFID and JBIC. 6. Source: JBIC/ IDCJ (2003), "Impact Assessment of Transport Infrastructure Projects in Northern Vietnam". 4 1990s, when a large cohort passed the $1 a day reduce the infrastructure deficit facing Vietnam poverty line. Enthusiasm about the reduction in in the early 1990s at the same time as meeting poverty rates should be tempered by the the needs of a fast-growing economy. Each realization that this cohort remains close to the sector has seen impressive growth in terms of poverty line and would be vulnerable to any access to services. economic downturn. Almost 50% of the Vietnam's road network has expanded from population remains poor at the $2 a day level. 96100 km in 1990 to 205,782 km in 2002.7 While Vietnam has made remarkable progress, National level roads expanded from 15,100 much remains to be done to eliminate poverty. km with 36.6% in good condition in 1997 to The role of infrastructure investments in 17,300 km with 44.8% in good condition in these reductions in poverty has been examined 2002.8 by Larsen, Pham and Rama (2004). The average Access to improved water grew from 26% of provincial poverty rate in 1998 was 41.7% of the population to 57% between 1993 and provincial population, with a maximum of 97% 2004, with 48% of rural households and 82% and a minimum of 2.2%. Analyzing provincial of urban households having access in 2004. data they find that an additional US$ 50 million Access to hygienic latrines grew from 10% of spent on infrastructure investments is associated the population to 31% between 1993 and with an average reduction of about 2% of the 2004, with rural access at 16% and urban poverty rate (on average, about 0.8 percentage access at 76% of the population in 2004.9 points reduction in the headcount measure of Teledensity (number of fixed and mobile poverty). They further find that the impact on lines per 100 people) increased from 1.08 in poverty is greater in the poorest provinces and 1995 to around 20 in 2005.10 lesser in the richest provinces. Disaggregating All urban areas in Vietnam are electrified. In the figures for infrastructure investment they rural areas, electrification grew from 51% to find that investments in water and sanitation 88% of households between 1996 and 2004.11 very strongly reduce poverty, transport projects strongly reduce poverty, and electricity investments make virtually no impact on poverty in the local province. This last finding can be understood when it is noted that power infrastructure frequently benefits many outside the province in which it is located. 1.2 Improved Access Vietnam's program for infrastructure investment is necessarily large: investment must Rural electrification 7. Sources: WDI (April 2005) for 1990 figure; JBIC Sector Study for Transport Sector in Vietnam August 2003 for 2002 figure. 8. Source: VITRANSS. 9. Source: Vietnam Development Report 2004, World Bank, constructed using GSO data. Note that access estimates differ substantially in Vietnam, as discussed in the water and sanitation sector chapter. 10. Source: ITU. 11. Source: EVN. 5 That Vietnam's high level of infrastructure 1.3 Changing Circumstances investment has delivered improved access is further revealed in a regional comparison. Despite Vietnam's success over the past Vietnam's access levels for improved water decade in the provision of infrastructure and electricity approach those of richer services, changes are required in the way that countries in the region. For sanitation and infrastructure is supplied and managed in telephones the access levels are some distance order to deal with important shifts in the behind the best regional performers, but economy. Increasing urbanization will bring controlling for income Vietnam does better particular challenges for the planning than average for sanitation and about average process. In the next ten years Vietnam will for telephones (see Figure 1.4). probably lose much of its concessional Source: WDI (2005). National output per person is expressed as the natural logarithm of the purchasing power parity measure, expressed in constant 2000 international $). 6 financing, so it must begin to find alternative since 1994. ODA has averaged 4.4% of Vietnam's financing sources. Where once the main challenge GDP. Over the same period, World Bank was one of access-just ensuring that people were commitments to Vietnam have averaged 1.5% of provided with infrastructure services-increasingly GDP, of which commitments to infrastructure the emphasis will be on ensuring that the service projects have averaged 0.77% of GDP. Apart provided at a reasonable price and quality. There from an $11 million grant from the GEF in 2002- will be an increasing need to ensure adequate 2003 and $75 million of project guarantee at maintenance and operational efficiency to 0.75% in 2003, all of the World Bank lending was minimize costs, and effective regulation to by IDA, which lends at low concessional rates. distribute costs appropriately across current and The threshold for IDA borrowing currently future taxpayers and consumers. And finally, stands at a GNI per capita of $895. Countries there is evidence of increasing inter-provincial that exceed this threshold begin a transition inequality, which will require new approaches to period of several years in which they ensure inclusive development. progressively lose the right to borrow at IDA's concessional rates, and 'graduate' to borrowing from IBRD. In 2003, Vietnam's GNI per capita 1.3.1 Impending Loss of Concessional was $480. Over the period 1995-2003, the growth Financing of GNI per capita expressed in US dollars Over the next decade Vietnam is likely to lose averaged 10.5%, while in the five years to 2003 access to the cheapest sources of donor funds, the average growth rate was 6.6%. Supposing resulting in a large increase in financing costs. that GNI per capita continues to grow at An increase in the cost to government of donor somewhere between these two rates and that the assistance has important implications for the threshold remains unchanged, Vietnam will cost of infrastructure investment overall. commence the graduation process between 2010 Figure 1.5 indicates the level of foreign and 2013. development assistance received by Vietnam Graduation greatly increases the present value of loan repayments on new loans, although it does not affect repayments on the stock of existing loans. A typical IDA credit has Table 1.2: Present value of repayments on a $1 loan from the World Bank Group Governmen's'Discount Rate 5% 10% 15% IDA $0.45 $0.20 $0.11 IBRD $0.74 $0.48 $0.34 Note: These calculations are indicative only, based on standard lending conditions. Loan terms for specific countries may differ from those assumed here. Calculations for IBRD assume a fixed spread loan with an interest rate of 2.3% and constant principal repayments. 7 a duration of 40 years, with a grace period of 10 higher proportion of GDP. Consequently, the years, no interest payable, and a service fee of Government will need to generate more 0.75% per annum. A typical IBRD loan has a financial resources to maintain the same level of duration of 25 years, a 3 year grace period, an physical infrastructure investment. interest rate currently in the order of 2.3%, and a To give a very rough indication of the service fee in the first four years of 0.85%. Table importance of the increase in financing costs, we 1.2 sets out the present value of the future can consider the 1996-2000 Public Investment stream of repayments for a hypothetical loan of Program (PIP). Donors provided VND 76,090 $1 from IDA or IBRD. The table indicates that if billion (around US$ 4.8 billion) for transport, the Government of Vietnam has a discount rate energy, water and sanitation projects in the PIP.13 of 10%, when it borrows $100 million from IDA, This sum represented 72% of funding for these all the future repayments spread over 40 years PIP projects. If all of this funding had been on have a present value to the government of just IDA terms and if the government's discount rate $20 million. But borrowing $100 million from were 10%, the cost of the borrowing in present IBRD, the cost to the Government in present value terms would have been VND 15,218 billion; value terms more than doubles to $48 million.12 if all donor funding had been on IBRD terms, the IDA eligibility also has implications beyond cost would have been VND 36,523 billion. The the cost of borrowing from the World Bank. The difference is VND 21,305 billion, or about 1.2% of World Bank's classification is the starting point total GDP during the period. for consideration for concessional funds and debt restructuring terms by other multilateral and bilateral institutions. Consequently within the next ten years the cost of borrowing from other donors is also likely to increase. It should be noted that even for IBRD loans the present value of repayments is less than the present value of the loan funds received. Provided the money is invested in sound projects, it makes good sense to borrow as much money as possible under these terms. After graduation Vietnam should still find it financially attractive to borrow as much as possible from the Bank Group, but in doing so the social cost of repayments will represent a Source: WDI (2005). GDP per capita data from 2003. 12 The arithmetic of these calculations can be understood supposing a very simple loan arrangement, where principal (P) plus interest (r) are repaid in one single payment after n years. Using the government's discount rate (), at the time the loan is incurred the present value (PV) of the future repayment is thus: P x (1 + r)n PV = (1 + d)n Provided the government's discount rate is greater than the interest rate, the present value of money repaid is less than the principal. The greater the discount rate, the smaller is the present value of repayments. The logic follows through to the case of multiple repayments. 13. Larsen, Pham and Rama (2004). 8 Urban settlements are categorized into six 1.3.2 Urbanization classes by the Ministry of Construction, based on High urban population growth is anticipated to be physical criteria, population, population the primary driver of future infrastructure density, level and nature of economic activity, investments. Currently Vietnam's population is GDP, and infrastructure provision (see Table predominantly rural, reflecting its current level of 1.3). The smallest towns to be classified as urban development. In 2003 the population was 25 per centers (Class V) have a population of more than cent urban. But as Vietnam's economy grows, it is 5000, with over 65% employed in non- likely to follow most of its regional neighbors agricultural sectors. The average population of towards higher rates of urbanization (see Figure each urban classification is expected to triple 1.6). Already Vietnam's cities and towns account between 2000 and 2020. The Government's for about 70 per cent of total economic output, and strategy is to promote urbanization of district most foreign direct investment is directed towards towns and some rural areas as a means of cities. Economic opportunities in urban areas reducing migration to the large cities. But currently attract about one million people urbanization projections suggest a decreasing migrating from rural areas each year. As a result proportion of the urban population is expected the urban population is currently growing at a rate to live in Class IV and V district centers and of 2.9% per year, compared with a total population towns. growth rate of 1.1%.14 It is likely that growth of The major growth triangles can be identified in Vietnam'sruralpopulationwillleveloffinthenext the Red River Delta bounded by Hanoi, Haiphong five to ten years, with all new net population and Halong in the North; the Mekong Delta growth being concentrated in urban areas. anchored by Ho Chi Minh City in the South; and Comparing China's historic income and a Central triangle based on Danang. Fast growth urbanization rates with Vietnam and extrapolating in urban population is expected to strain current forward based on Vietnam's expected income urban infrastructure capacity, revealing major growth, Vietnam's urban population is likely to bottlenecks in infrastructure service provision. account for 45% of the total population by 2020. These bottlenecks are likely to be particularly Table 1.3: Urbanization Forecasts 1998 2010 2020 Urban Class Number % of urban Number of % of urban Number of % of urban of Cities population Cities population Cities population Hanoi & HCMC Special 2 37% 2 39% 2 40% Cities National Cities Class I 3 9% 3 10% 3 11% Regional Cities Class II 12 15% 12 16% 12 17% Provincial Cities Class III 16 7% 18 8% 20 9% District Towns Class IV 58 14% 62 13% 66 12% Townlets 612 18% 1172 14% 1831 11% Class V 14. Source: WDI (2005), data for 2003. Note that urbanization projections vary. The GSO forecasts 22% urban population by 2020. 9 pronounced in and around the major urban areas such as Ho Chi Minh City, Hanoi, Haiphong, and Danang. Urbanization presents an opportunity to reduce the costs of infrastructure provision, through economies of scale. However, this advantage requires that new investments be well planned. If new infrastructure can be put in place in peri-urban areas before development occurs, the costs will be much lower than trying to retro-fit infrastructure in areas that are Gravel roads improve access already populated. Urbanization presents a variety of challenges for the planning system. sections of the country. Addressing the Despite the opportunities for cost reduction infrastructure needs of these remaining pockets presented by more dense networks, the overall will pose difficult policy problems concerning the needs of the growing urban population are likely extent to which expensive subsidies are merited to require large increases in investment amounts for small pockets of the community. at the municipal level. At present only half of urban residents have access to piped water, no 1.3.3 Larger Stocks of Infrastructure cities treat wastewater, and urban transport is already being threatened by greater congestion. The emphasis of infrastructure policy over the Addressing the infrastructure backlog at the same past decade has been the rollout of new time as catering for new urban residents will infrastructure, providing access to new require mobilization of large amounts of finance, consumers. As seen above, the task of providing requiring the government to look beyond current access is still far from complete. Nevertheless, as sources of finance, and new fiscal arrangements the stock of infrastructure increases, it is possible between different levels of government. that there will begin to be diminishing returns to Urbanization also presents challenges for how infrastructure investment, there will certainly be Vietnam addresses poverty and inequality. The an increased need for maintenance, and as the percentage of people in poverty is lower in urban task of ensuring universal access draws to an end areas than rural areas. But there are more poor increasing attention should be turned to per square kilometer in urban areas. Poverty in ensuring that the installed infrastructure is urban areas, both in percentage and density efficiently operated and maintained. terms, is likely to increase, at least in the medium There are high social returns to the initial term, as more of the rural poor migrate. Because provision of infrastructure networks. The of the economies of scale in cities addressing the average economic rate of return on the World infrastructure needs of urban poor will be less Bank's four completed infrastructure projects in costly than addressing the needs of the rural Vietnam during 2000-2003 was 30.2%.15 But poor. At the same time, it seems likely that there are also likely to be diminishing marginal pockets of rural poor will remain as the poorest returns beyond a certain point. For example, 15. Economic rates of return calculated at evaluation, on FY2000 power development (19%), FY2000 power sector rehabilitation (38.8%), FY2002 highway rehabilitation (38%), and FY2003 2nd highway rehabilitation (25%). 10 providing a gravel road to a rural village for the a large component. Infrastructure investments first time could yield a high marginal benefit as directed to providing access to infrastructure will a result of increased access to markets. tend to have high returns, but the increasing Subsequently sealing the road may yield ICOR suggests that greater scrutiny is additional benefits, but probably not as great as particularly warranted for investments that are the original marginal benefit. The average not directed to the access agenda. economic rate of return across World Bank Vietnam needs to increase the efficiency with infrastructure projects in the East Asia and which investments are selected, and, once Pacific region during 1990-2004 is 21%, investments are made, to increase the efficiency providing suggestive evidence of lower returns with which infrastructure services are managed. in other countries where infrastructure networks Investments to increase access to infrastructure are more developed. services are relatively easy to identify (find It is possible to interpret Vietnam's increasing sections of the population without access) and incremental capital output ratio (ICOR) (see have high social returns. Once universal access Figure 1.7) as evidence of diminishing returns is achieved, it will become increasingly difficult from infrastructure investment. ICOR is to identify which projects should be allocated measured as annual investment divided by the investment funds. Improved planning processes annual increase in output (GDP). Other things will be required, to ensure that limited funds go equal, the more productive is investment, the to the projects with the highest rates of return. greater the increase in output associated with a Efficient management of services is a unit of investment, and the lower is the ICOR. question of eliminating waste, lowering the cost The increase in ICOR during recent years can be of service provision, and improving quality. seen as suggestive of diminishing returns to There appears to be considerable scope for investment, of which infrastructure investment is improving efficiency in service provision. For example, a benchmarking exercise carried out in the water sector highlights that CAPEX efficiency gains of the order of 43% of total capital costs could be made in achieving the goal of 100% urban coverage if water utilities were to catch up with the industry top quartile performers. Improving such aspects of service provision will require, among other matters, improved incentives for infrastructure managers. Another implication of the transition from providing access to providing efficient services is an increased need for maintenance. This is particularly likely to be true for roads. With the road network fairly new, there has been relatively little need for maintenance. But as the recently-built roads age, there will be an increasing need for maintenance spending. Source: WDI (2005). ICOR is calculated as gross capital formation (constant LCU) divided by the annual change in Between 1998 and 2002 VRA spent an average of GDP (constant LCU). US $23 million on periodic maintenance of 11 national roads and US $12 million on routine increased in recent years. The national Gini maintenance. These figures represent less than coefficient has risen from 0.34 in 1992/93 to 0.35 half the maintenance needs as estimated by VRA in 1997/98 to 0.37 in 2002.16 The ratio of the top under its Ten-Year Strategic Maintenance Plan. to the bottom quintile's per capita expenditures has risen from 4.6 to 4.7 to 5.3 in the same years. Examining just the rural population or just the 1.3.4 Rising Inequality urban population, the Gini coefficients have Although Vietnam has done much to ensure that stayed broadly stable, indicating that the rising the benefits of growth are spread across the inequality is mostly due to increasing inequality country, national measures of inequality have between rural and urban populations. Rural Source: GSO. Note: ethnic minorities exclude Kinh and Chinese groups. Source: GSO. 16. Source: VHLSS. 12 areas are poorer and the decline in poverty has population: Northern Uplands, North Central been smaller in rural areas than in urban areas Coast and Central Highlands (see Figure 1.9). (see Figure 1.8). The Figure also indicates that Since 1993 the benefits of growth have been ethnic minorities are constrained from unequally spread across regions, and migration participating in economic opportunities, has also redistributed the incidence of poverty signaling a potential disconnection between across regions. Figure 1.10 illustrates that growth and poverty reduction in remote and poverty has become more concentrated in the disadvantaged areas. three poorest regions, while the poor have Poverty is unequally spread across the become a smaller proportion of the population regions. Fifty-three percent of the poor live in in the South East region. three regions that account for 34% of the total There is also evidence of increasing Note: The figure shows each province's contribution to poverty which is defined as the difference between the province's share of the poor population and the province's share of total population. Source: Joint Donor Report (Vietnam Development Report 2004). 13 inequality in access to infrastructure services. households are more likely to live in villages Figures 12 and 13 illustrate that not only do the without road access, and that the increase in rich have greater access to clean water and poor or near poor households with road access hygienic latrines, but the increase in access has been smaller than for middle or near rich between 1993 and 2002 has been greater for the households. It seems likely that inequality of rich than for the poor. Measuring access to roads access will continue to increase in the medium in rural areas by the percentage of households term, since the poorest households are the least living in a village that a car can drive to, the willing and able to contribute to the cost of story is a little more complicated (see Figure infrastructure connections. 1.13). But it remains true that the poorest To the extent that inequality is a policy Source: Joint Donor Report (Vietnam Development Report, 2004) Source: Vietnam Household Living Standards Surveys (1998, 2002) 14 concern for the government these various trends infrastructure challenges in a flagship study, will require the design of tailored policy "Connecting East Asia". The flagship study responses to minimize increases in inequality organizes infrastructure challenges into three across the country. main themes: inclusive development; coordination; and accountability and risk 1.4 Shared Challenges management. Inclusive development is concerned with Dealing with Vietnam's changing the goals of generating growth and ensuring circumstances requires an evolution of its benefits are shared across the Vietnam's infrastructure strategy. New community. The role of Vietnam's financing sources must be mobilized to permit infrastructure in generating growth and accelerated implementation of desirable reducing poverty have been discussed in projects, and to prepare for the transition to this chapter, and additional measures that non-concessional donor assistance. Investment can be taken to effect a more equitable criteria should be improved to focus on distribution of benefits are discussed in economic rates of return, and planning Chapter 5. processes need to be streamlined. Coordination concerns the State's ability to Infrastructure procurement and service generate strategic vision and translate that efficiency need to be improved. And revised vision into infrastructure outcomes. This is approaches to subsidy delivery are needed to the subject matter of Chapter 3, dealing with deal with the changing characteristics of planning. Chapter 6, dealing with reform poverty in Vietnam. prioritization, is also intended to assist the These challenges are shared by many of planning process. Vietnam's neighbors. The ADB, JBIC, and the Accountability and risk management World Bank recently examined the region's address the interaction of the various players, including the State, consumers, service providers, and investors, and how it can be guided to ensure appropriate infrastructure outcomes. Accountability involves rewarding good performance and punishing bad performance. Risk management involves ensuring that the potential costs and benefits of actions are equitably and sustainably allocated. These issues are addressed in Chapter 2, on financing and investment decisions, and Chapter 4, dealing with mechanisms for improving efficiency. These common themes underline the potential to learn from regional neighbors, and more generally from international experience. This report illustrates particular ideas for reform with examples from international experience. 15 16 2. Financing Issues (i) Financing of new infrastructure investment currently amounts to about 9-10% of GDP. An increase to 10-11% would seem to be justified for the coming five years, based largely on the goal of providing increased access to electricity and water, and keeping pace with demand growth in electricity. (ii) Currently donors meet around 30% of the ultimate burden of the investment program, and consumers ultimately pay for around 50%, with the Government budget bearing the remainder. In future the contribution of donors is likely to diminish, and greater burden should be placed on consumers. (iii) Diversification of financing mechanisms would allow more investment to be brought forward in time. To achieve such diversification will require wide-ranging reforms in capital markets, as well as greater cost recovery in some infrastructure sectors. F inancing needs are a function of the GDP each; while water and sanitation and growth and equity objectives sought to be telecommunications infrastructure investment achieved by planning decisions, and the have been in the order of 1.4% and 0.8 % of GDP efficiency of resulting investments. They are respectively. Across sectors, these investments thus the outcome of matters addressed in sum to about 9.4% of GDP, without taking subsequent chapters. However, before planning account of gas sector investment. proceeds too far there is a need to take into Looking to the future, sectoral plans and account the financing possibilities; the budget forecasts suggest future annual infrastructure envelope. So it is useful in this chapter to take investment summing to 11.4% of GDP, an stock of possible financing needs and the increase of 2% of GDP over recent levels:17 sources of finance available to meet them, In September 2005, the Ministry of before moving on to the details of potential Transport estimated future financing needs infrastructure reforms in subsequent chapters. in a Medium Term Expenditure Framework, which matched proposed investment with 2.1 Level of Infrastructure Fincancing potential financing sources. The proposals for capital spending in 2006 to 2008 Table 2.1 provides rough estimates of recent amounted to VND 69,186 billion (US$ 4.3 investment levels in the different infrastructure billion) over the three years, and averaged sectors. The greatest investment has been in 4.1% of GDP per year. transport and energy, with roughly 3-4% of In the electricity sector, investments 17. In 2005, 2% of GDP was about VND 15,250 billion (US$ 966 million). Estimates of investment as a proportion of GDP assume that GDP grows at 7% annually. 17 required to meet the Fifth Power Master of VND 57,547 billion (US$ 3.62 billion) Plan amount to VND 215,078 billion (US$ during 2005-2010, or 1.2% of GDP annually. 13,743 million) in the years 2005-2010, or In the telecommunications sector, in October about 3.9% of GDP. This figure is now 2005 the Ministry of Post and Telematics regarded as an underestimate, because of adopted a target of 32-42 total telephone higher than expected demand growth in lines per 100 population by 2010. To achieve recent years. The financial model used by 35 lines per 100 population would require EVN to plan future investments suggests about VND 57,000 billion (US$ 3.6 billion). that during 2005-2010 capital expenditure Spread over the period 2006-2010, this will amount to VND 237,246 billion (US$ 16 would amount to around 1.4% of GDP billion), which in annual terms is about 4.7% annually. of GDP. The forecasts should not be interpreted as an In the water and sanitation sector the endorsement of sectoral investment proposals. Government has set coverage targets to Closer analysis of the individual sector plans achieve its 2010 development goals. The may find ways of economizing on investments, targets are 85% for urban water and and budgeting decisions could result in sanitation, and 75% for rural water and indefinite deferral of some investment sanitation, which would require investment proposals. Nevertheless, there is a reasonable Table 2.1: Vietnam's Recent Investment in Infrastructure 1999 2000 2000 2001 2001 2002 2002 20032003 VND billion VND billion Water & Sanitation 2,132 2,306 2,532 2,778 Telecommunications 8,422 Electricity 13,517 18,172 19,548 Transport 11,219 11,660 17,871 21,576 US$ million US$ million Water & Sanitation 153 163 172 182 Telecommunications 543 Electricity 918 1,189 1,260 Transport 805 823 1,214 1,412 % GDP %GDP Water & Sanitation 0.53 0.52 0.53 0.52 Telecommunications 1.39 Electricity 2.81 3.39 3.23 Transport 2.81 2.64 3.71 4.03 Note: Blanks indicate missing data. The water & sanitation data are estimated based on statements in the water and sanitation strategy paper that over the past 10 years US$ 1.003 billion was spent on urban water, and during 1999-2002 VND 3160 billion was spent on rural water and sanitation; and supposing that annual investment grew at a smooth rate of 7%. Telecoms figures based on VNPT's investment budget in 2003 of $133 million, and a BCC for $230 million of foreign investment. While BCCs are irregular, this figure is close to the annual average of BCC investment since 1994. Electricity data are taken from a financial model of EVN, using historic data prepared according to international accounting standards, to which are added PPI database figures for investment in the Phu My II and III BOTs, supposing that contracted amounts were split equally across 2003 and 2004. Investment in gas pipelines is not included. Transport data are taken from the PER, Table 11.7, subtracting recurrent spending from total spending. Official exchange rates from WDI. 18 case for some increase in investment levels. Even using the outdated Fifth Power Master Plan estimates, annual electricity investment would need to increase by about 0.7% of GDP. Annual investment in water and sanitation would need to increase by about 0.7% of GDP if the Government's development goals are to be reached. In the telecommunications sector, it seems likely that increased competitive pressure on VNPT will decrease its profit New bridge in Halong replacing slow ferries margins and hence ability to finance investment. If sectoral targets are to be met, telecommunications, and the transport MTEF telecommunications investment will need to estimates which seeks to match proposed stay at roughly the same level as a proportion of investments with available sources of finance. GDP, requiring mobilization of alternative Nevertheless, given macro-economic finance, notably increased private investment. concerns about declines in the marginal For purposes of thinking about finance productivity of investments (see section 1.3.3 mobilization, a figure of 10-11% of GDP seems on the ICOR), these estimates should be subject reasonable for investment in transport, to further scrutiny. Individual investment electricity, water and sanitation, and decisions should be justified at the micro- telecommunications. This financing target is economic level, on the basis of good feasibility based on the goals of satisfying demand in studies and estimated rates of return. In the electricity, and meeting Government targets for absence of project monitoring that measures access to electricity, water, and the financial and economic impact of Table 2.2: Infrastructure Investment Financing Mechanisms (% of GDP) Finance source Finance source Transport Transport Electricity Electricity Telecoms Telecoms Water Water Total Total Users 0.9 0.3 0.1 1.3 ODA 1.7 1.2 0.3 0.3 3.5 Budget 0.8 0.1 0.1 1.0 Govt. Bonds 1.2 1.2 SOCBs 0.1 0.2 0.3 Private 0.2 1.2 0.6 2.0 Community 0.1 0.1 Total 4.0 3.4 1.4 0.6 9.4 Source: Own calculations based on data from the following sources: Transport: Ministry of Transport and Department for International Development, "Strategic Review of Transport Donors' Support to the Government of Vietnam's Socio-Economic Development Plan (SEDP) for 2006-2010", June 2005; Electricity: EVN financial model; Telcommunications: crude estimate of proportions of VNPT's investment, based on statements in Zita (2005) that ODA contributed about 35% of investment in 1993- 2001, and that Vietindebank lent around $63 million in 1999 supposing that these levels of financing continued in subsequent years; Water: data in the Water Supply and Sanitation Strategy volume. The estimates are derived from 2002 and 2003 according to data availability, and various assumptions have been used in their calculation. Funding from DAF is incorporated according to the original source of funding. 19 infrastructure investment, the Government since the principal must be repaid from future cannot be sure that it is earning a good return earnings. Future consumers of electricity also bear on its infrastructure investment. Given the the burden when the government receives ODA magnitude of the investment program, for electricity projects. The government requires improved monitoring and evaluation is a EVN to repay the loans at a market interest rate, so matter of some urgency. that debt service must be built into future tariffs. 11% Current taxpayers pay when the 2.2 Who Pays for Investment, government uses budget revenue to finance and When? investment. 7% Future taxpayers pay when the Table 2.2 sets out information concerning the government borrows money, either from mechanisms used to finance infrastructure donors or by issuing bonds, and repays the debt investment in recent years. Figure 2.1 reports from future tax revenues, but their burden is the use of different financing mechanisms as a reduced by the margin made by the percentage of total infrastructure financing. Government in on-lending ODA to EVN. Notwithstanding the use of particular 30% Donors pay for the grant component of financing instruments, ultimately all concessional loans, and Vietnam also benefits infrastructure investment is paid for by from the difference between market interest consumers, taxpayers, or donors. For example, rates facing donors and Vietnam. As discussed when private financing is used, consumers bear earlier, if the Government of Vietnam has a 10% the ultimate burden since investors recoup their discount rate and borrows from IDA; the investments through user tariffs. When donor present value of the repayments is just 20% of loans are used, taxpayers are responsible for repayment of the debt, but only pay a part of the present value of the loan. Using the information about the financing mechanisms, an impressionistic attribution of the ultimate payment burden of infrastructure investment can be obtained:18 15% Current consumers pay when infrastructure enterprises use retained earnings to finance their investments or when communities finance their own water and sanitation projects. 37% Future consumers pay when infrastructure enterprises raise money by issuing bonds, by borrowing, or by raising equity for a private investment, 18. These calculations are not precise: donors' loan terms differ, the boundary between the present and future is not precise, in some cases ODA loans to the transport sector may be supported by project revenues rather than taxpayer revenues, and the underlying data on finance sources is only approximate in any case. 20 the amount borrowed, so that donors can be bearing some of the burden of infrastructure interpreted as bearing the ultimate burden of investment. For example, it is generally 80% of the sums lent. impractical to collect tolls for the use of rural Consumers (current and future) bear 52% of roads, and the social benefits of sanitation and the overall financing burden for infrastructure waste water treatment generally exceed private investment, while taxpayers (current and willingness to pay for these services. The future) bear 18%. As between consumers and challenge for the government is to gradually taxpayers, a greater proportion of the increase the contribution of consumers, while investment burden should be placed on limiting the contribution of government consumers (present and future) though either revenue to the relatively few cases where it is direct user charges or borrowing backed by necessary. infrastructure revenues: The breakdown of who bears the ultimate One argument for this position is that burden of infrastructure investment is also increasing the amounts paid by consumers revealing in respect of the allocation across time. serves as a means of limiting demand Current consumers and taxpayers pay for 26% growth, and hence reducing the financing of infrastructure investment, while future burden. Taxpayer funded infrastructure is consumers and taxpayers pay for 44%. Increased perceived as free by consumers, resulting in use of alternative financing instruments would potentially excessive demand from a social enable a greater proportion of the burden to be viewpoint. borne by the future. For example, increased borrowing or private equity investment would Another argument is that where revenues enable investment to be brought forward in can be raised from consumers they should time. With more finance available, the level of be, in order to free tax funds for use in other infrastructure investment could be increased, or sectors where cost recovery is lower. government finance could be withdrawn for use Another argument rests on an idea of elsewhere while maintaining the same level of fairness: between otherwise equal people it infrastructure investment. seems fair that one who benefits from a Funding by donors pays for a significant service (a consumer) should pay for it, while amount (30%) of infrastructure investment, those who do not benefit (non-consuming raising the issue of how to manage the taxpayers) should not pay. transition to the situation when concessional And finally, diversification of financing funds will not be available on the same scale. mechanisms (to liberate government capital Countries typically respond to the end of for alternative uses) will be limited when the concessional funds by borrowing less from ultimate burden is borne by taxpayers. official development agencies. Vietnam should Payments from government revenues occur take advantage of concessional finance while it through annual budget allocations, and are remains available, using the time to put in place inherently uncertain. Medium and long the necessary reforms to mobilize alternative term financing is more readily arranged financing sources. when the ultimate burden is borne by consumers, and the ultimate risk is 2.3 Finacing Institutions and commercial. As a group, consumers are Mechanisms more predictable than the political process. There is a case for government revenues Meeting current investment plans with an 21 increased level of investment, and preparing for infrastructure sectors differs according to each the transition away from concessional donor sector's ability to set cost-covering tariffs. financing, both suggest a need to mobilize new In the transport sector few data were available sources of finance. Even without these on cost recovery for this report. Saigon Port's developments, the arguments of section 2.2 operating ratio (operating expenses/operating suggest a case for shifting the sources of revenue) gradually increased from 0.78 in 1995 to investment finance. Diversification of financing 0.91 in 2002, indicating that the port's operating sources, notably with greater reliance on private revenues covered its operating costs, but by a financing, would also help to decentralize smaller margin over time.19 Over the same period financing decisions reducing the burden on the port's return on equity declined from 24.7% to central planning organizations and potentially 6%. Declining margins may reflect increased improving the efficiency of investment competition from the nearby private VICT decisions. The following discussion examines terminal. Can Tho Port's operating ratio desirable reforms that would allow increased from 0.86 in 1989 to 1.28 in 1993, diversification of infrastructure financing. declining again to 0.95 in 1995.20 Combined, Reform of infrastructure services themselves these data provide weak evidence that Vietnam's is important to the financing possibilities. ports operate a policy of recovering operating Ensuring cost-covering tariffs for infrastructure costs, but generally do not self-finance major services, where feasible, provides infrastructure investment. enterprises with not only the possibility of self- Vietnam Railways made losses in the mid financing using retained earnings, but also 1990s, but between 1999 and 2003 revenues opens the possibility for alternative financing increased at 15% per annum. VR now basically sources that rely on future revenue streams. covers its operating costs including a And reforms that improve the efficiency of contribution of 10% of its revenues to the infrastructure procurement and services can maintenance of infrastructure. Arguably, help to defer the need for new investment, reducing the overall financing needs. 2.3.1 User Payments By the estimates of the previous section, retained earnings of infrastructure enterprises account for around 30% of all infrastructure financing. A prerequisite for self-financing is that tariffs more than cover the costs of operation. Cost recovery is also a necessary step towards diversification of financing sources, since most financing institutions seek to earn a positive return on their investment. The ability to diversify finance sources across Source: IDB, JBIC, & World Bank (2005), Annex 1. 19. ADB (2003). 20. World Bank, Inland Waterways and Port Rehabilitation Project, Project Appraisal Document, p.108. 22 Source: IDB, JBIC, & World Bank (2005), Annex 1. however, insufficient funds are spent on increasing tariffs without encountering maintenance. significant affordability or business Road user charges (fuel surcharge, license competitiveness obstacles. and inspection fees and toll charges) amounted In the telecommunications sector, VNPT to VND 5,671 billion in 2001, more than fully covers its costs. It funds its own covering road maintenance costs. These investments (from retained earnings, donors, revenues generally pass directly into the state and commercial bank borrowing), and makes budget, so there is no necessary link with the enough profit to contribute to the State budget actual level of maintenance spending. with dividends. In 2003, the contribution to the In the electricity sector, EVN is self- State budget was VND 3,450 billion (US$ 222 financing. World Bank loans to the sector are million), according to the VNPT website. on-lent by the Government to EVN, and EVN is Figure 2.4 illustrates that all but two required to repay the debt at a market interest Vietnamese water utilities covered their rate. Tariffs have been set to cover costs, operating costs in 2003. In developing countries including capital. Nevertheless, tariffs will need to increase to meet future investment needs. Much of the planned new investment can be financed with additional debt, but in turn this requires an equity contribution to keep the gearing ratio reasonable. Tariffs will need to increase to generate the cash to make this equity contribution. Figure 2.2 shows that an average Vietnamese households spend 2.9% of their income on energy services. This is not especially high regionally. In Figure 2.3, Vietnam's average residential and industrial tariffs of US$ 0.05/kWh are less than the regional residential average of US$ 0.068/kWh and the regional industrial average of US$ 0.069/kWh. These figures suggest there is some room for Electricity meters assist cost recovery 23 this is a rare positive achievement. and accurate inclusion of all O&M costs, Nevertheless, capital costs can account for depreciation, debt payment, and return on around 80% of water utilities' full costs, so that investment. The speed of implementation of there may be a considerable gap between this decree remains to be seen. Provincial covering operating costs and full cost recovery. People's Committees are responsible for In November 2004 the Ministry of Finance and reviewing and approving water tariffs Ministry of Construction issued Joint Circular proposed by water utilities. Tariff adjustments 104/2004/TTLT-BTC-BXD requiring all water have been irregular in the past, and have supply companies to set tariffs based on the full sometimes taken several years to implement. Some indication of the feasibility of improving cost recovery by increasing water prices can be obtained from comparisons of household spending and tariffs. Figure 2.5 compares household spending on water across the region. Vietnamese households devote on average 1.4% of their spending to water, less than the 2003 average of 1.9% in the sampled countries. Figure 2.6 compares the average water tariffs in Hanoi and Ho Chi Each bar reports operating revenue as a percentage of operating costs for an Minh City with other major individual utility. Data for 2003. Source: Benchmarking data from Vietnamese Water Supply Association regional cities. In 2003 the average tariffs were $US 0.26 in Hanoi, US$ 0.18 in Ho Chi Minh City, compared with a regional average of US$ 0.22. Figure 2.7 suggests that water is cheaper in most Vietnamese towns than in Hanoi and Ho Chi Minh City. Together these indicators suggest some scope for improving cost recovery. 2.3.2 Efficiency Improve- ments in Procurement and Service Provision While not a direct financing mechanism, efficiency Source: IDB, JBIC, & World Bank (2005), Annex 1. improvements can reduce the 24 Source: IDB, JBIC, & World Bank (2005), Annex 1. overall investment burden. For example, a reduction of 1% in electricity transmission and distribution losses would be the equivalent of an increase in system capacity of 1%, or a 112 MW power plant costing around US$ 100 million. (Electricity demand side management is discussed in greater detail in the Power Strategy volume.) Improving procurement processes, notably through greater use of competitive bidding and with greater checks on corruption, could similarly significantly reduce investment costs. Chapter 4 deals with means of improving efficiency. Each bar represents a separate utility. A further utility (Than Po, Ho Chi 2.3.3. Budget Funding Minh City) reported revenue of $1.71/m3, but is not shown in the graph because it would reduce the visible variation between other utilities. Data Budget funds are limited, and so need from 2003. Source: Benchmarking data from Vietnamese Water Supply Association. to be allocated to their most productive 25 uses. Spending budget funds on infrastructure benefits of some forms of infrastructure exceed means there is less of the budget available for the private benefits. For example, private other areas of government activity. And since individuals' willingness to pay for treatment of budget funds are drawn from tax revenues,21 waste water is low, but there are public health and taxation imposes welfare costs on the and environmental benefits that would economy, there is a real cost imposed on the frequently be sufficient to justify investments in economy whenever budget funding is used (see waste water treatment plants. Similarly, since Box 2.1 on the marginal cost of public funds). addressing poverty is a high priority for the For both of these reasons it is desirable to try to Government, investments which provide use alternative financing sources to the benefits for poor communities, greater than the maximum extent possible, and to limit the use communities' ability to pay, may be socially of budget funding to only those projects for justified. Considerations such as externalities or which it is necessary. social equity may thus justify the provision of There is, however, a strong case for budget government funds, without a requirement for funding in some cases. In particular, the social repayment. Box 2.1: The Marginal Cost of Public Funds In general, households obtain economic "surplus" spending system, government spending would be when they purchase goods and services. They value increased to the point where the marginal benefit of their purchase more highly than the money paid, or public spending equated the MCF. In practice no they wouldn't make the purchase. When governments country bases its decisions about government raise money through taxes, households lose not only spending on estimates of the MCF. One problem is the tax revenue that is paid to the government, but also that measures of the MCF are not sufficiently the economic surplus they would have enjoyed if they reliable. had used that revenue to purchase goods and services. For purposes of this report an estimate of the MCF For this reason the social cost of raising a unit of in Vietnam was generated, using the computable public funds through taxation usually exceeds one general equilibrium model of Warlters and Auriol unit. A commonly quoted estimate of the "marginal (2005). Supposing that tax rates on domestic goods, cost of public funds" (MCF) in the United States is exports, imports, capital, and labor were each 1.30, which means that the welfare cost of raising one increased by 1% of the tax rates, the resulting estimate dollar of tax revenue is the dollar transferred to the of the MCF is 1.10. The methodology used is too government plus 30 cents of lost surplus. simplistic to serve as a reliable measure (it is likely to Taxation is socially worthwhile only if the be an underestimate, because among other matters government spends the resulting funds on projects that non-tax distortions are not modeled), but it is useful for yield public benefits greater than the social cost. For policy-makers to bear in mind that funds raised by the United States this would mean that publicly- taxation are not free. A minimum rate of return on funded projects should yield social returns greater than public investment must be earned, simply to offset the 30%. distortionary costs of taxation used to raise the public The MCF usually increases as taxes increase, funds. while the marginal benefits of public spending usually decrease since the government concentrates on high return projects first. In an ideal public 21. General government revenue amounts to about 23% of GDP, of which tax revenue constitutes about 57% and oil revenues about 30%. When the Government seeks to adjust its level of spending it must ultimately adjust its tax collection, since its sales of oil are driven by commercial conditions. Consequently the marginal dollar of budget revenue is usually thought of as being derived from taxes. 26 In an ideal public finance system, the set of can demonstrate a large gap between social projects eligible for budget support would be benefits and private benefits are more likely to limited to projects where: receive budgetary support, and projects for Cost recovery through user charges is which non-budgetary finance could be accessed achieved to the maximum extent possible, receive lower priority in budget allocations. but this is not sufficient to ensure financial Adaptations to the planning process could be viability of the project using non-budgetary supported by guidelines indicating what sorts financing; and of projects are likely to exhibit the greatest The social benefits of the project have been externalities, and how to calculate these shown to exceed private benefits by reason benefits. The budgeting and planning processes of externalities or social concerns. are discussed further in Chapter 3. Projects within this set would then be ranked in descending order of social benefit, and funds 2.3.4 Banks allocated to projects until the social benefit of the marginal project were equal to the marginal Vietnam's financial sector has a wide range of cost of public funds. financial institutions (see Box 2.2), but is While Vietnam may not achieve such a dominated by four major state-owned public finance system in the near term, planning commercial banks (SOCBs), accounting for processes could be adapted so that projects that about 80% of the capital, lending and assets of Box 2.2: Vietnam's Financial Sector large corporate groups (General Corporations) FORMAL FINANCIAL SYSTEM Banking financial sector Non-bank financial sector 5 State-owned commercial banks, of which 18 insurance companies o 4 large SOCBs: 8 finance leasing companies: 3 of which are joint Bank for Foreign Trade (Vietcombank) ventures with foreign investors or wholly foreign Industrial and Commercial Bank (Incombank) owned; 5 of which are subsidiaries of SOCBs Vietnam Bank for Agriculture and Rural 1 postal savings system, the Vietnam Postal Savings Development (Agribank) Service Company Bank for Investment and Development (BIDV) 2 stock exchanges: Ho Chi Minh City Securities o 1 small SOCB Trading Center; Hanoi Securities Trading Center. Housing Development Bank for the Mekong 4 investment funds River Delta 1 Debts and Assets Trading Company (DATC) 1 Social Policy Bank established in 2003, belonging to the Ministry of 25 foreign banks' branches Finance 6 foreign banks' sub-branches 40 foreign credit institutions' representative offices INFORMAL FINANCIAL SYSTEM 5 joint venture banks Moneylenders, relatives and friends 36 domestic joint-stock commercial banks Rotating savings and credit associations (ROSCAs) Central People's Credit Fund System and 32 branches Source: Hoang Tien Loi (2004), "Insolvency Systems and Risk 888 local credit funds Management in Asia, paper presented at the Forum on Asian 7 finance companies, of which 5 are affiliates of Insolvency Reform 2004, the Oberoi Hotel, New Delhi, 3-5 November 2004. 27 capitalization. Arrears in the Ministry of Transport to contractors amount to VND 1,200 billion, and those of the Transport Construction Corporation amount to a further VND 1,000 billion. This problem was the result of a mismatch between planning and financing approvals, combined with the failure of SOCBs to provide credit on strictly commercial criteria. A practice of informally directing SOCBs for purposes of government policy and limited credit analysis capacity led to the accumulation of non-performing loans (NPLs), amounting to about 18% of outstanding loans at the end of 2003. A large proportion of NPLs were accumulated during the period 1995-98 when Bank for Investment and Development (BIDV) policy loans were made to inefficient state- owned enterprises. Since then the State Bank of the banking system. Over the past decade the Vietnam has applied stricter control including SOCBs have evolved from specialized policy- increased reserve requirements to account for lending vehicles to more commercially oriented NPLs, the banks have improved their credit financial intermediaries. 22 analysis, the Government has provided state With the exception of firms in the transport budget resources to resolve NPLs of state- sector, infrastructure enterprises have not owned enterprises, and has established the DAF borrowed large amounts from the SOCBs. But as a specific vehicle for policy lending and the illustrating the weaknesses of the current Debts and Assets Trading Company to help system, when transport construction firms have finance SOEs that can still trade their way out of borrowed from SOCBs, the outcome has not debt. Weaknesses continue, however, with always been happy. During 1999-2002 about continued practices of directed credit, a low 35% of transport commitments had been capital adequacy ratio (equity/risk assets) approved by the Prime Minister's office, but not averaging 3.5% for the SOCBs compared to the allocated funding. The Ministry of Transport international standard of 8%, and progress still contracted state-owned construction companies required in credit analysis. to undertake work on the promise of The mismatch between the long-term subsequent reimbursement. SOCBs were financing needs of infrastructure investment encouraged or directed to lend to the and the short-term deposits held by banks contractors to finance the construction works. means that banks are not the ideal financing SOCBs have subsequently been forced to grant institutions for infrastructure. Nevertheless, by loan rollovers, as in many cases the interest pooling their contributions in investment payments due are in excess of enterprise consortia the banks are likely to continue 22. There seems to be no universally accepted definition of "policy lending." It involves a formal request by the government that a bank lend to a particular enterprise, regardless of the bank's assessment of the enterprise's creditworthiness. In some cases these credits are backed by designated funding, some with explicit or implicit government guarantees. Typically these loans have lower margins than purely commercial lending. 28 playing a role in infrastructure financing, and it bonds for infrastructure development and VND is important that the financing is directed 2.5 trillion for the education sector, representing towards projects with the highest returns. about 0.7% of GDP. Bonds of 2 years and 5 years The SOCBs should be established on a more maturity have carried coupons of around 8%. In clearly commercial basis, free of political October 2005 the Government issued its first direction. Credit should be given only to overseas government bonds, raising US$ 750 projects with sound fundamentals. Risks need million at a rate of 7.125%. to be properly accounted. Credit rating The bonds are kept off-budget, to comply agencies, including branches of international with the State Budget Law's limit on the budget credit rating agencies, could be established to deficit of 5% of GDP. Including off-budget assist in the process. The SOCBs currently have bonds and SOCB recapitalization would raise a non-performing loan portfolio of 10-15% of the official level of public debt by about 3 total loans, or 5-8% of GDP. Systemic bank percentage points, from its current level of lending to risky projects played an important around 33% of GDP. The overall level is not role in the East Asian financial crisis of 1997 and currently worrying from the viewpoint of in Japan's long economic stagnation. The macroeconomic stability, but as the bond dangers are clear; Vietnam needs to reform its program expands the contribution to the level banking system. of public debt will increase. Clearly the bond issues should be reflected in official statistics of public debt, and if the bonds make economic 2.3.5 Bond Issues sense the State Budget Law's limit on the deficit There are three relevant types of bond issuers: should be amended. the national government, provincial The principal purchasers of bonds have been governments and infrastructure enterprises. SOCBs and insurance companies. To ensure full National government bonds are backed by the subscription, the government has directed Government's power to tax. Provincial SOCBs to purchase bond issues. Insurance governments' bonds are similarly backed by companies are obliged to invest in bonds or those governments' general revenue-raising bank deposits. These investors would, if they powers. Corporate bonds are backed by the could, seek alternative investment ability of the enterprise to raise revenue by opportunities. Obliging financial intermediaries selling its products. to invest in bond issues is not the ideal fashion The national Government has been working to ensure the highest returns for the country's to develop the government bond market, in part savings. to directly finance investment, including At the provincial level, the first municipal infrastructure, and more broadly to serve as a bonds were issued by the Ho Chi Minh City benchmark for broader capital market government in 2003, in the form of a general development. It plans to raise VND 63 trillion obligation bond, raising US$ 127 million. In (US$ 4 billion) by 2010 to be used mainly to 2004, a provincial government-owned finance infrastructure and education projects investment fund (HIFU) managed the issue of including the north-south Ho Chi Minh another US$ 127 million of municipal bonds. Highway, roads along the borders with China The rules for issuance of municipal bonds are and Cambodia, and irrigation projects in the not yet clear, and they do not always provide the disaster-prone central provinces. In 2004 the right incentives to the issuers. Disclosure rules Government issued about VND 5 trillion of for the public offerings either do not exist, or are 29 very weak. The stock of sub-national significant development but important government debt in Vietnam is not currently a institutional reforms, addressing governance threat to fiscal stability. But plans for increased and transparency in particular, are required to investment are likely to see sub-national debt permit this potential to be realized. increase significantly, requiring national oversight. 2.3.6 Government Investment Funds Issuance of corporate bonds for infrastructure development was pioneered by In recent years specialist government EVN, which issued bonds for the development investment funds have been created at the of the Ialy hydro-electric power plant in 2001. national and provincial level, with significant On May 5, 2005 EVN began issuing bonds to roles in infrastructure financing. At the national raise VND 200 billion to finance a 500 kV level, the key public financing institution for transmission line project in the Central infrastructure is the Development Assistance Highlands region. The coupon rate is 8.8% for Fund (DAF), established in 2000, with branches the first year of the five-year bond, while in the throughout the country. At the provincial level, following years the interest rate will be twelve provinces have followed the lead of Ho equivalent to the average interest rate of the Chi Minh City (see Box 2.3) in establishing local four major SOCBs plus 1.1%. Between now and development investment funds (LDIFs). 2010, EVN plans to sell more than US$ 1.6 These investment funds serve as billion worth of registered bonds on local and mechanisms for aggregating and managing international markets. funds from a variety of sources, financing a Overall the market for bonds is poised for range of projects not confined to infrastructure. Box 2.3: Ho Chi Minh City Investment Fund for Urban Development (HIFU) Established in 1997 as a pilot program, HIFU is the issues of US$ 127 million each were made in 2003 most advanced of Vietnam's thirteen local and 2004. HIFU is now examining the possibilities for development investment funds. One of HIFU's issuing bonds backed by project revenues. functions is the management of funds provided by the HIFU can invest directly in joint stock city/provincial government, helping to transform state companies that invest in infrastructure fields. In subsidies in areas such as new area building into 2001 it established the Ho Chi Minh City budget lending with full repayment. On the basis of its Infrastructure Investment company (CII), success as a funds manager, HIFU has also been contributing 15% of the initial US$ 20 million entrusted with the management of the Pollution equity capital and mobilizing the remainder from Minimization Fund of Ho Chi Minh City and the the public. CII has itself invested in two toll-road Revolving Fund for environmental improvements. concessions, the Phu My Bridge BOT, the Kenh HIFU lends to urban infrastructure projects in Dong water treatment plant, and Tan Phu Industrial transportation, water, health, education, housing, and Zone. With CII now on a sustainable footing, HIFU industrial parks. HIFU is beginning to take the lead is considering selling its shares in CII. position in syndicates, raising capital from Other direct investments made by HIFU include commercial banks, financial institutions, and the Kenh Dong Water joint stock company, the Ho organizations and individuals as it puts together Chi Minh City Securities Joint Stock Company, the financing packages for large scale projects. In Song Tan Industrial Zone Infrastructure Investment syndicated projects HIFU's capital contribution has Joint Stock Company, and the Thu Duc BOO Water been about 20% of the loan amount. Joint Stock Company. HIFU's strategy is to contribute Ho Chi Minh City has also provided HIFU with about 10-20% of the initial capital of these funds raised by issuing municipal bonds, backed by investments, and then withdraw the capital for the city's general revenues and taxing powers. Bond reinvestment when the companies stabilize. 30 An important difference between the DAF and management incentives, weak the LDIFs is that the DAF raises its funds solely accountability, and limited supervision. from public sources, and lends to public The DAF has no reserves for bad debts, no enterprises. One of the motivations for the mechanism for evaluating the credit- LDIFs is to provide a legal structure for worthiness of loans, no portfolio limits on organizing joint ventures with private weighting for individual sectors or investors, and the LDIFs can also make equity companies, and no external audits. contributions to projects. Many operational aspects of the institutions, The financial resources involved are including the LDIFs, are still at an early considerable: stage of development, including credit risk The DAF is the biggest financial institution management, accounting and reporting in the country. In 2004, the DAF stock of standards, information systems and loans outstanding was around 12 percent of supervision. GDP, and its capital amounted to VND Decree 106/2004/ND-CP is a recent 94,145 billion (US$ 6 billion), including improvement in DAF's regulatory framework. contributions from ODA (39.9%), It narrows the list of eligible borrowers, and Government bonds (14.8%), domestic trust states that only projects that are capable of funds (12.1%), social security fund (10.2%), direct repayment, are socio-economically postal savings (5.9%), Treasury bills (4.2%), efficient and have feasible business plans are state budget (3.6%), capital mobilized by eligible for DAF support. Project assets are to be DAF's branches (3.1%) and State credit used as security, and those assets cannot be (1.4%). Of the resources mobilized assigned until loans are fully repaid. An domestically, about 80 percent has been on- element of risk-sharing, through co-payments lent to SOEs. by other government bodies or by commercial In 2004 the total capital channeled through banks, is also required. DAF investment lending LDIFs was approximately US$ 400 million. and credit guarantee cannot exceed 70% of the The four most active LDIFs are located in Ho total capital of a project. These measures, if Chi Minh City (HIFU), Dong Nai (DNIF), effectively implemented, will increase the Binh Duong (BDIF) and Hanoi (HANIF). probability that debts will be serviced and fiscal The proportions of these provincial costs minimized. But other problems of governments' investments handled by their governance and transparency remain. LDIFs in 2004 were 13%, 9%, 7-8%, and 33% respectively. Because these institutions are fairly new, their governance arrangements have not been fully developed. The DAF formally reports to the Prime Minister, but is also subject to oversight through its Board of Management by the Minister of Finance, State Bank of Vietnam, and the Ministry of Planning and Industry. The combination of these various lines of Toll-road financed by Ho Chi Minh City Infrastructure authority mean the DAF suffers from mixed Fund (HIFU) 31 The same general weaknesses in also reduce the commercial focus of the governance and transparency exist in the case investment funds, reducing the rigor of their of the LDIFs. The central government has project evaluations. plans to legislate in this area, but the decree A weakness shared by DAF and the LDIFs is envisaged in the 2001 Public Administration the risk posed to their respective governments' Reform Master Program remains in draft fiscal positions. Given the magnitude of their form. The absence of central regulation on operations and the potential for making loans governance has been a source of flexibility, that are not commercially viable, there is a need allowing provinces to experiment with to develop governance structures that places the different structures. It is important that if or institutions at arms' length from the when the central government legislates the governments, to discourage false expectations best features of each LDIF be retained. At that projects are ultimately backed by the same time, legislation on crucial government. Alternatively, there is a need for features such as governance of the funds more public accounting of these institutions, may help to provide confidence that and the inclusion of the accounts within investors' rights will be protected, helping consolidated government accounts. the funds to raise more long-term capital. Overall, these funds are helping to fill the One of the criticisms of the LDIFs is that gap in long-term finance in Vietnam's capital they have not been very successful in markets, but they pose significant risks. Various leveraging their initial charter capital. governance and transparency reforms are Although the institutions have a commercial required to lessen these risks, and even then, it focus, they can be directed to undertake projects will be beyond the capacity of many provincial that may not be commercially profitable at governments to establish effective LDIFs. These market interest rates. sorts of funds alone will not meet all of the The DAF onlends its funds at interest rates needs of infrastructure financing. that are lower than the cost of raising them. The government subsidizes the interest rate 2.3.7. Sub-National Government Financing difference as well the operating costs of the DAF. Decentralization has increased the spending Seven LIDFs currently actively administer obligations at sub-national levels. As "entrusted" funds, provided by provincial decentralization has progressed, the share of governments to support favored policies. sub-national governments in total government These funds are not subject to the typical expenditures has risen from 26% in 1992 to project appraisal process of the LDIF, and 48% in 2002. During 2005-2010 annual the LDIFs receive a fee for their requirements will be of the order of US$ 378 administration. million for urban water supply, US$ 280 The rationale for supporting non- million for wastewater collection and commercial transactions is not clear. This sort of treatment, US$ 239 million for drainage support is nothing less than a public subsidy, including canal rehabilitation, and around US$ which should be subject to the normal rigors of 800-900 million for urban transport. This gives public expenditure review. Subsidies should be a total of US$ 1.7 to 1.8 billion annually, or justified in terms of addressing externalities, or around 3.7% of GDP over the period 2001- particular poverty issues, so that subsidy rates 2010. In addition annual required spending on should differ across sectors. These policies may low income housing in urban areas, a 32 municipal responsibility, has been estimated at levels. At present there are many overlapping US$ 835.4 million, or 1.8% of GDP.23 fees on different real estate assets and This has given rise to a challenge to mobilize transactions, which could be consolidated in a financing at sub-national level. The major single more efficient property tax. Since avenues for provincial governments to mobilize property development is a strong driver of funds for municipal infrastructure are: demand for municipal infrastructure, property Budgetary resources, including transfers taxes are frequently seen as an efficient form of from the central government. cost recovery for publicly provided Borrowing from SOCBs. infrastructure. There may also be the potential Own-source revenues generated mostly for greater cost recovery for a range of from land use rights and partnerships with municipal services (eg parking fees). the private sector. Another area examined in the PER-IFA is State development credits from the DAF. the system of equalization transfers from the Bond issues. central government to the provinces, which LDIFs. plays an important role in reducing horizontal The potential contributions of SOCBs, the disparities between provinces arising from bonds market, the DAF, and LDIFs have differing abilities to raise their own finance, in already been discussed. The central source of turn arising from differences in provincial funds is likely to remain transfers from the wealth and differences in provincial central government, but more could be done government capacity. Greater reliance on to improve sub-national governments' objective formulas (rather than ad hoc own revenues. negotiation) in the allocation of these transfers The 2005 PER-IFA examined the challenges would provide greater certainty to the inherent in assigning adequate revenues to sub- provinces over their future revenues, and national governments. One potential area for would thereby enhance sub-national reform is greater revenue autonomy at sub- borrowing capacity (since lenders, too, would national level. At present all taxes are centrally have greater confidence concerning the ability collected. The revenues from some taxes are of sub-national governments to repay debt). It retained 100% at the central level, some other is important that such formulas are based on taxes are assigned 100% to provinces, and revenue potential, rather than actual revenues revenues of remaining taxes are shared between collected, to ensure that provincial the central government and the provincial governments do not have disincentives to raise governments where the taxes are collected. their own revenues. District and commune governments can collect At present municipal governments certain fees such as waste collection and school frequently raise revenue through deals with tuition fees, but there are no sub-national taxes. private property developers, particularly The PER-IFA suggested the possibility of through the sale of land use rights. As permitting provincial governments to introduce provincial governments do ad hoc deals with personal income taxes that piggyback on the the private sector under less than ideal existing national income tax, and of introducing disclosure environments, possibilities exist for a modern property tax at district and commune inappropriate behavior. There is a need for a 23. For the assumptions behind these estimates see the Urban Infrastructure Strategy paper. 33 basic framework at the provincial level that complements to the banks (see, for example, makes public the operational standards of the Box 2.4). Such institutions can help to broaden provincial government for partnering with the the range of maturities and risks available to private sector. Ideally, the standards should be investors, and thereby offer offer a wider range developed by each provincial government and of maturities and risk-pooling services for announced to the public; alternatively, they investors. Currently much private domestic may be proposed by the central government. saving is directed toward investment in These standards should impose an obligation to property, small-scale business ventures, gold, use competitive bidding, and should establish a offshore accounts or simply held 'under the transparent procedure for dealing with mattress'. The promotion of vehicles for long- unsolicited proposals. term investment may help to promote the national returns on these savings, and would also help to provide a long-term source of 2.3.8. Non-Bank Financial Institutions finance for infrastructure. In more developed financial markets, risk By providing competition to the banks, pooling institutions (insurance companies) and non-bank financial institutions can help to contractual savings institutions (such as mutual promote overall efficiency. And their presence funds or private pension plans) are important can help economies to recover more quickly Box 2.4: Using Pension Funds to Finance Infrastructure in Chile To increase investment in infrastructure during the term financial instrument, the Infrastructure Bond, early 1990s, Chile's government introduced a was created. The typical infrastructure bond offered concession program to attract private capital into the a 20-year fixed rate bond denominated in Unidades transport infrastructure sector, covering roads and de Fomentos (an inflation-adjusted unit of account highways, bridges, tunnels, and airports. The used in Chile with a AAA local rating and a program has managed to attract over US$ 3.6 billion monoline guarantee. The bonds are sold exclusively in private investment in infrastructure. to local private investors, including local pension Chile was the first Latin American country to allow funds, and they have been continuously pension funds to invest in infrastructure projects. In oversubscribed. 1981, Chile replaced its bankrupt pay-as-you-go Of the 16 toll road concessions awarded, 11 retirement system with a fully funded system of have opted for the alternative of Infrastructure individual retirement accounts managed by the Bonds, 3 have financed through bank loans and 2 private sector. By 2001, more than 95% of Chilean concessions have not yet decided their financing workers had joined the system; the pension funds structure. The development of the infrastructure have accumulated US$36 billion in assets; and the bond market was assisted by the fact that in 1995 average real rate of return has been 10.9% per year. Chile achieved an "A-" credit rating, creating an Initially, pension funds were legally constrained opportunity for monoline insurance of bond from investing in infrastructure projects. In issuances. In November 1998, the consortium particular, the lack of investment grade rating for handling the upgrade of the Talca ­ Chillan stretch bonds or other financial instruments issued by of the nation's main thoroughfare, Route 5, issued concession companies was an obstacle. In order to the first US$ 150 million in infrastructure bonds. By facilitate investments from pension funds and mid-2002, a total of US$ 963 million of insurance companies legal changes to financial and infrastructure bonds had been issued in five infrastructure regulations were introduced during offerings. The concession program is now being the mid-1990s. These reforms helped pension funds expanded to fund private investment in jails and and insurance companies to invest in bonds without urban infrastructure. history. As a result of these reforms, a new long- Source: World Bank (2004) 34 from shocks to the banking sector. While the 2.3.10. Equitization current reform priority is the banking sector, because of its general role in financing all Internationally, many governments have used businesses, some efforts could be directed to the sale of shares of state-owned enterprises as the promotion of the non-bank financial sector. a means of raising substantial revenue. As Care is needed to ensure adequate prudential Vietnam confronts the financing challenges of supervision of the sector. its major investment program, equitization could provide an additional source of finance. The equitization program is a process of 2.3.9 Credit Rating Agencies diversification of ownership of state-owned Credit rating agencies could help to improve enterprises by sale of shares. For the most part, the efficiency of various elements of financial equitization has involved sales of shares to markets, by improving the quality of workers, and has been attributed with information concerning the likelihood of increasing workplace productivity by repayment by companies or governments providing stronger worker incentives. seeking finance. Such information would assist Equitization can also entail sale to another SOE, in more accurate valuations of financial assets so it is not necessarily equivalent to such as bonds or shares, whether issued by privatization. Equitization frequently entails a governments or enterprises, and could be also sale of as little as 15% of the shares, with the used by banks to assist in determining credit- State remaining the dominant owner. worthiness of firms seeking loans. In 2003, about 450 SOEs were equitized, and Vietnam's first ever credit rating agency, the a further 700 in 2004. Surveys conducted in 850 Credit Ratings Vietnamnet Center (CRVC) was equitized SOEs found that businesses which launched on June 4, 2005, by the state-owned successfully completed restructuring increased VASC Software and Media Company. The their capital by 44%, turnover by 24% and labor initiative arose with VASC rather than income by 12%. Most of the equitized government officials. It appears unlikely that enterprises have been small, with capital under this firm will have the resources to provide VND 5 billion (US$ 300,000). Firms with over credit information on infrastructure firms. VND 10 billion capital accounted for only 13% Supportive regulation may be required to of the equitized companies in 2004.24 establish an agency with the capacity to obtain Rules related to infrastructure under useful information on infrastructure firms. Such Decision 155 of 2004 include: regulation could include rights of access to The national electricity transmission system information concerning tax and customs, or will remain State owned, but distribution legal obligations for firms wishing to be listed and generation are open to equitization of or to issue bonds to have a credit rating. up to 49%. Newspapers report that the Ministry of National and international communications Planning and Industry is seeking a foreign cables will remain State owned. There is no partner to set up another credit rating agency as discussion concerning who has the right to a joint venture or 100% foreign-owned use the cables. enterprise. Management and maintenance of the 24. Source: Vietnam Economy (2005) 35 national railway network are to remain State regime does not provide adequate owned, as are large airports and seaports, shareholder rights to direct managers, or sewage treatment works in big cities and does not protect minority shareholders' public lighting. rights to a proportional share of profits; Companies that have State capital of at least Investors in infrastructure are not able to VND 30 billion and average annual obtain management control; contribution to the State budget of VND 3 Shares are not listed on a stock exchange, billion and that operate in air and rail reducing the ease with which shares can be transportation will continue to be 100% State sold. Only a small proportion of equitized owned. companies are listed. In 2005 only 28 The State will retain at least 50% of capital in equitized SOEs were listed on the Ho Chi large urban water companies. Minh stock exchange, out of more than 2,400 The State will retain at least 50% of the equitized SOEs. capital in companies operating in maritime Sales are frequently restricted to managers transport. and workers, who may be willing or able to The State will retain at least 50% of the pay less for particular shares than general companies operating in the management investors. and maintenance of important roads, As the equitization process expands in size waterways, boats and bus stops. and scope, these problems need to be remedied. Construction companies no longer appear This could, in part, be achieved by a new on lists of SOEs where the State will retain at comprehensive law on equitization (or on least 50% of the capital. equitization of infrastructure firms), dealing Thus the new Decision and the new Decree with the methods of sale, legal rights of redress provide a legal basis for the equitization of of minority shareholders etc. Alternatively, the some infrastructure SOEs. By the summer of government could start with pilot projects, and 2005, equitization pilots had been undertaken in improve its practice as it goes on. both electricity generation and distribution, and plans exist to equitize all of the existing power 2.3.11 Private Investment plants of EVN except for the large hydro plants, during the next three years. The Ministry of There is great potential for more private Transport and Communications has already investment in infrastructure. Private equitized 48 enterprises, and in June 2005 investment, including foreign investment, announced plans to equitize 141 enterprises in offers a virtually limitless source of financing, 2005 and 2006. Consideration is being given to and could go far to meeting the infrastructure equitization of VNPT's two mobile phone investment agenda. But taking full advantage of subsidiaries. this potential requires sound projects in which Several general features of the current prices fully cover costs, including a return on equitization program reduce its financing capital; careful transaction preparation; and a benefits. Investors will reduce the amount they sound regulatory environment. While there are willing to pay for shares in a company if: appears to be reluctance within government to There is inadequate disclosure of advance rapidly toward a major program of information about the accounting position private investment in infrastructure, a strong and the business risks; case can be made for increased experimentation An underdeveloped corporate governance with private investment transactions, to 36 determine the extent to which a broader private potential candidate for increased private investment program would be desirable, and to participation. International capital markets are, build up the necessary experience to be able to for example, usually very willing to invest in move to a broader program. telecommunications. Moreover because Table 2.3 summarizes the amounts invested telecommunications markets can support in infrastructure projects with private strong competition they pose lesser regulatory participation since 1994. Over the period 1997- difficulties than other sectors. Involving the 2003 private participation in infrastructure (PPI) private sector in telecommunications markets commitments amounted to about 15% of total could increase financing available for infrastructure investments. Excluding a single telecommunication investment, and free public project, the US$ 1.3 billion development of a gas resources for investment in other sectors. More field and pipeline, PPI commitments amount to competitive telecommunications markets have 8.5% of total investment. That is, setting apart also historically showed stronger jobs growth. the gas development, private financing has Increased private investment in telecoms would historically played a quite small part in require an acceleration of the current movement infrastructure investment. towards liberalization, including relaxation of Energy has been the principal recipient of the current restrictions on foreign ownership. PPI, with the development of the Nam Con Son To further accelerate the process, existing gas field and several BOT independent power telecoms companies could be equitized, with projects (IPPs). Going forward, in the absence permission for foreign participation. of other financing sources EVN will need to The biggest single area of new investment purchase more than half the incremental power required is in transport, of which roads required during 2005-2010 from independent represent the largest proportion of investment sources, mainly independent power plants. The (about 80%). Toll roads can provide interesting Phu My II experience of competitive bidding possibilities for private investment. There are and successful closure provides a good many potential projects in other sectors, both potential template for further IPPs. large and small, that could potentially benefit The telecommunications sector is a prime from greater private finance, including water Table 2.3: Private Investment (Contractual Commitments)-US$ millions Ports Ports Airports Airports Tollroads Tollroads Telecoms Telecoms Water Water Electricity Electricity Gas Gas 1994 10 1995 128 1996 15 40 205 1997 70 714 110 1998 237 38.8 1999 120.5 2000 20 2001 154 2002 20 10 480 1300 2003 230 412 2004 Source: PPI database, except for telecommunications, where BCC network investments are drawn from USAID (2005). 37 and sewerage treatment plants, bridges, and to their state-owned enterprises or the private port development. sector to assume a greater proportion of But involving the private sector in infrastructure financing, they have often undertaking significant investments in provided guarantees or other forms of infrastructure is a complex and difficult task. To contingent support. For example, a state-owned attract private finance, investors must expect to enterprise's bond issue might be guaranteed by earn a return on the capital invested the government, or the government might commensurate with the risks undertaken, but guarantee the purchase of a minimum quantity these needs must be balanced with the of electricity from an independent power protection of consumers from the market power producer by its state-owned utility. The aim is of privatized infrastructure. This balancing act to increase the expected returns for private must be implemented in transaction documents investors, and hence private investment, (legal contracts, licenses, and laws established without direct cash from the budget. to induce the initial investments) and in the In considering whether to give contingent ongoing regulatory environment established to support to a project it is useful to distinguish govern the infrastructure firm's operations. To between policy and non-policy risks.25 Policy get all of this right is a highly complex affair, risk is variation in a project's net returns that requiring skilled economists, accountants, and may result from changes in government policy. lawyers, as well as careful political guidance. Unilateral changes by the government to laws, The best way of establishing these skills would regulations, or even contracts, can reduce be through experience, which suggests that project profitability. When private investors are Vietnam should, in addition to the IPP program exposed to these risks their cost of capital is envisaged for electricity, seek to establish pilot increased. When the Government bears these projects with private participation, including risks it has a stronger incentive to establish and management control rights, in a range of maintain sound policies. Overall, agreements to infrastructure sectors. compensate investors in the event of policy changes can reduce project costs. Non-policy risks are those over which the 2.3.12 Risk Management government has little or no influence. Examples It is desirable to advance investments through include the costs of construction, future demand time, but doing so introduces a risk that the for the infrastructure service, or the value of local government will not be able to repay the currency. Internationally, some governments advanced funds. A traditional element of risk have given guarantees to cover non-policy risks control has been debt management, to ensure because of the illusion that no cost is borne by the that debt repayment does not occupy an government. As with policy risks, there is a cost excessive proportion of government to the Government of bearing these risks since expenditure. As alternative financing there is some probability that the guarantee will instruments are increasingly embraced, greater be called, but in this case it is not clear that the attention will also need to be given to cost is any lower for the government than for contingent liabilities, incurred both at the private investors. national and provincial level. When guarantees are given, a fiscally Internationally, as governments have looked prudent government should take reasonable 25. See Brixi (2005). 38 steps to control the "exposure", "fiscal cost", and Government cannot afford to have sub-national "fiscal risk" created. Exposure means the governments or major infrastructure enterprises maximum possible amount the government collapse because they have assumed excessive could pay as a result of giving the guarantee. liabilities. So either the national Government Fiscal cost means the expected net present value must ensure that it has adequate revenues to of the cash flows paid as a result of giving the cover the consolidated exposure of these guarantee, taking account of the probability that entities, or that each of these entities has its own the guarantee will be called. Fiscal risk means adequate risk management framework. the variability of the cash flows paid by the government. 2.4 Recommendations Contingent liabilities can be an effective mechanism for the Government to leverage Recent levels of investment in infrastructure scarce budget resources, encouraging greater have been around 9% of GDP. Infrastructure private financing. The fact that they involve investment is devoted to the backlog of risks does not mean they are to be avoided investment required to provide consumers with altogether. Rather, it suggests a need to monitor basic services combined with system expansion the risks, to ensure they are not excessive. to keep pace with Vietnam's rapid pace of Elements of an effective risk management growth. Given that the backlog remains in terms framework include: of various access statistics, and electricity Development of guidelines and criteria for investment has barely kept pace with demand, the sorts of risks that should be guaranteed there is no evidence that this level of investment by the government; has been excessive. Indeed sectoral plans suggest Policies that limit the government's a possible need for infrastructure investment exposure to risks to prudent levels; financing of 10-11% of GDP, although these Quantitative analysis of the fiscal costs and plans need to be subjected to review on a project risks of proposed guarantees and other by project basis to ensure that each project yields forms of government support, positive net social returns. Financial reporting that discloses Within the overall level of investment there government guarantees and their expected is significant room to increase the proportion costs in the government's accounts. of non-budgetary and non-ODA financing. Institutional support for these policies, This would free up budget and ODA including staff with the appropriate skills. resources, permitting either an increased level Issues of risk management are likely to be of infrastructure investment or spending on encountered in the near future with the pressing other government priorities. The development need to develop IPPs in the electricity sector. of alternative financing reforms would also The government's approach to guarantees for help to replace concessional ODA, as it draws IPPs will have implications for other sectors. to an end. A variety of reforms would help to Policy in respect of IPP guarantees should be develop such alternative financing sources, developed as part of a broader government- and to improve the efficiency of existing wide approach to risk management. financing sources. Vietnam's risk management framework To assist in prioritizing, recommendations should embrace the activities of the national for reform are accompanied by an indication of government, sub-national governments and their proposed timeframes: (S) short-term (1-2 state-owned enterprises. In practice the years) and (M) medium term (3-5 years). In 39 general, recommendations that suggest a policy recommendations requiring capacity building change or a simple review can be implemented may require a slightly longer timeframe. within a short timeframe, whereas Recommended actions are: (2.1) Im prove project m onitoring and evaluation m echanism s to assess financial and (M ) w ider econom ic returns achieved by the infrastructure investm ent program .A particularpriority isthetransportsector,w heretherearelessobviousaccesstargets to be achieved than in other sectors and w here there is considerable reliance on publicinvestm ent. (2.2) M ovetoachievegreatercostrecoveryacrossinfrastructuresectors,w herefeasible. (S) (2.3) Establish criteriafortheuseoftaxpayerfunding in infrastructurefinancing lim iting (S) theuseoftaxpayerfundstoprojectsw here: · the socialbenefitshave been show n to exceed private benefitsby reason of externalitiesorsocialconcerns;and · cost recovery through user charges is achieved to the m axim um extent possible,butthisisnotsufficienttoensurefinancialviability. (2.4) Im prove the com m ercialfocus of public financialinstitutions,including SOCBs, (M ) DAF,and LDIFs.Lending decisionsshould bebased on com m ercialassessm entsof theprobability ofrepaym entand loansshould bepriced to reflecttherisk involved. M easures to im plem ent this include developm ent of appropriate governance structures and legalm andates w hich prescribe the conditions under w hich loans m ay be m ade,and technical assistance to build capacity in assessing potential returnsand ratingrisksaccurately. (2.5) Im prove the efficiency of bond m arkets by, am ong other m atters, im proving (M ) inform ation disclosure concerning the ability of public authorities to m eet debt obligations,issuinggovernm entbondsw ith arangeofterm s,toprovidebenchm arks fornon-governm entfinancialinstrum ents,im provedebtissuanceand m anagem ent by Treasury,increase secondary activity and liquidity of the governm ent bonds through enhancem entstothelegalfram ew ork. (2.6) Establish guidelines for the issuance of governm ent bonds to be used for (S) infrastructure financing, giving preference to bonds backed by infrastructure revenuesratherthan bytheGovernm ent'sgeneralrevenues. (2.7) Conduct an assessm ent of m unicipal financing needs and m eans, com paring (S) m unicipalneedsw ith an assessm entoffinancialresourcesavailable,and potentially available,atm unicipallevel. (2.8) Im provem unicipalfinancing capacities.Com m encew ith pilotexercisesw ith lessons (M ) to beapplied nationally.Elem entsofthepilotexercisescould include:adiagnosisof existing strengthsand w eaknessesin m unicipalcapacity;review oftheefficiency of the levels and structures ofm unicipaltaxes and charges;explore possibilities for increased transparency and publicparticipation in budgeting;build capacity in cost control; im prove accounting system s (e.g. com puterization, `m odified accrual accounting');and develop new m unicipalfinanceinstrum entsincludingbonds. 40 (2.9) Revise governance arrangem entsforthe LDIFsto legally distance them from their (S) ow ning governm ents,in thesensethatrecoursem ay notbehad to agovernm entfor liabilitiesincurred byan LDIF. (2.10) Im provetheregulatory fram ew ork forequitization,including enhanced inform ation (S) disclosure and better protection of shareholder rights; and a requirem ent that equitized infrastructurefirm sbelisted on publicstockexchanges. (2.11) Accelerateprivateinvolvem entin thetelecom m unicationsand electricity industries, (S) and launch pilotprogram sforgreaterprivate sectorinvolvem entin the w aterand sanitation and transportsectors. (2.12) Establish a risk m anagem entfram ew ork thatestablishesa cap on thegovernm ent's (M ) exposureto contingentliabilities,providesguidelinesfortheappropriateallocation ofrisksbetw een the public and private sectorsin public-private partnerships,and requiresM inistry ofFinanceapprovalforanypublicsupport,directorcontingent,to public-privatepartnerships. 41 42 3. Planning and Coordination Issues There are three broad areas of difficulty with current infrastructure planning and coordination: (i) The absence of economic criteria for setting priorities between different projects. (ii) The horizontal coordination of decisions between ministries with planning responsibilities, particularly in respect of the incorporation of financing considerations and spatial development goals into infrastructure investment planning. (iii) The vertical allocation of responsibilities across levels of government, with the principle of "dual subordination" potentially complicating or delaying approvals and with decentralization leading to difficulties of coordination across sub-national levels of government. In addition to these issues of general cross-sectoral application, improvements are particularly needed in urban planning, where spatial planning and timing are more critical than elsewhere, and in incorporation of environmental and social considerations into the general investment planning framework. 3.1 Prioritizing Investment Decisions investments. There are no guidelines for project appraisal prior to planning approval, and the The importance of economic criteria for planning process does not provide for project choosing between investment projects is likely monitoring to gain evidence on the sorts of to increase as the infrastructure stock increases. returns obtained from different project types. Identifying high return projects was easy when The lack of economic criteria to guide priorities much of the population lacked access to extends to the separation of planning for new infrastructure services. As the access rollout investment versus maintenance. In some cases advances, choosing between investments that increased maintenance will yield higher returns upgrade the quality of service will become more than new investment, and so should receive difficult. higher funding priority. An economically efficient planning process A first step towards improved criteria for the would estimate the economic rates of return allocation of public funds to public projects associated with each project, and accord would be improved feasibility studies for priority according to the rate of return. Financing would be allocated to projects in proposed infrastructure projects. Even if precise accordance with their priority, until such time rates of return could not be estimated for all as budgeted public finance had been projects, improved information would assist in exhausted. distinguishing higher priority projects from The current planning process is a long way lesser priority projects. Box 3.1 identifies areas from this ideal, with no explicit statement of for improvement in typical Vietnamese how trade-offs are to be made between desired feasibility studies. 43 Box 3.1: Common Weaknesses of Vietnamese Feasibility Studies Appraisal Requirements Most Frequent Shortcomings A. OVERALL JUSTIFICATION Lack of national and sectoral perspective, especially in Country and sector issues relation to master plans. Usually not derived from high-level plans and strategies; Development objectives generally narrow in focus. Top-down approach, possible overlap with other Funding options projects in case of donor funding. B. PROJECT DESCRIPTION Logical frameworks linking actions and indicators are Key indicators not commonly used. Limited analysis of options based on technical, Alternatives considered economic, social and environmental criteria. C. IMPLEMENTATION AND OPERATION Insufficient analysis of the commitment and capacity of Institutional arrangements the project executing agency Insufficient attention to operation and maintenance Sustainability aspects of the project. Usually based on outputs, not involving baselines or Monitoring and evaluation impact assessments. Insufficient analysis of risks (e.g. difficulties in land Critical risks acquisition) and mitigation strategies. D. PROJECT SUMMARY Limited detail on standards, operational aspects and Technical environmental implications. Estimates driven by cost norms; unreliable methodology Economic and financial for estimation of returns. Assessment of fiduciary risks and corruption mitigation Fiduciary strategies usually absent. Insufficient consultation and assessment of potential Social impacts on vulnerable groups. Limited use of environmental impact assessments and Environmental safeguards. Source: Vietnam Development Report 2006, citing KFW (2005) A second step would be the development of those goals, it is necessary to define measurable a results framework with clear goals and performance indicators. The Transport Strategy benchmarks for each sector. When developing paper illustrates how this could operate. For the overall strategy direction for a sector, it is example, a goal might be to improve the important to link strategies to goals and to link mobility of people in rural areas. A strategy to projects and policy reforms to the achievement achieve this could consist of investing in and of those goals. To determine success in achieving maintaining all-year access to poor communes, 44 with particular projects involving a bond issue, providing the justification for projects, there is community contributions, and various donor then a need for a governmental process that is projects. An indicator to measure performance capable of allocating funds to the highest might be the number of additional households priority projects, with lower priorities receiving provided with access to an all-weather road funding only to the extent of available funding. within 2 kilometers. The results framework The example of Malaysia's planning process should be comprehensive. Projects that are not (see Box 3.2) suggests that projects that could directed to achieving particular sectoral goals potentially be privately funded may receive low should not be approved. priority for public funding. With improved criteria for distinguishing An important element of such processes is the between projects, and a results framework monitoring and evaluation of projects to Box 3.2: Development Planning in Malaysia Development planning in Malaysia addresses long- NDPC determines broad development policies and , medium- and short-term planning horizons, and sectoral priorities. Ministries, departments, blends centralized and decentralized planning. statutory authorities, and non-financial public Vision 2020 was launched in 1991, spelling enterprises are invited to submit bids for out the national development aspirations over a 30 development funding for the next five years to year period. It is supported by 10-year outline implement the identified strategies. Sub-national perspective plans that provide an indication of agencies are required to discuss their development specific programs to support the Vision. Medium- programs with the appropriate State Economic term planning occurs with 5-year development Planning Unit before submitting them to the plans that set out the allocation of the public relevant federal ministry. This ensures that the sector development program. By identifying state governments are aware of the development priority sectors the plans also give guidance to the proposals of the federal agencies operating within private sector in determining their own investment their boundaries. Submissions must include policies. In the middle of the 5-year planning descriptions of the proposed projects, including cycles, a mid-term review (MTR) of the five-year cost estimates. On receipt of the submissions the plan is carried out. The MTR determines whether EPU assesses and prioritizes development projects. the plan is implemented in accordance with the It consults with the ministries, agencies, and state stated targets and development schedule, and governments to review past performance and makes adjustments to sectoral policies and better examine the scope and cost of each strategies if needed. Short-term planning (and program. The NDPC has ultimate jurisdiction over adjustment of plans) occurs through the annual the selection of expenditure programs for the five- budget prepared by the Ministry of Finance. year plans. At the national level development objectives The number and size of proposals always exceeds available resources. Accordingly the EPU are formulated by the National Economic Council has to match and prioritize the requirements with (NEC)--a ministerial council chaired by the Prime respect to sound public finance practice. Some of Minister--and the National Development the broad criteria applied when prioritizing the Planning Committee (NDPC)--composed of top projects are growth promotion, project viability, civil servants from federal ministries. The social obligation and needs, poverty eradication, Economic Planning Unit (EPU)--located in the in and promotion of regional balance. Projects in Prime Minister's department--acts as a urban areas that have potential for privatization coordinating and integrating agency rather than as are given less priority than projects with little initiator of sectoral plans. A similar institutional scope for privatization. Projects in the less arrangement exists at the state and district levels. developed states and regions are given more At the state level, the State Economic Planning weight than those in the more developed states Units and the State Development Offices are and regions. Continuing projects are given priority responsible for formulating state development over new projects. strategies. At the beginning of every Plan the NEC and Source: Economic Planning Unit (2004). 45 determine their developmental impacts, Index measuring inequality (Figure 3.1). This including collection of baseline data that indicates can be calculated periodically with releases of the situation before the project, and subsequent the Vietnam Household Living Standards analysis which indicates how consumers have Survey. The Government could set a threshold altered their behavior in response to the project. index, beyond which any increases in inequality These results can be used to determine the would result in a greater allocation of resources economic impact of projects, and hence refine the to poverty alleviation. appraisal of future projects. If detailed analysis of all projects is too costly, at least a sample of 3.2 Coordination of Planning Across projects should be analyzed, to provide Ministries indications of what works, and what doesn't. A complication in setting investment Vietnam has an elaborate investment planning priorities based on rates of return is how process, comprising three types of plan- poverty-related interventions, which may have socioeconomic, sectoral, and spatial-undertaken low rates of return, should be treated. When at all levels of government, over varying time Vietnam reaches the point of having systematic frames, ranging from 1 to 10 years. While the estimation of rates of return from investment socio-economic development plans appear to be projects, extra weighting could be given to reasonably well integrated with sectoral plans, projects that meet special development criteria, problems arise in coordination with spatial such as poverty reduction. In the absence of plans and with financing possibilities. such information, broad rules of thumb may be Socioeconomic development plans (SEDPs) required such as minimal investment levels in are guided by ten year national development each province or in poverty-related subsidies. strategies, defined by the National Assembly, Broad success in meeting poverty alleviation following Party resolutions. The five year socio- goals could be verified with the national Gini economic development plan (SEDP) consists of Source: WDI (2005) using the most recent observation available for each country. A Gini Index of 0 implies perfect equality. A Gini Index of 100 implies perfect inequality (the country's entire income is concentrated in the hands of a single person). 46 an analytical report that assesses the progress the Vietnam Development Goals, which should accomplished under the previous plan, result in a more outcome-focused plan. identifies the challenges faced by the economy, Although the draft 2006-2010 SEDP has made sets targets for a range of economic and social progress over the previous SEDP in drawing indicators, and makes policy recommendations. out the linkages between broad growth and The plan covers all levels of state-led poverty objectives and specific investments, investment, including economic infrastructure. there remains room for improvement. In response to a request from donors, since 1996 Sectoral investment plans, such as the the five year socio-economic development plans Master Plans for water or electricity, are have been accompanied by a Public Investment developed by line ministries and relevant SOEs. Program (PIP), intended to serve as a basis for Consistency between sectoral plans and socio- dialog between donors and government, as well economic plans is coordinated by the Ministry as to guide the allocation of ODA. of Planning and Investment at central level and The country's Comprehensive Poverty by Planning and Investment departments at the Reduction and Growth Strategy (CPRGS)- provincial, city and district level. established in fulfillment of borrowing Spatial planning takes place under the requirements from the donor community-can direction of the Ministry of Construction and sets be regarded as an extension of the five year out spatial arrangements, building footprints plans. The Prime Minister's guidance to and infrastructure siting at the regional, ministries preparing the 2006-2010 SEDP is that provincial, city and district level. Unfortunately the principles of the CPRGS should be spatial planning constraints are not incorporated incorporated into the SEDP. The guidelines into the preparation of sectoral investment plans. require that the five year plan should address Construction approvals appear to be facilitated by SEDP investment approval, but SEDP investment approval is neither necessary nor sufficient for construction approvals to be granted. There is inadequate coordination between sectoral investment plans and spatial plans. The impact of this lack of coordination, aggravated by a divergence between national and local spatial planning, is particularly felt in urban areas, and is discussed in greater detail in section 3.4. 3.2.1 Incorporating Financing Constraints into Investment Planning The principal failure of coordination in the preparation of socio-economic and sectoral investment plans is the failure to incorporate financing constraints into investment planning. Vietnam's system of "dual budgeting" entails the separation of authority for investment and recurrent expenditure. In effect, it also entails the separation of planning from budgeting. The 47 Ministry of Finance (MOF), and Departments Lack of coordination between investment of Finance (DOF) at sub-national levels, are and financing approvals has created serious given responsibility for preparation of the fiscal problems in the past. During 1999-2002 framework and recurrent expenditure, while about 35% of commitments for transport the Ministry of Planning and Investment (MPI), had received prime ministerial approval, and Departments of Planning and Investment but had not been allocated funding. The (DPI) at local levels prepare the investment Ministry of Transport contracted state- budget, including capital expenditure and owned construction companies to donor funded projects. undertake work, on the promise of The Public Investment Program provides a subsequent reimbursement. State-owned long list of investments compiled from commercial banks were encouraged to sectoral master plans. But the PIP is prepared advance credit to the construction without reference to financing sources. It is companies, and to provide subsequent loan effectively a wish-list which could potentially rollovers when budget funds were still not be implemented in the absence of a hard allocated. Arrears in the Ministry of budget constraint. To fully implement the Transport amounted to VND 1,200 billion, 2001-2005 PIP would have required and debts of the Transport Construction investment of approximately 15 percent of Corporation to its creditors amounted to GDP per year. VND 1,000 billion. The Government A central process for allocation of public ultimately agreed to absorb debt incurred funds to the PIP would be desirable, to permit for projects implemented in fulfillment of all proposed projects to be considered master-plans, but many projects had not together when financing priorities are even been the subject of master plans. The decided. In practice, sectoral ministries obtain brunt of the Government's decision not to finance directly from the state budget (with pay for these projects was borne by allocations made by the National Assembly, or construction companies and by the SOCBs. Provincial People's Councils), or from line To date, the government's attempts to better ministries' own budgets, from the DAF, ODA, co-ordinate budgeting and investment planning or from retained SOE earnings. Finally, the has focused on clarification of the respective State Bank of Vietnam can place informal responsibilities of the MPI and MOF, rather pressure on SOCBs to lend to specific projects. than better integration. The absence of consistent criteria for project One recent step towards better matching of selection across these organizations means finances with planned projects is the that there is no effective system for introduction of pilot programs for medium prioritizing the commitment of public funds to term expenditure frameworks (MTEFs) (see Box investment projects. 3.3) in the transport sector and other non- A better organized system for the allocation infrastructure sectors. A positive effect of of public funds would provide greater certainty incorporating budget constraints into the to sectoral planners when designing projects. Ministry of Transport's investment planning Under the current system, uncertainties over appears to have been achieved in the Ministry's financing lead to projects frequently change initial expenditure proposals prepared in the scope, size, location, and timing. There are context of the MTEF in September, 2005. Where unimplemented projects, unfinished projects, previous estimates of annual financing needs and untimely delivery. for potential investments had amounted to 48 Box 3.3: A Medium Term Expenditure Framework (MTEF) An MTEF consists of a top-down resource envelope used to make budgets fit squarely within the consistent with macroeconomic stability and broad envelope. policy priorities and a bottom-up estimation of the Improved inter- and intra-sectoral resource current and medium-term costs of existing national allocation by effectively prioritizing all programs and activities and an iterative process of expenditures (on the basis of the government's decision-making that reconciles these costs with socio economic program) and dedicating available resources. Annual budgets are prepared in resources only to the most important ones. a medium term context, reflecting what is affordable More efficient and effective public expenditures, over the short term, there is a clear link between essentially by allowing line ministries greater forward estimates of expenditure and the annual flexibility in managing their budgets in the budget, and there are transparent rules for any context of hard budget constraints and agreed upon policies and programs. reallocation of resources, both during budget formulation and execution. MTEFs alone cannot deliver improved public Objectives sought with the introduction of MTEFs expenditure management in countries in which include: other key aspects of budget management, such as budget execution and reporting, remain weak. Improved macroeconomic balance, including fiscal discipline, through good estimates of the Sources: Le Houerou & Taliercio (2002), Holmes & Evans available resource envelope, which are then (2003). 12.4% of GDP,26 or 8.5% of GDP,27 the MTEF increases as a result of new investments there is proposal called for annual investment of 4.1% of a need for increased maintenance spending. But GDP, a more feasible level. Further areas for the Government follows a rule that the growth improvement include the development of rate of capital expenditure should be higher objective criteria for allocating priorities, and than the growth of recurrent expenditure. better budget discipline, to ensure that projects Accordingly capital budgets grow at a faster for which secure financing has not been rate than recurrent budgets. In the longer term, organized are not commenced. an ever-growing share of government capital The direction for reforms should be to expenditure is not a sustainable strategy. There integrate financing and investment decisions, so is a need to recognize that new investments that a project cannot be given investment carry implications for the recurrent cost budget. approvals unless secure financing plan is in place. Provision of insufficient funds for recurrent expenditure has been particularly acute in the transport sector. Recurrent 3.2.2. Integrating Recurrent and Capital expenditure has declined significantly as a Budgets percentage of total transport expenditure A further problem arising from the dual since 1996, while capital expenditure has budgeting system is a failure to incorporate the boomed (see Figure 3.2). A recent World implications of investment plans into plans for Bank financed Road Network Improvement recurrent spending. As the capital stock Project found that were expenditure to 26. The Ministry of Transport submitted a Vietnam Transport Strategy up to 2020 to the Prime Minister in December 2002. This called for investment of about VND 789,977 billion (US$ 50 billion) during 2002-2010. 27. The Strategic Review of Transport Donors' Support to Vietnam's 2006-2010 SEDP, released in early 2005, estimated total investment requirements of VND 361,439 billion (US$ 23 billion) during 2006-2010, 49 remain at its current level, the percentage 3.2.3 Spatial Development Goals and of national roads in good condition would Investment Planning fall to just 10% of the total network. The situation was even worse for provincial There is a tension between the Government's roads. In its funding request for 2003 to stated spatial development objectives and the 2005, the Vietnam Roads Agency was able practice of its investments process. The to secure less than half of the finance Orientation Master Plan for Urban required to cover all maintenance needs on Development to 2020, prepared by the Ministry national highways. of Construction, seeks to limit growth of the Poor coordination between capital and major cities, and spread urban development maintenance expenditure is a common feature more widely. Specific objectives include: of countries that operate systems of dual Establish population targets for cities and budgeting. A recent review of developing district towns in an urban growth hierarchy; country experience with dual budgeting sees Limit growth of Hanoi and Ho Chi Minh the introduction of medium term expenditure City and reduce population densities in the frameworks as a first step in addressing the center of the primary cities; Create satellite cities for Hanoi and Ho Chi issue, since a medium term perspective helps Minh City; to highlight the capital savings presented by Encourage growth at the urban fringe; adequate maintenance.28 Nevertheless, a Promote the development of medium and complete response to the issue requires small cities and district towns; integration of budget preparation for Create new urban areas in the more remote recurrent and capital spending, including provinces and in proximity to major cities as a staffing integration, unified budget meansofcontrollinggrowthofthelargercities; documentation, and unified accounting and Preserve agricultural land and plan rural reporting systems. development. 28. Sarraf (2005). 50 In practice, investment planning tends to Despite the difficulty of implementing the focus on specific growth centers in the north, Orientation Master Plan, the objectives should south and center of the country. The idea is that not be lightly discarded. While mega-cities may higher returns to infrastructure investments can offer economies of scale, they may also suffer be obtained in areas of concentrated population considerable problems of congestion, pollution, where there are stronger returns to scale and and difficulties in urban planning and complementarities between different sorts of infrastructure provision. To the extent that these investments. At the same time, investments are problems become significant, the objective of made in rural areas to address poverty maximizing economic growth and the objective objectives. The overall spatial balance of of more widely-spread urban development may development appears to be broadly be consistent. appropriate. While inter-provincial inequality Determining whether it makes sense to has increased (as observed in section 1.3.4), the promote greater urban growth of mid-sized increase has been quite small, and this is being cities would require much better analysis of the achieved at the same time as rapid growth is economic rates of return to potential projects in enjoyed at the aggregate level. the major cities and the mid-sized cities, taking Large migration from rural areas to the account of a range of externalities such as major cities has made a significant contributor congestion and pollution, as well as taking into to the success (in terms of generating growth account the transaction costs of administering without large increases in inter-provincial large cities. If the Government were to pursue inequality) of the current investment strategy. the Orientation Master Plan objectives more The presence of large numbers of unregistered closely, a first step would require that sectoral migrants in the major cities, and the investment plans be adapted to meet the spatial urbanization forecasts of section 1.3.2 suggest priorities. But successful regional development that high levels of migration to Hanoi and Ho would also require a concerted development Chi Minh City are likely to continue. effort going beyond mere investment in International experience suggests that the regional cities. Examples of such policies might forces driving such migration are very difficult include expanding opportunities for state to counter. Overall, the spatial objectives of employment in the lesser cities, or releasing developing mid-sized cities and containing the more private land to keep the price of housing growth of major cities are not being achieved and business development lower in regional in practice. cities. Overall, considerable analysis is required to determine whether the Orientation Master Plan's goals are appropriate, and if they are, how best to shape the existing strong forces for migration from rural areas to Ho Chi Minh City and Hanoi. 3.3 Allocation of Responsibilities Across Tiers of Government Countries around the world struggle to find the appropriate allocation of powers to levels of government. There is a tension between Traffic Congestion 51 devolving power to ensure decisions are level governments could make decisions responsive to local needs, and centralizing without referring back to higher level power to ensure that decisions are governments. This could help to limit the coordinated, that externalities (very broadly tendency towards excessive bureaucracy and defined to include matters such as fiscal provide greater certainty about what has consequences of decisions, issues of national been decided. concern such as poverty, environmental The tradition of centralized state effects, etc) are adequately addressed and that planning underwent a major reform when the level of government has adequate the 1996 State Budget Law inaugurated a resources (fiscal and technical capacity). process of decentralization. As a result sub- Vietnam bears witness to this tension, as it national governments' shares of total deals with problems inherited from its expenditures increased from 26% in 1992 to traditional principle of "dual subordination" 43% in 1998 and 48% in 2002. The 2002 State and newer problems arising from Budget Law gave the provinces broad decentralization.29 powers to organize expenditure assignments Vietnam has four levels of government, with for the districts and communes within their 64 provinces, 643 districts, and 10,602 borders. It also strengthened the prohibition communes, each with their own Assembly (or of unfunded expenditure mandates from People's Councils at sub-national level) and higher to lower levels of government. executive (People's Committees at sub-national Services are assigned to levels of level). To ensure consistency of decision- government broadly consistent with the making, administrative units of the executive geographic area of benefits. Sub-national operate under a system of "dual spending is funded through a combination subordination": they report to their own level's of locally raised revenue and transfers from People's Council, and are also accountable to the central budget. the next higher level of government. The Decentralization brings a range of potential difficulty with this system is that it can lead to coordination problems, including: inefficiency in public administration. For Excessively thinly spread investment, as example, up to 14 official approvals are each commune and district places pressure required before investment can occur, with on Provincial People's Committees. Too decisions sought at multiple levels of many small projects at once may be a factor government. Incompatible horizontal and behind the delayed implementation of vertical instructions can also leave authorities infrastructure investment, over- to decide for themselves which instructions to commitment of budget and buildup of treat as binding, or leave agencies to compete arrears to contractors. for authority where responsibilities are unclear Unnecessary duplication of facilities. For (see Box 3.4). example, almost every province has at least A possible direction for evolution of the one industrial zone in order to attract FDI, system would be for higher levels of even though foreign investors prefer to government to prescribe guidelines or concentrate investment in clusters close to criteria for decisions made by lower level the main metropolitan areas. There is a governments, and within those criteria lower similar risk with decisions to construct 29. The following discussion draws on the PER-IFA (2005). 52 Box 3.4: Weaknesses in the Coordination of Road Maintenance The dilution of responsibility in the Vietnamese the PDOTs. public financial management system is The result of these overlapping jurisdictions exemplified by arrangements for maintenance of complicates the assignment of responsibility and national and provincial roads. The Vietnam Roads monitoring of results. While the VRA is formally Authority (VRA) was established in 1993, and is responsible for managing the national roads formally responsible for the management and network, it relies on provincial roads management oversight of the whole roads sector, and for units for the greater portion of work undertaken implementation of work on national roads. In on the network. The VRA has limited control over practice, however, it is unable to effectively fulfill the provincial units and is limited in its capacity this role, for a number of reasons, related to ensure that funds allocated for national road primarily to how financing responsibilities are maintenance are actually spent as planned, allocated in the system. despite the fact that the purpose of the funds is The Ministry of Transport receives financing specified in detail, and distinguishes between from the state budget, as well as from different kinds of maintenance. This arises international financial institutions, and divides because parts of these funds are transferred via this amount between the Vietnam Roads Authority provincial finance departments, which can delay (VRA) and Provincial People's Committees (PPCs), disbursement. The VRAs have no effective means based on the size-classification of the repairs that of monitoring work carried out. they undertake. The VRA takes responsibility for While the VRA is also responsible for planning part of the national roads network, while the PPCs and the setting of technical standards for all are responsible for the remainder of national roads, it has very little oversight of roads at sub- roads, and their own provincial roads. The VRA national level, other than advising on technical delegates work on the national networks to standards and administrative matters. This is Project Management Units (PMUs) and Regional because the PDOTs retain direct managerial Roads Management Units (RRMUs), while the responsibility for provincial roads, and funds PPCs delegate work to Provincial Departments of allocated for these roads are transferred to Transport (PDOTs). For large repairs to the provinces, without direct involvement of the VRA national road network, between a half and a third ­ be it to inspect or approve plans. As a result, it of work is managed by the VRA's PMUs. The is not at all clear to what extent allocated funds remainder is managed by the PDOTs. For routine are actually used for road maintenance or maintenance and medium repairs on the national construction. road networks, most work is managed by the RRMUs, while the remainder is managed again by Sources: Louis Berger (2003); ports. In 2005 a start was made in them. For example, most district and addressing this problem by preparing commune governments lack the capital regional plans for the greater metropolitan funds for their needs for rehabilitation, areas of Hanoi, Ho Chi Minh City and Danang, but the initiative is limited to spatial planning. Managing externalities: an upstream municipality might not be especially concerned about treating its waste water; a downstream municipality might wish otherwise. "Vertical fiscal imbalance": there can be a mismatch between the responsibilities of sub-national governments to spend money Road maintenance - essential for preserving capital and the financial resources available to investment 53 replacement and new construction of would be preferable to address squarely the infrastructure.30 problems of coordination in a decentralized In some sectors, the potential problems of environment. Currently, the bulk of the funds decentralization are avoided by the relatively that can be used by sub-national governments crude method of retaining central control. for investment in infrastructure are transferred Since 2001, the PIP classifies projects into A, B from central government in the form of and C level investments. A-level investment unconditional grants. The central government projects-which include the largest and most should develop financial tools through the strategic infrastructure investments (for public finance management system to align instance major ports, or main roads)-rest with provincial investment with national priorities. central government, requiring authorization For example, conditional or matching grant of the Prime Minister. Such investments are facilities, or ring-fenced minimum expenditure shielded from the complications of provincial requirements could be used to channel service delivery. Similarly the national level resources to particular infrastructure priorities. state-owned enterprises in the energy and telecommunications sectors are responsible 3.4 Urban Planning for their own financing and planning The difficulties in urban infrastructure illustrate processes. They are not subject to the many of the problems of vertical and horizontal limitations of either dual subordination or coordination, as well as highlighting that the dual budgeting. Nor is responsibility for their basic types of plans produced are inappropriate delivery diffused across different levels of for an economy in which development occurs government. Some rural water projects have increasingly in response to market requirements been included in a National Target Program, rather than central planning decrees. which is implemented independently of Spatial planning presents the greatest provincial planning. problem for urban infrastructure, both in the Remaining infrastructure projects face the way it is conducted and in how it relates to risks posed by decentralized decision-making, financing and sectoral plans. Most plans are the potential delays and conflicts arising from prepared by the National Institute of Urban and the principle of dual subordination, and the Rural Planning (NIURP) or, in the south, by the financing difficulties of dual budgeting. The Institution of Planning and Architecture of the impact of these risks and problems is felt National Corporation of General Construction principally in transport projects, and smaller Consultancy (NAGECCO). Both institutes are scale infrastructure services in urban areas. The subsidiaries of the Ministry of Construction. impact of the coordination and planning Only the three largest cities have their own weaknesses in the transport sector has already planning institutes. been illustrated with the example of debts Spatial plans are prepared in four levels of passed on to the construction and banking detail: orientation plans (national policy), industries. regional plans, general plans (province or city), Rather than simply retaining central control and detailed area plans (ward, industrial zone, for some projects, and subjecting other projects or project). Until 2005, no consideration was to the risks of decentralized decision-making, it given to regional planning: there was no 30. See PER-IFA p.84 54 architecture, built form, construction heights, and landscape of each urban area and street was introduced by a Planning Decree in 2005. One difficulty with the centrally produced plans is that they tend to be too rigid in their technical specifications, and based around idealized visions of urban development that do not take account of realities such as unofficial migration, or market-based development. Deviation from specified technical standards at the general plan level requires an arduous bureaucratic process. Plans lack the phasing and incremental development mechanisms to translate them to reality in a mixed economy where development Master (spatial) Plan for Danang is likely to occur on an incremental basis directed by decisions made by investors coordination amongst neighboring provinces. rather than government planners. With a In 2005, a start was made on preparing regional mismatch between the central planners' plans from the greater metropolitan areas of visions and local reality, and with enforcement Hanoi, Ho Chi Minh City, and Danang. This is a of construction and land use regulations positive development in overcoming one of the vested at the local government level weaknesses of decentralization. (Departments of Transport and Public Works At the provincial/city level, general spatial in large cities and Public Works Companies in plans are required to include long and medium smaller towns), it is not surprising if plans are term directions for physical development and frequently ignored at the local level, or treated the arrangement of urban space and as mere guidelines. infrastructure networks and facilities. They also A different sort of planning is required to cover the characteristics of urban areas, take account of rapid market-led development. population size, land use, resettlement, Plans need to be regularly updated, desirably redevelopment, conservation, and zoning. They with the involvement of local communities. also prescribe technical standards for Stricter enforcement of planning laws and constructions, such as street widths, floor area construction regulations is required, but at the ratios, or floor area per occupant. A map is the same time spatial plans should become more principal element of the plan. The Prime strategic. They should give guidance and Minister approves the general plans for Special, orientation on how cities should develop, but Class I and Class II cities. not prescribe too much detail. They also need to Detailed area plans are prepared under the be flexible within their overall orientation and guidance of sub-national People's Committees. local governments should be given more They determine the specific uses of urban space authority to adjust them quickly to meet and include the quality, quantity, and position changing needs. Local authorities should be of each development type and building made accountable with realistic checks and footprint. An urban design element to express balances. Construction regulations should be 55 based on performance standards rather than results in irreparable damage to the social strict technical norms. For example, road widths fabric and well-being of the residents. Housing should relate to estimated traffic projections prices in the newly created development will rather than pre-defined dimensions; often be well beyond the affordability of those wastewater should be treated to a level relevant displaced. Experience in many other countries to the river, or sea, into which the effluent will such as Indonesia and Brazil demonstrates that be discharged; water consumption levels and it is usually better on cost effectiveness and quality should relate to what people are likely social grounds to adopt an incremental to be willing to pay. approach developed with the active Much of the vertical coordination problem participation of the beneficiaries. would be resolved with more flexible standards Problems of horizontal coordination and planning processes that permitted greater between different government ministries occur flexibility for local authorities. Part of the with a mismatch between budgets and spatial problem is also that plans have been centrally plans, and mismatches between sectoral and prepared, when greater local participation is spatial plans. Spatial plans are generally required. The new Construction Law (2004), prepared independently of financing with new (2005) Decrees on Planning and on considerations. Lack of budgets to implement Construction Investment Project Management, plans can provide further grounds for has introduced greater decentralization of implementation failure at the local level. Lack of approvals for plans, and public consultation. timely financing means public infrastructure These are positive steps, but without greater (water supply, solid waste management, capacity at the local level the plans will continue drainage, and sewers) often has to follow after to be developed by the central planning development has occurred. Rapid, unplanned institutes. There is also an issue concerning how growth of the peri-urban fringes of large cities is local governments should be held accountable leading to serious environmental degradation for compliance with essential elements of and significantly higher costs for infrastructure centrally developed plans. than would be the case if the infrastructure were The introduction of public consultation is a built at an earlier stage. (There are, however, particularly important development in terms of some well-planned peri-urban areas, such as the holding local governments accountable to their Tu Lien development in Hanoi and Phu My populations. Idealized top-down plans fail to Hung in Ho Chi Minh City.) take adequate account of the preferences of Sectoral master plans for the same location local stakeholders. Such idealized plans can are also developed independently, and may not result in the wholesale clearance of be linked in phasing, finance, or communities and housing to permit implementation. For example the drainage redevelopment to a higher and more included as part of a transport master plan may technically mandated standard. This often not be coordinated with the drainage and results in the destruction of tightly knit sewerage master plan. In some cases they may communities and housing with their own even propose conflicting strategies. carefully developed economic and social support systems that have evolved over many 3.5 Enviromental and Social Policies years. Experience from other countries, including many in Western Europe and the Infrastructure projects can have adverse United States, indicates that demolishing such environmental and social effects that conflict neighborhoods, often with the best intentions, with the objectives of sustainable growth and 56 equitable improvement of living conditions. pollution alone at between 3.5 and 7.7 percent of Among the environmental concerns are air and GNP.31 While large scale development projects water pollution, effects on water quantity and are inevitably the primary focus of attention by flow patterns, and contribution to climate environmental and social agencies and the change. Transport developments can open public, in many countries the vast numbers of access to environmentally sensitive areas, inadequately designed and implemented small leading to potential deforestation and possible scale projects frequently pose a greater consequent losses of biodiversity, increases in environmental and social threat. Consequently flooding or silting of water systems. Social there is a need for all government ministries to concerns include disruption of social fabric incorporate environmental and social (inclusiveness and cohesion of communities), considerations into their planning and project involuntary land acquisition and displacement appraisal mechanisms. of people, and impacts on ethnic minorities. Environmental issues arising in respect of Many environmental and social issues are infrastructure in Vietnam include: difficult to quantify in monetary terms. Despite Serious environmental and health concerns limitations in the ability to precisely measure are caused by water pollution from environmental and social costs, rough estimates untreated human waste and unregulated of the damages associated with infrastructure discharge of industrial wastewater. In 2004 projects indicate that they are often sufficiently no city collected or treated municipal high to warrant the serious attention of wastewater, although several treatment planning and finance ministries, and not just plants were under construction. Residential those responsible for the sectors concerned. For and commercial premises are required to example, a major World Bank study in China have on-site septic tanks, but they are rarely estimated environmental damage from properly designed or constructed and Box 3.5: Strategic Environmental Assessment in Bali The Bali Urban Infrastructure Project was concrete recommendations about implementation designed to improve urban infrastructure services of the sub-projects as well as selection of throughout the island of Bali, with major priorities, which included the importance of subprojects in urban roads and traffic maintaining cultural and historic heritage. The management, water supply and sanitation, SEA also included detailed recommendations for drainage and flood control. Although it was not a institutional capacity building required to ensure legal requirement, Strategic Environmental proper execution of the investment program. Assessment (SEA) was carried out in order to help The SEA produced a comprehensive address the most critical environmental issues in Bali, with water catchments, forests, and cultural environmental profile of Bali, and in particular a property all being threatened by population set of maps defining environmental zones, placing growth, industrial development, and tourism. sub-projects and their potential impacts in relation The SEA was designed to ensure that urban to the different zones, and helping to avoid infrastructure development would take place in adverse environmental and social consequences of the context of, and be sensitive to, this overriding urban infrastructure development programs. concern. The SEA involved extensive public consultation at local levels, which led to several Source: Warford (2004). 31. World Bank (1997). 57 effluent frequently leaks out, contaminating the groundwater table. Due to lack of enforcement of regulation, many new housing constructions in Ho Chi Minh City have direct contributions to the city drainage system without the obligatory septic tank. Only 17 out of 91 solid waste disposal dumps are properly designed with leachate collection and treatment facilities. Fifty have been officially declared environmental hazards that must be closed as soon as possible. In major urban centers, transport is a significant contributor to air pollution - Waste water interceptor tunnel being constructed in Ho Chi Minh City particulates (PM10 and PM2.5), ozone formation and carbon monoxide. Old motorcycles and diesel trucks are the biggest resulted in a net subsidy for fuel, with polluters. Motorcycle emissions are entirely implications for the level of emissions from uncontrolled. the transport sector. The Government's attempts to smooth the The siting of infrastructure investments, such price of petroleum products have effectively as new roads or power plants, can have Box 3.6: Resettlement and Land Markets Vietnam's Land Law of 2003 requires compensation to who suffer from compulsory resettlement. But in be paid for land compulsorily acquired by the Vietnam high prices are partly a product of land government. The Vietnam Development Report 2005 policies which serve to push up prices contained a discussion of Vietnam's compensation artificially: policies, concluding that they are largely in In Hanoi in particular, the Government holds a accordance with international practice, but in practice large proportion of the land, so that the supply of less than full compensation tends to be provided for land tradable in private markets is very limited. the dislocation suffered. Limited supply combined with high demand serves While social policy objectives suggest that to push up market prices. Vietnam's compensation regime could be more Throughout the country, there are high transaction generous, infrastructure development objectives costs in legally registering land, so that many would seek to contain resettlement costs. A people occupying land do not have full legal title particularly prominent cost arises from the high price to the land. The Vietnam Development Report of land. For example, a 10 km road proposed as part 2006 contains a useful discussion of the of a Hanoi Urban Transport Development project consequences. Again, the scarcity of land with full would resettle about 1100 households. The cost of title serves to drive up the price of such land, and road construction is estimated at about US$ 60 this price then becomes the reference point for million, while the resettlement costs are estimated to people seeking resettlement compensation. be in the range of US$ 170-210 million. In the case of Releasing government land and reforming land a recently-completed, JBIC-financed flyover in Hanoi, registration arrangements would improve the resettlement accounted for over 80% of project costs. efficiency of land markets, raise revenue for the Clearly resettlement costs can add significantly to the government, and have the happy side-effect of total cost of developing urban infrastructure. reducing resettlement costs for infrastructure High land prices are certainly not a reason to development. avoid paying proper compensation to people 58 significant local environmental impacts. In These are all very positive developments. A principle these should be addressed through challenge in coming years will be to ensure environmental impact assessments and adequate resources to environmental agencies, follow-up mitigation activities required under and enforcement of the new regulations. existing legislation. In practice the quality of Vietnam's large infrastructure investment impact assessments is often inadequate. program inevitably involves considerable The choice of fuel mix in the energy sector requirements for land acquisition and has important implications for greenhouse resettlement. For example, an urban gas emissions and for other forms of air redevelopment program in Danang involved pollution. At present this choice is distorted the resettlement of one in five households over by under-pricing of coal, relative to its a seven year period. In such circumstances, economic value. there is a risk that the costs of social dislocation Addressing these issues will require a mix of could severely undermine the benefits new specific investments, such as waste water infrastructure. To mitigate such risks, treatment plants or improved public transport international practice is to ensure that adequate systems, introduction of new environmental compensation is provided for any loss of land, standards (eg emission control for motorcycles), other assets, and income-earning possibilities. and policy changes that ensure higher priority The Vietnam Development Report 2005 is given to environmental issues. contained a discussion of Vietnam's On the policy side, an important recent compensation policies, noting that "it is by now development is the passage in November 2005 accepted that compensation should be of a revised Law on Environmental Protection, provided for the loss of land and properties attached to the land. Assistance measures for to take effect in July 2006. The major stabilizing the living standards of affected developments under the revised law include: populations have been introduced, and the The introduction of strategic environmental general principle that resettlement sites should assessment (SEA), a process for offer conditions which are equal or better than systematically mainstreaming environment the previous ones has been acknowledged. into the appropriate levels of policy making. Many of the gaps between international Strategic Environmental Assessments can be principles and Vietnamese policies used, for example, when preparing spatial disappeared, on paper at least, with the 2003 plans for land use in regions or river basins. Land Law." Box 3.5 discusses an example of SEA from Difficulties remain in the provision of Bali, Indonesia. compensation for those without formal legal Greater detail about the types of projects title and compensation for loss of business. that require environmental impact Another gap in the current legal framework is assessments, and how those assessments consultation with resettled populations and should be conducted. active steps to help them integrate in their new Introduction of a licence system for waste host communities. While provincial producers. governments can undertake these additional A community 'right to know', under which steps if they wish, they are not mandated to do environmental protection authorities must so. Independent monitoring of the report to their communities the names of implementation of resettlement plans is not part establishments causing pollution. of Vietnamese policies either, although it tends 59 to be required on donor-funded projects. In 3.6 Recommendations addition to weaknesses in the degree to which compensation is provided for loss of well-being, as In the long-term, it seems likely that different tiers discussed in Box 3.6 the interaction of land of government will evolve exclusive areas of acquisition policies with weak land markets poses responsibility (to avoid costly revisions of decision- practical problems for infrastructure development. making), while some domains will remain shared, To be effectively implemented, environmental providing for central government oversight. Much and social objectives need to be incorporated into of the necessary reform should occur in response to the "mainstream" activities of infrastructure developments, and so requires a framework of constant monitoring and reaction to problems. This ministries, and their planning and financing monitoring and reaction could take place within overseers. For example, environmental objectives the Prime Minister's department. There is a suchasavoidanceofwaterpollutionshouldbepart pressing need to better integrate financing of the objectives of agencies responsible for water decisions into the investment approvals process, and sanitation. And reliance should not be placed and a starting point for this would be a solely on project level appraisals. For example, government-led review. The most urgent area for EVN is planning an expansion of its hydro-electric systematic review is coordination of planning generation capacities. Individually, the processes for urban areas. An ideal response is environmental and social impact of the planned likely to take some time to implement, and so the projects may lead to only marginal impacts, but the recommendations are placed in a medium-term program also needs to be examined at the country setting. Nevertheless, the urban problems are of a level during the planning stage, to ensure that the significance demanding that solutions begin to be cumulative impacts of the individual projects are developed immediately. acceptable. The following actions are recommended: (3.1) Establish a system of evaluation of investment projects to measure the rates of return (M) achieved. (3.2) Improve the quality of feasibility studies, addressing all areas identified in Box 3.1 (M) (3.3) Develop a results framework for each sector, setting out sectoral goals, strategies for achieving them, and performance indicators for measuring progress towards the goals. (S) Ensure that all proposed projects fit within this framework, and provide for monitoring of projects' contribution toward the goals. (3.4) Develop a governmental process for integrating budgeting decisions with investment (S) planning, ensuring that projects are allocated budget funding in accordance with their priority. The process should not allocate budget funding to projects capable of obtaining finance elsewhere. (3.5) Develop budgeting processes that ensure an appropriate balance between spending on (S) maintenance and on new investment. Ideally, rates of return from maintenance spending should be estimated. (3.6) (S) Review the costs and benefits of promoting growth of mid-sized cities to determine whether revisedpoliciesareneededtosupporttheobjectivesoftheOrientationMasterPlanforUrban 60 Development to 2020. (3.7) Developfinancialtoolsforaligningprovincialprioritieswithregionalornationalpriorities. (S) Examples include conditional or matching grant facilities, and ring-fenced minimum expenditure requirements. (3.8) Monitor the effects of dual subordination. Where the principle results in excessively slow (M) decision-making or conflicts between decisions, consideration should be given to either revised processes to improve coordination across levels of government, or else exclusive powers being granted to one level. Consideration should be given to exclusive domains of decision-making to lower governments in areas in which local governments are rarely overruled. (3.9) Develop urban planning institutions to better deal with a mixed economy. The planning (M) system should move toward performance standards, decentralization, and stakeholder participation. A strategy to deal with this issue should promote: Public benefit analysis - the urban planning and approval process must be able to judge public benefits and negative externalities in proposed developments. Best Practices and Performance Standards - the adherence to rigid single purpose technical master planning specifications will need to be relaxed and replaced with performance standards, particularly as more development comes from the non-state sector and must be made to fit and benefit local situations rather than prescribed national standards. Performance standards (transport capacity, waste management, open space, height limits, setbacks, mixed use compatibility, noise, etc) should be introduced to the planning system as minimums that need to be met, but that allow flexibility in meeting them. Decentralized planning with more local control, transparency, and stakeholder involvement should replace adherence to formulae and specific physical design standards. Integrated Planning - cooperation among the elements of the fragmented planning process (including financing and budgeting for the state sector) is necessary to rationalize urban planning and management. Financial Reality - plans at all levels are made without apparent reference to financial reality or cost. For urban planning to be useful, financing and budgeting for state sector responsibilities and projects must be part of the process. Decentralization of Planning - planning will need to be decentralized to be able to addresslocalconditionsandgreatertransparencyandpublicparticipation.Aconcerted program to develop local planning skills and facilitate integration will be necessary. Planners must establish enough credibility that their analysis will be recognized and given credence by ultimate decision-makers. (3.10) Ensure that environmental and social considerations are considered in the objectives of (M) agenciesresponsibleforinvestmentplanning,thattheyareadequatelyaddressedinproject feasibility studies, and that overall plans for series of projects are similarly subject to assessment of environmental and social impacts. (3.11) Ensure the National Environment Agency has the resources and the mandate to set, (S) monitor, and enforce appropriate environmental standards. 61 62 4. Efficiency Issues (i) Infrastructure service providers in Vietnam are reasonably efficient, given Vietnam's level of development, but of course improvements can always be made. More efficient infrastructure services would lower costs to consumers and businesses, and potentially reduce the amount of infrastructure financing required. (ii) Tools for improving the efficiency of Vietnam's infrastructure services include public sector reform, competition, private participation, and regulation. There is much the Government could do in all of these areas. (iii) Corruption can also have an impact on efficiency, and measures must be taken to combat it where possible. M ore efficiently operated infrastructure between private operators for the right to services achieve greater output for given provide a service can provide an alternative inputs. Operational improvements can means of identifying efficient operators. By thus directly lead to cheaper services, helping to providing increased profits in return for address poverty objectives and providing a performance improvements, regulation can also stimulus to growth. Improvements in provide incentives for improvement. operational efficiency are also part of the Finally, corruption can significantly solution to Vietnam's infrastructure financing undermine the performance of infrastructure difficulties. For example, reductions in water or service providers. Happily, many of the other electricity technical losses can delay the need for measures that can be taken to improve system expansion and so generate capital efficiency will reduce the opportunities for savings. corruption. But these measures do need to be This chapter considers the various tools that supplemented by explicit anti-corruption are available to improve the operational measures, such as regular physical and financial performance of infrastructure service providers. auditing and a system for prosecuting In general, the strongest incentives are provided corruption when it occurs. by active competition between commercially focused service providers. In general, a 4.1 Current Effciency Levels commercial focus (ie profit motivation) is a pre- requisite for other tools that provide additional Overall, Vietnam's infrastructure service incentives to improve performance. providers are reasonably efficient for the Unfortunately, for most infrastructure services country's level of development, but of course active competition between providers is not there is room for improvement. possible. In these cases, periodic competition Figure 4.1 indicates that Ho Chi Minh City is 63 in the worst half of major Asian cities for of its water. Variation within the country unaccounted water (lost to leakage or theft). illustrates the scope for improvement. Figure 4.2 illustrates that Ho Chi Minh City Figure 4.3 illustrates recent improvements in is near the average for Vietnamese water staff productivity in water utilities in Hanoi utilities for unaccounted water, with the and Ho Chi Minh City. Nevertheless, Hanoi, worst performer in the country losing 95% with 7 staff per thousand connections Source: IBNET database, http://www.ib-net.org/wb/bench/nodes/ADB.html Each bar represents a separate utility. Data for 62 utilities in 2003. Source: Benchmarking data from Vietnamese Water Supply Association. 64 nation's best performers in staff productivity. The national average is 11 staff per 1000 connections, and the worst quarter of firms have over 15 staff per 1000 connections. Figure 4.5 illustrates that labor productivity in telecommunications is poor compared to productivity in neighboring countries. Figure 4.6 illustrates that despite steady reductions in losses of electricity in transmission and distribution, still performs Leak detection activities in Ho Chi Minh City poorly in comparison with China and Thailand. To some extent this comparison is unfair. For example, China has a higher performs worse than the average for the proportion of businesses receiving high sample regional cities (6 staff). Ho Chi Minh voltage supply, and so has lower distribution City's utility performs better with 3.5 staff losses. More recent data than is shown in the per thousand connections. graph puts transmission and distribution Figure 4.4 highlights that the Hanoi and Ho losses in Vietnam at 12.2% in Vietnam, but Chi Minh City water utilities are among the there is still room for further improvement. Source: ADB, JBIC, World Bank (2005). 65 Each bar represents a separate utility. Data for 60 utilities in 2003. Source: Benchmarking data from Vietnamese Water Supply Association Source: WDI (2005). Data are from 2003 for Cambodia, Laos and Vietnam; 2002 for the Philippines and Thailand; 2001 for Source: WDI (2005) Indonesia; and 1999 for China. Figure 4.7 reports the proportion of road Vietnam's trains have low operating speeds expenditure devoted to maintenance. At of 40 km/h for passenger trains and 22 7.1% of total road expenditure in 2003, km/h for freight trains, because for lack of Vietnam has the lowest maintenance maintenance and new investment the rail expenditure in the sample. See also Figure network has deteriorated. Labor 3.2 which highlights the downward trend in productivity is low at 124,000 traffic road maintenance. Neglect of maintenance units/employee, compared with 548,000 in is inefficient since it is likely to increase Thailand and 610,000 in Indonesia. long-term maintenance costs. Accident statistics for Vietnam's railways 66 Failure to reduce input costs will mean that Vietnam benefits less from opening to international trade than it otherwise would. 4.2 Reforming Infrastructure Enterprises Until the 1980s, around the world there was little competition or private participation in the financing or operation of infrastructure. Attempting to improve efficiency many countries attempted reform within the public sector. The international experience has Source: ADB, JBIC, World Bank (2005). been that these measures offered improvements in commercial suggest a neglected network. In 1998 there operation, but that even greater were 41 deaths per 1,000 km of track. This improvements have been delivered by figure increased to 271 in 2003. subsequent competition and ownership Corresponding figures for Indonesia were reforms. A notable difference between these 11 in 1998 and 16 in 2003, and for Thailand: sorts of reform is that public sector reforms are 5 and 2. easier to reverse, and hence less durable, than Performance appears to vary across measures that establish new competitors or Vietnam's ports. Some ports are reported as private property rights. A good public sector achieving 15-20 moves per hour per manager may improve performance until his or stevedoring gang, compared, for example, her replacement occurs, but the introduction of with 25-30 moves in the Philippines.32 On competition provides an enduring pressure for the other hand, Vinalines reports performance enhancement. throughput on container berths in Saigon of Internationally, one of the major problems of 20-25 containers per hour and 30 containers state ownership has been inadequate per hour in the new port of Cai Lan. commercial focus of state-owned enterprises. A All of these measures suggest there is company whose objective is profit room for reducing costs of infrastructure maximization will actively seek to keep costs services. This is not simply an issue for down. While the politicians and officials who residential consumers. Businesses use make government decisions would like to see infrastructure services as inputs. High cost profitability increased they may also seek other inputs force up the final price of their goods, non-commercial goals such as maximization of reducing their international competitiveness. employment. While some non-commercial Reducing input costs would permit lower goals are legitimate goals of public policy, prices for exports, and thus greater mixing them together with commercial goals international demand for Vietnam's exports. hides their true cost, reduces the ability to 32. PDP Australia Pty Ltd/Meyrick and Associates (2005). 67 examine trade-offs, de-motivates managers, and Affairs, the Ministry of Planning and provides them with plausible reasons for poor Investment approves their investment projects, financial performance. and the Ministry of Finance grants funds. In many cases non-commercial goals can be Corporate governance in Vietnam is achieved at less cost through alternative means. generally said to be weak. A new Unified For example, the provision of social services Enterprise Law (UEL) was enacted in 2005 for might be best achieved through direct transfers implementation from April 1, 2006. It is to the poor, while leaving infrastructure firms intended to provide common and improved free to pursue directly commercial goals. In rules of corporate governance for domestic and addition, the weight attached to non- foreign private firms. But SOEs will only be commercial goals may not be communicated to subjected to the new UEL if they are specifically the public. Most governments with a policy of converted into either single member limited transparency and public policy debate find that liability or joint stock companies. Subjecting an informed public can play an important role infrastructure SOEs to the UEL would be a in improving the quality of public policies. logical element of any corporatization program, To encourage greater commercial focus but there currently seems to be little impetus in many governments have "corporatized" their this direction. enterprises, applying private sector company In addition to subjecting public enterprises law. Company law is designed to provide to the corporate governance rules of the private private owners with rules that allow them to sector, there may be a need for state-owned manage the enterprise effectively, make infrastructure enterprises to be governed by strategic decisions about the enterprise's additional rules, to ensure a transparent debate direction, and hold the enterprise managers about the trade-off between commercial goals accountable for its performance. The same sorts and non-commercial goals. A possible set of of rules are desired by the government as additional rules to support a commercial focus owner. Of course, the effectiveness of and allow balancing with non-commercial corporatization in imparting a commercial objectives might, for example: 33 focus and providing necessary information to give the enterprise the objective of operating owners depends on the strength of company as profitably as possible; law in each country. set up procedures for negotiating contracts In Vietnam most infrastructure services are or business plans between the government provided by state-owned enterprises. Corporate and the enterprise as the only procedure for governance is under the Law on State-Owned politicians or officials to direct or influence Enterprises. SOEs are not subject to the general the enterprise; principles of private sector corporate provide for the government to pay the governance, and are not able to make their own enterprise to pursue non-commercial goals autonomous commercial decisions. To the and prevent it from directing the enterprise extent that business strategies exist they are to pursue such goals without paying; embodied in sectoral Master Plans prepared by require the appointment of directors who line ministries, personnel policies are controlled are not government employees and thus by the Ministry of Labour, Invalids and Social cannot be directed on a day to day basis by 33. These suggestions are taken from Irwin, and Yamomoto (2004. 68 the government, and don't face the threat of were not the owner. And as owner of a punishment if they resist political monopoly, the government can regulate the interference; industry in arbitrary fashion, without resistance specify the procedure the government must from persons representing the commercial use to appoint directors; interests of the firm. establish performance pay for directors While these conflicts of interests cannot be (who in turn may establish it for entirely removed their negative effects can be managers); and lessened by measures such as: require additional public reporting of Separating the ministries responsible for performance and policies not required for being the shareholder of a state-owned private companies, such as: enterprise and those responsible for - economic profitability taking into industry policy. For example, in New account an estimated cost of the government's Zealand the Ministers of State-Owned equity in the enterprise; Enterprises and Finance hold shares in New - any directions given to the enterprise by Zealand's public electricity companies, the government; while the Ministers of Energy and - performance in billing and collection; Commerce have responsibility for electricity and policy. The ministry responsible for - the number of employees. industry policy could also be given the task Appointment of privately successful of purchasing or subsidizing services not business people as directors may help to instill fully paid for by customers. a commercial culture. Listing a minority of Creating and using independent regulators shares in an enterprise brings to bear the stock and competition agencies to enforce some of exchange rules for information disclosure, and the rules (regulation is discussed in more also brings close monitoring of financial detail below in Part 4.5). performance by the minority shareholders. Establishing high-level rules that create a Similarly, requiring the enterprise to borrow bias in favor of competition that politicians from commercial lenders, rather than seek and officials cannot easily undermine when government financing, brings close monitoring making lower-level decisions. of financial performance by those lenders. In addition to reforms to encourage better Vietnam has not used such measures to general commercial and policy decisions, there promote commercial focus and to ensure are some public sector reforms which could be transparent trade-offs between commercial and undertaken to address particular problems non-commercial goals. The suggestions above encountered in Vietnam. Vietnam could could be used as an agenda to be explored for increase the use of performance based pay for purposes of improving public sector managers to address specific measurable infrastructure efficiency. problems. For example, Figure 4.1 highlights a Apart from a weakness of commercial focus, problem with unaccounted for water. the second major difficulty with public Performance pay linked to reductions in ownership encountered internationally is that unaccounted for water could be a useful tool governments face a conflict of interest that for addressing the problem. Care must be undermines the quality of policy. For example, taken in the design of such schemes, however, as owner of a firm the government is more since a manager could, in an extreme case, likely to protect it from competition than if it achieve zero unaccounted for water by 69 stopping all production. Moreover managers In natural monopoly markets there is the can make little progress on unaccounted for possibility of using "competition for the market" water if funds are not provided to install to identify more efficient firms. For example, meters to identify where leakage occurs, or to the government can sell the right to operate an repair leaks when they are identified. enterprise to the firm offering the lowest prices Finally, public procurement practices could to consumers, or to the firm offering the highest be reformed to make greater use of competitive fee to the government. In theory, the bidding bidding, and less use of independent expert firm with the lowest costs would expect to make verification of sole-source bids. the most profit from any given pricing Particularly in the transport and arrangement, and so could afford to offer the telecommunications sectors there are many lowest prices to consumers or the most money possibilities for SOE reform for enterprises that to the government. Competitive bidding serves serve the core infrastructure facilities. For as a means of identifying the least cost firm example, there are many construction from among multiple bidding firms. companies in transport that could be separated The difficulty with the "competition for the from the Ministry of Transport and equipment market" approach is that the greater producers in telecommunications which could investment that is sought, the longer the be separated from VNPT, and given revised contract needs to be to ensure that investment governance structures and stronger incentives costs are recovered. This requires a long-term for commercial performance. Going a step contract that is sufficiently flexible to cover further, these sorts of enterprises could be changing circumstances. With large exposed to stronger competition, to provide investments, these contracts may last for ongoing incentives for efficiency upwards of 30 years, and of course it is improvements. unlikely that all circumstances can be foreseen over 30 years. Flexibility can be introduced by 4.3 Competition entrusting discretion to a regulator, but even this has its limits (see the section on regulation, Competition is the most powerful mechanism below). Thus re-negotiation is very common for improving efficiency. Competition provides where "competition for the market" is used. firms with the incentives to keep costs to a Since re-negotiation occurs under very minimum, to offer products that are better different circumstances from the initial adapted to the needs of consumers, and to competitive bidding, it is not clear that the adapt new technologies as they become benefits of competitive bidding are always available. retained. In any case, over the life of a long There are various possibilities for increasing contract it is not guaranteed that the firm that competition in the infrastructure sectors (for was most competitive at the time of contract example, transport construction companies, award remains the market leader. telecoms equipment manufacturing) but there In Vietnam the use of competition as a tool are also various natural monopoly sub-sectors, for improving efficiency varies across such as electricity transmission or water infrastructure sectors, but generally the pipelines, where direct competition is not continuing philosophy is one of trust in feasible. Cases where direct competition is not government planning processes and feasible pose the greatest challenge for bureaucratic performance targets rather than efficiency improvement. market competition. Annex 1 reviews the scope 70 for introducing greater competition across 4.4 Private Participation infrastructure sectors, with the greatest potential being in the telecommunications and At the moment Vietnam's efforts to involve the electricity sectors. private sector in infrastructure sectors is largely In telecommunications international focused on meeting financing needs, through experience strongly suggests that the speed of the equitization program and BOTs, rather than network rollout is accelerated by greater improving infrastructure efficiency. But private competition. Several new entrants have been participation can be introduced as a means of authorized to compete with VNPT in fixed line improving efficiency, especially when and mobile services, but VNPT remains introduced through competitive bidding for the dominant. Effective regulation, in particular right to serve a market. Greater use of private spectrum management and resolution of participation as a means of improving interconnection disputes, will be important in enterprise efficiency could be encouraged with various institutional reforms. facilitating the progress of the new entrants. Faster progress could be made by allowing the entry of foreign firms. In this respect, the United 4.4.1 Equitization States has obtained an early advantage, obtaining preferential access for its firms under Equitization provides for a simple change of a Bilateral Trade Agreement. But even these ownership. International evidence suggests that compared to the introduction of competition, advantages limit foreign ownership to 49% and ownership changes of themselves are likely to 45% in the mobile and fixed line services deliver relatively small efficiency markets. These limits restrict the potential for improvements. There is strong empirical competition to drive greater investment and evidence that private firms in competitive markets improved services. outperform public firms across a host of The 2004 Electricity Law sets out plans for a measures, including total social welfare.34 Thus, phased transition over 20 years to direct for example, telecommunications markets could competition in electricity generation, with be strengthened by eliminating the existing eventual choice of generators for consumers. barriers to competition and introducing new There are various obstacles to the private competitors. But in infrastructure implementation of these plans, including the natural monopolies the international evidence difficulty of encouraging private investment in is much weaker concerning efficiency IPPs (a major sectoral priority) when the future improvements induced by mere changes of market structure is uncertain. Managing the ownership. Changes of ownership in transition to a competitive electricity sector will infrastructure natural monopolies do, however, be one of the most difficult policy challenges in offer the potential for improved performance infrastructure. when linked to competition for the market. In other sectors, the introduction of Vietnam's equitization program introduces a competition could occur with the introduction level of private ownership into infrastructure of private participation by means of firms, and provides an injection of funds that "competition for the market". can be used for investment. But as a means of 34. See, for example, Megginson and Netter (2001) and references cited therein. 71 delivering efficiency improvements in majority of the contracts are BOTs. (The infrastructure the current program has telecommunications business cooperation important weaknesses: contracts (BCCs) are a means of introducing Equitization tends to be focused on current private financing without transferring workers and managers. While providing management control). Competitive bidding for a workers with stronger incentives has helped BOT project can be used to identify efficient to improve productivity in various smaller service providers. Because the winning bidder is enterprises in Vietnam, in large responsible for operations, management, and infrastructure enterprises these incentives investment it also offers strong ongoing are likely to be weaker. When the benefits of commercial incentives for efficient performance. better performance are shared across more Unfortunately, the Government has workers, workers have stronger incentives historically tended to award BOTs on a to free-ride on the efforts of others. negotiated basis, rather than through Equitization is not used as a means of competitive bidding. International evidence introducing new management in suggests that competitive bidding of BOTs infrastructure, so it is unlikely to find new yields lower final prices than direct solutions to poor management. negotiation.35 This was certainly observed with It is rare for equitized firms to be listed on the Phu My 2.2 project (see Box 4.1). the share market. This is unfortunate as an International experience also suggests that important element of privatization is the competitive bidding tends to be less susceptible possibility for outside shareholders to take to corruption than direct negotiations. control when they see the possibility of A number of BOTs have been negotiated efficiency improvements. with state-owned construction companies. If the equitization program is to be used as a While local financing has advantages in terms means of improving efficiency of infrastructure of foreign exchange risks, the use of foreign firms the current rules (see section 2.3.10) enterprises with specialist infrastructure requiring that the State retain majority ownership experience could provide a stronger infusion of even in competitive segments of infrastructure management expertise, new technology, and industries should be relaxed. Such rules are not new ideas for efficiency improvements. And a necessary in markets where there is a choice of difficulty with state-owned enterprises is that supplier as, for example, in electricity generation weak governance structures may provide weak or mobile telecommunications. Moreover, with commercial incentives, undermining the aims relaxation of these rules, equitization should be of a BOT program. There is scope for greater used to introduce new management in at least a openness toward foreign private enterprises in selection of infrastructure operators, to provide a infrastructure investment. competitive spur towards innovation and The legal basis for BOTs is set out in the 1996 efficiency improvement. Foreign Investment Law, and the related Decrees 62/1998/ND-CP and 02/1999/ND-CP. 4.4.2 BOTs These laws encourage foreign investment in transport, communications, power production Table 4.1 sets out instances of private and trading, water supply and drainage, waste participation in infrastructure in Vietnam. A treatment, and other fields decided by the 35. Albouy, and Bousba (1998). 72 Prime Minister. They offer tax exemptions and identified several further problems with the set out procedures for the conduct of feasibility legal regime for BOTs, including investors' studies, procedures for government approvals, concerns about how priorities would be contractual terms, and mechanisms for dispute allocated in the event of foreign exchange resolution, although not in great detail. shortages, which State bodies had the legal The current BOT legal regime permits, but authority to provide and honor guarantees, the does not require competitive bidding. The 1999 possibilities for land-use rights to be transferred Country Framework Report (PPIAF, 1999) in the event of sales of buildings, the "step-in" Table 4.1: Private Participation Contracts in Vietnam Contract Closure Duration Country of type date (years) What Where Sponsor Phu My, 70 km from France, BOT 1994 25 Deep water port HCMC Norway BCC 1995 10 MobiFone mobile network National Sweden BOT 1996 Air cargo terminal Ho Chi Minh City Singapore Diesel power generation, Hiep Phuoc, EPZ 15 ROT 1996 50 Taiwan transmission lines & toll-road km from HCMC BCC 1996 10 Network development Four provinces South Korea BCC 1997 15 Network development North-east Hanoi Japan BCC 1997 15 Internal network HCMC France BCC 1997 15 Network development East Hanoi UK BOT 1997 VICT container terminal Ho Chi Minh City Japan BOT 1997 30 Diesel power generation Bien Hoa Thailand BOT 1998 20 Water treatment plant Ho Chi Minh City Malaysia BCC 1998 6 International telecom network National Australia France, BOT* 2001 25 Water treatment plant Ho Chi Minh City Malaysia Gas field, transmission pipeline, & BOT 2002 Approx. 20 Nam Con Son UK, US processing facility France, BOT 2002 20 Gas-fired power generation Phu My 2.2 Japan BCC 2003 15 S-Fone mobile network National South Korea UK, Japan, BOT 2003 23 Natural gas power generation Phu My 3 Singapore BCC 2005 15 CDMA mobile phone network Hanoi UK Source: BCC information from USAID (2005); other information from PPI database. BCC ­ Business Cooperation Contract. ROT ­ Rehabilitate, Operate, Transfer. * In February 2003 Suez Lyonnaise (France) and Pilecon Engineering (Malaysia) withdrew from the Thu Duc water project following disputes with the construction company and local partners. In August 2005 a Vietnamese consortium led by Ho Chi Minh City Infrastructure Investment Joint Stock Company (CII) won the tender to replace the foreign investors under a revised BOO scheme. 73 Box 4.1: Phu My 2.2 Project all BOT projects, with exceptions only granted under a limited and carefully defined set of The 715 MW Phu My 2.2 gas-fired power project was the first circumstances; infrastructure project in Vietnam to use international competitive bidding. Six international consortiums bid for a 20 year BOT to The decree should clearly construct and operate the plant in Vung Tau, near Ho Chi Minh City. identify in which sectors BOT The World Bank helped to finance technical assistance for the contracts may be granted, and project, and provided a US $75 million partial risk guarantee that helped to mobilize a further US$ 405 million in finance. In 1996 an establish who has the authority to engineering consultancy firm was employed to develop the enter into BOT contracts; contractual framework for the project, including a proposed power The decree should establish purchase agreement. A request for proposals was issued in late minimal project preparation steps, 1997; questions were accepted from bidders; then clarifications provided. Bids were opened in April 1998. including feasibility studies, to be The contract with the winning bidder provided for the delivery carried out before calling for bids; of power to EVN at US cents 4.1 per kWh (including fuel costs based The decree should clearly state on the gas price agreed with Petro Vietnam) on a levelized basis which public authorities (preferably over the life of the project. This was lower than bids for other projects being negotiated directly with project sponsors, typically only the Ministry of Finance) may around 5 cents per kWh. provide financial or economic support, including contingent support such as guarantees, to the rights of lenders in the event of failure by an implementation of BOT projects; investor to fulfill contractual obligations, and the Specified bidding procedures could allow for right to specify foreign arbitration in the event of pre-qualification of bidders; and for a two- a dispute between the BOT company and stage selection process, with an initial hurdle another Vietnamese enterprise. of meeting certain technical standards, and The government is currently drafting a then all remaining bidders being evaluated replacement BOT decree. Desirable features of a solely on a single financial criterion. BOT decree would include:36 Procedures should be specified for how Competitive bidding should be required for negotiation would be conducted in the event that competitive bidding is not used. Procedures should be specified for dealing with unsolicited bids, potentially permitting some form of compensation for the intellectual property and financial costs of unsolicited project proponents, but nevertheless requiring that such projects be subjected to competitive bidding. Provisions dealing with the contents of a BOT contract, including governing law, ownership of assets, responsibility for acquisition of rights to the project site, Thu Duc, Ho Chi Minh City, Build-Own-Operate (B.O.O.) water treatment plant under construction, May assignment of the contract, and duration and 2006 termination of the contract; 36. A useful statement of international best practice is UNCITRAL (2004). 74 Provision for dispute resolution, reduce costs by identifying the private distinguishing between disputes between sector firm that can perform the service at the contracting authority and the investor, least cost. disputes involving suppliers to the BOT, Management contracts are used to address disputes involving customers of the BOT more general problems of inefficient facility, and other disputes. management. Basic management contracts Because the details of BOTs differ transfer responsibility for operations and substantially across sectors, there could also be a maintenance to a private firm. The private need for supplementary sectoral regulations firm seeks to make efficiency improvements setting out minimal contractual details, while in return for a fixed fee. Payments can also preserving flexibility to adapt contracts to provide incentives on particular targets, but circumstances. As discussed in section 2.3.12, it specifying these targets clearly can be would also be desirable to have government difficult. guidelines governing the provision of Under a lease arrangement a private firm contingent support. leases the assets of the enterprise from the government and takes on the responsibility 4.4.3 Other Forms of Private Participation for operating and maintaining them. Because the lessor effectively buys the rights The almost exclusive use of BOTs as a means of to the income stream from the utility's private participation in Vietnam suggests that operations (minus the lease payment), it the focus has been on obtaining private finance, assumes much of the commercial risk of the rather than being focused on improving the operations. This provides strong incentives efficiency of existing enterprises. The BCCs in to the private firm to lower costs and telecommunications provide further suggestive increase revenue collections, and lessens the evidence, since they obtain private financing need to contractually specify particular without ceding management control to the operational targets requiring management private sector. attention. Leases leave the responsibility for But as reviewed above, the efficiency of financing and planning investments with existing enterprises is not perfect. There are the government. One of the major many contractual options for involving the complications of leases is the coordination private sector in the provision of infrastructure services, which can be used as a means of improving efficiency. Competitive bidding is a central element of the use of these schemes to improve efficiency, since it serves to identify the most efficient firms. Table 4.2 outlines the various possibilities: Service contracts provide for the contracting out of specific tasks, such as reading meters, computer services, road maintenance or collecting payments. They can be used as a means of bringing in specialist expertise that is missing in the public sector, and/or to Phu My 2.2 BOT715 MW gas turbine power station 75 required between the government's and delays. Build-operate-own (BOO) investment plans and the private operator's contracts provide that the built assets remain operational plans. indefinitely with the private firm. Concessions give the private partner Divestiture can occur through a sale of assets responsibility not only for the operation and or shares. A complete divestiture gives the maintenance of a utility's assets but also for private sector full responsibility for investments. Asset ownership remains with operations, maintenance, and investment. But the government, however, and rights to all unlike a concession, a divestiture transfers the assets revert to the government when ownership to the private sector. With a the contract ends. Concessions are often bid concession, the government needs to devise by price: the bidder that proposes to operate rules that ensure the assets are returned in the enterprise and meet the investment good condition. Such rules are not needed targets for the lowest tariff wins the with divestiture since the private owner has concession. The concession is governed by a sufficient incentive to maintain assets. contract that sets out such conditions as Consideration should be given to use of mechanisms for adjusting tariffs, these PPI alternatives as a means of performance targets such as quality and improving the efficiency of existing service coverage, and arrangements for infrastructure enterprises. Pilot exercises resolving disputes. The main advantage of a should be undertaken across the concession is that it passes full responsibility infrastructure sectors, to gain experience in for operations and investment to the private project preparation, and also to assess the sector and so brings to bear incentives for effectiveness of private participation as a efficiency in all the utility's activities. means of improving efficiency. Because of the Build-operate-transfer (BOT) arrangements difficulties in attracting private investment in are basically the same as concessions, with the sectors where there has been little history of added requirement that the private firm private investment, initial experiments construct the infrastructure facility concerned. should focus on projects that are likely to be These contracts help the government reduce commercially attractive. In order to assess the public risks of construction cost overruns effectiveness it would be important that these Table 4.2: Responsibilities under the Main Private Participation Options Operations and Capital Option Commercial risk Asset Ownership Typical Duration maintenance investment Public and Service contract Public Public Public 1-2 years private Management Private Public Public Public 3-5 years contract Lease Private Shared Public Public 8-15 years Concession Private Private Private Public 25-30 years Private and BOT/BOO Private Private Private 20-30 years public Divestiture Private Private Private Private Indefinite 76 pilot projects be accompanied by careful work, the government should have already monitoring and evaluation of their effects. identified sufficient technical standards, and must have clear financial criteria for evaluation 4.4.4 Preparing for Private Participation of the bids, and all of these should be included in the bidding documents. Competitive bidding requires careful Finally, winning bidders have been known to preparation by the Government. Ideally, use the period after bidding to negotiate revised projects will be sufficiently well prepared that a terms and conditions. This risk can be lessened if common set of conditions can be offered to all all of the terms and conditions are set out in a bidders, without the need for any further draft contract prior to bidding occurring, with negotiation after the winning bidder has been the only remaining detail to be filled in being the identified. Even if competitive bidding is not financial result of the bid. Bidders should be made automatic, careful preparation by the informed that no modification of the contract Government before approaching private firms will be permitted after the bidding. In the can help to reduce the time and expense for the absolute best of international practice, the draft private sector, and so help to reduce final costs. contract is pre-approved by Government, and Preparatory work that should occur prior to the winning bidder is required to fill in the bidding includes identification of the scope of financial bid and sign the contract immediately the project, an assessment of the potential after selection. economic benefits of the project, an Preparing for a competitive bid is a time- environmental and social impacts appraisal, a consuming process. But all of these steps would market appraisal, an assessment of the likely need to be performed even with a negotiated costs of private sector capital, preparation of a proposal, and the benefit of careful preparation financial model for the project, an assessment of is that the full force of competition can be used whether the implied tariffs are compatible with to generate greater cost savings in procurement the government's policies on affordability, and of the desired infrastructure service. an overall appraisal of the likely social costs and Careful project preparation also requires benefits of the project. All relevant documents specialist economic, accounting, and legal skills. should be available for inspection by all Most governments, even those with extensive potential bidders. PPI experience, find that the skills within Where the project involves sales to final government need to be supplemented with the consumers, there is often a need for regulatory skills of consultants with expertise in project arrangements governing tariffs and service preparation. Recognizing the difficulty in trying quality. Regulatory reforms should be to reproduce such skills across many ministries developed and enacted prior to bidding. and tiers of government, some countries have To identify the most efficient operator it is opted for specialist institutions to be involved in common practice to use a two-stage process in developing a pipeline of projects, project which bidders' proposals must first meet a preparation and, in some cases, project specified technical standard, and then the approval. Good examples include the winning bidder is chosen purely on the basis of Philippines BOT Center, South Africa's Public- financial proposals (eg. the firm proposing the Private Partnerships Unit (PPP Unit), or in India, lowest tariff to consumers, or the highest the Gujarat Infrastructure Development Board payment to government, or asking for the lowest (see Box 4.2). subsidy from government). For such bidding to In supporting provincial and municipal 77 Box 4.2: Gujarat Infrastructure Development Board The State of Gujarat in India, located on the framework, and the bidding criteria. coast next to Pakistan, has a population of over Preparation to the point of a bankable project 50 million people, and has had an annual is expensive. The GIDB operates a revolving growth rate of 10 to 12% over the past five fund to pay for pre-feasibility studies. Some years. The Gujarat Infrastructure Development projects are feasible, others are not. When a Board (GIDB) is headed by the State's Chief feasible project proceeds to selection of a Minister, and consists of various ministers private operator, a fee is charged by GIDB, responsible for infrastructure. It is supported by enabling the development costs to be a technical secretariat with expertise in each recovered and used for further pre-feasibility affected sector. studies. The GIDB's mandate is to pave the way for Much of GIDB's early efforts were focused on fast-track implementation of infrastructure developing clear policies, such as bidding projects. Planning processes identified 383 criteria and model concession agreements to infrastructure projects required to meet demand guide future development. At the same time, real during 2000-2010. This list of projects was then progress on introducing private participation has assessed on economic criteria to determine been made, with 6 port projects, 10 independent priorities. Projects are being assessed in order of power projects, 6 toll-road projects and 2 priority for their potential for private railroad projects completed since 2000, participation. involving over US$ 5 billion of investment. A Where it is decided to involve the private number of other projects are close to sector in a project, the GIDB undertakes completion. project preparation, including the risk allocation framework, the financing Source: GIDB website: governments, a central "PPP Unit" or "BOT costs and the incentive for regulated firms to Center" could be given an advisory role reduce costs over time. The design of (providing support when requested by lower regulatory schemes involves specific sorts of levels of government) or a mandatory role rules to manage these trade-offs (Box 4.3) as (approval of the unit would be required for the well as institutional arrangements to balance project to advance). Alternatively, LDIFs could the interests of consumers and investors (Box be developed as the centers of expertise in 4.4). Annex 2 provides an overview of further preparation of PPPs, although this strategy issues that need to be addressed in the design would not work for the many provinces that of a modern regulatory system. have not established LDIFs. At present, Vietnam has very limited experience with the establishment of the sorts 4.5 Regulation of regulatory schemes and institutions found in more developed market economies. The Where competition is not present, effective traditional regulatory institutions have been regulation is the key to efficient operation. government ministries. A good first step Regulation can provide incentives to firms to towards a specialist infrastructure regulatory reduce their costs and can mandate prices institution was taken in 2005 with the designed to achieve efficiency. Modern establishment of the Electricity Regulatory economic theory recognizes a trade-off Agency of Vietnam (ERAV), described in the between the goal of keeping prices close to Power Strategy paper. 78 It is likely that the evolution of ERAV A gradual and evolutionary approach, will affect the development of regulation in entrusting greater powers to the agency only as other infrastructure sectors. A major task it establishes its competence is natural. But over for ERAV will be to build regulatory time, the aim should be to remove the capacity by hiring staff with specialist skills ministerial influence over ERAV, establishing it in areas such as auditing, accounting, as an independent agency, with strong economics, and law. professional skills. It would be desirable to ERAV does not currently have the remove retail tariffs from the political arena. powers associated with many regulatory Vietnam needs large amounts of foreign agencies elsewhere. Significantly, the investment in IPPs to meet growing demand. Minister of Industry presides over the While IPP tariffs will be fixed under power agency, final decisions on retail power purchase agreements with EVN, the financial tariffs remain the prerogative of the Prime viability of EVN as the single buyer of electricity Minister, and details of information- will be determined by the retail tariff. The gathering and enforcement powers remain perceived risks of EVN default, and hence the to be developed. cost of capital, would be reduced by a system in Box 4.3: Forms of Price Regulation There are three main approaches to preventing set, commonly every five years, to ensure that monopolistic infrastructure utilities from charging consumers benefit from these cost reductions. excessively high prices: rate-of-return regulation, Yardstick competition can be used where there are price cap regulation, and yardstick competition. many similar firms, such as water or electricity Regulatory agencies that use a rate-of-return distribution companies. It is a more refined version approach first determine a reasonable rate of return of a benchmarking program, which recognizes (profit), and then set the utility's price to cover there may be legitimate reasons why unit costs operating costs plus a margin that is just enough for differ across utilities. For example, fixed costs tend investors to earn the specified rate of return on their to be a higher proportion of total costs in a investment. The regulated price can be adjusted company with fewer customers. Information on upward if the utility starts making a lower rate of each firm is collected, and statistical methods are return, or downward if the utility makes a higher rate. used to calculate the unit costs that would be This system encourages investment, because it incurred by an efficient firm, taking account of its provides a sure rate of return, but it does little to system characteristics. A different customer price encourage cost reductions. for each utility can then be set equal to the costs of Price-caps are an alternative approach to setting an efficient firm operating under the same utility prices. Under this approach, the regulated constraints. If a firm's performance does not price is adjusted each year by the rate of inflation achieve the benchmark its profits are low, while if minus some predetermined amount and without it out-performs the benchmark its profits are regard to changes in the firm's profits. The price- increased. As individual firms improve their setting rule is sometimes called RPI-X, where RPI is efficiency, the benchmark requirements are the retail price index and X represents the expected tightened for all firms. annual gain in the utility's efficiency. In this system, Hybrids of these forms of price regulation are firms have a strong incentive to reduce costs because possible. For example, an efficient benchmark or a efficiency improvements generate higher profits for rate-of-return calculation can be used to set an initial the firm. Failure to achieve the expected rate of price-cap; and the more frequently price-caps are re- efficiency improvement will result in regulated price set, the more the system resembles rate-of-return increases that trail inflation. The price cap can be re- regulation. 79 Box 4.4: Discretion in the Regulation of Private Infrastructure Enterprises The regulation of consumer tariffs for infrastructure and reasonable" price, and a reputation for services is subject to conflicting forces: protecting the legitimate interests of investors. In a developing country with limited reputation for Governments would generally like to keep respecting private property rights, such wide tariffs down to protect consumers, and face discretionary powers would not provide credible political pressures to reduce tariffs after protection of investors' rights. To compensate for investments have been made (effectively, to the perceived risk of expropriation, investors expropriate the investment). would demand a high rate of return for their Investors are aware of these pressures, and will capital. not invest in the first place unless the At the other extreme, some countries government makes a credible commitment to implement regulation through tightly specified rules that permit a reasonable return on capital laws or contracts that seek to eliminate discretion. invested. The lower the credibility, the higher This approach has often been favored by investors the cost of capital. who perceive a high risk of misuse of discretion by The long-term nature of most infrastructure ministers or regulators. But the international investment makes it difficult to create credible experience of the past decade suggests that such commitments. Detailed rules specifying how contracts are highly vulnerable to changed prices will be established over time could circumstances, resulting in frequent disputes and provide a degree of certainty to investors, but renegotiations. this would leave little flexibility to pursue Most regulatory systems lie somewhere efficiency as circumstances change in between these extremes. Key policies and unforeseen ways. principles tend to be defined in laws, licenses, or There is thus an important tradeoff between contracts, which carefully delimit residual reducing the risk of expropriation and with it the discretion through reference to criteria, factors cost of capital, and retaining the flexibility to and objectives. When discretion is retained on pursue efficiency and deal with unexpected tariffs or other issues of concern to investors, the circumstances. Policy makers need to decide how challenge is to manage it in a way that minimizes much discretion to introduce into regulatory the risk of misuse. The exercise of discretion systems, and how best it should be exercised. needs to be insulated from short-term political The discretion in regulatory systems differs pressures and other improper influences and to widely across countries. At one extreme, US be based on competent analysis. International regulators typically have wide powers to set prices experience suggests that these requirements are that are "just and reasonable." But the United best satisfied by specialist regulatory agencies, States has more than a century of experience in desirably independent of ministerial influence. regulation of private utilities, with an established body of jurisprudence as to what constitutes a "just Source: Smith (1997). which an independent regulator established network. If a competitive and cost-effective retail tariffs on purely technical criteria related telecommunications industry is desired, to costs. regulation should be performed by an agency There are greater weaknesses in regulatory that is separate from the Ministry and has no institutions in other sectors. In interest in the regulated firms. telecommunications, regulation rests with the The ports sector provides an even starker Ministry of Post and Telematics. The Ministry's example of a conflict of interest. Vinamarine ownership of VNPT establishes a conflict of regulates port operations, but also operates a interest between maximizing VNPT's profits number of small ports. Effective regulation and developing strong competition for VNPT. cannot be expected in cases where regulatory This will be particularly apparent in disputes in enforcement would diminish Vinamarine's which competitors seek access to VNPT's profits. 80 Better is the arrangement in railways where support to local authorities to assist in these Vietnam Railways Administration regulates, tasks. while Vietnam Railways Corporation provides As market liberalization and entry by private rail services. Given the accident rate in railways, firms occur in different infrastructure sectors however, it would be reasonable to question there will be an increasing need for autonomy of whether safety standards are adequately regulatory processes from political interests (ie enforced. Part of efficient service provision greater separation from ministries) to reassure should be providing adequate resources to investors that their investments will not be regulatory agencies to permit enforcement. A subject to political whims. But for the moment review of regulation in transport is currently the most pressing requirement is to build greater under way, addressing roads, railways, inland regulatory capacity in terms of both auditing, to water, maritime transport, ports, air freight, verify the true costs of regulated firms, and multi-modal transport, and customs and cross- economics, to set prices in an efficient manner. border issues. Recommendations for reform of The aim should be to develop experts who can regulatory institutions in transport await the improve the efficiency of price and other forms outcome of the review. of regulation. Such experts could be made In the water sector, although the requirement available to lower levels of government to assist of cost-covering tariffs has recently been in regulatory reviews. One option for imposed at the national level by the Ministry of consideration is the concentration of economic Finance, the details of regulation are effectively experts in a multi-sectoral regulatory agency, implemented by local People's Committees. It which would help to address the shortage of seems unlikely that the People's Committees economic and other capacity for specialist price have adequate resources to perform the more regulation. economically demanding tasks of price regulation, which could potentially improve the 4.6 Addressing Corruption welfare of their citizens. There may be a role for central government to provide regulatory The Transparency International Corruption Perceptions Index suggests that Vietnam has a serious corruption problem. Although perceptions of corruption are about average for the region (Figure 4.8), on a broader international scale Vietnam was ranked 102nd out of 146 countries in 2004. Corruption is both a symptom of poverty (poor countries tend to have higher levels of corruption, because of inadequate systems to control it) and a cause of poverty (it increases the risks and direct costs of business transactions, hampering growth). Note: The maximum possible score is 10 for a country free of corruption. Academic studies have found Vietnam's score in 2004 was 2.6. 81 Box 4.5: Bangladesh Rural Electrification Board Gerlagh (2004) present evidence that the principal transmission mechanism is corruption's effect in constraining In Bangladesh, the Rural Electrification Board (REB) and its rural electric cooperatives (Pally Bidyut Samities) have protected investment, by increasing costs and themselves from the corrupt practices commonly seen in other risks of investing. power sector utilities through a number of innovative With around 10% of GDP being arrangements: channeled into infrastructure investment Administrative Arrangements: The Board of each PBS is elected in Vietnam, infrastructure is an obvious by consumers. This Board and REB management approve the salary structure for the PBS, which is usually market based (de- area for potential corruption, and there linked from the government salary scale). Since meter reading is have been several documented instances a common source of corruption, meter readers are hired on of corrupt behavior in connection with contracts of only one year. With good performance record the contract may be extended, but never can it exceed three infrastructure projects (see Box 4.6). The years--after which the meter reader will have to seek a different magnitude of investment combined with career. A good performance record as a meter reader can lead high social returns to infrastructure raise to a linesman or other job with a PBS, and this job expectation is a strong incentive to maintain a good track record as meter theopportunitycostsofcorruptiontovery reader. high levels. For example, suppose the Operational Arrangements: Every year the management of each averageinfrastructureprojectyieldsatotal PBS negotiates a results agreement with REB. This is known as return of 20%, and corruption boosts Performance Target Agreement (PTA). If a PBS meets the PTA, its management receives a bonus. Not meeting the PTA targets project costs by 10%. Without corruption, results in penalties. A standard PTA has about 20 targets, with investment of 10% of GDP in high weights given to system loss, collection efficiency, infrastructure would yield social benefits revenue/km of line, cost of supply/km of line, and debt repayment. worth 2% of GDP. With corruption, criminals would receive a transfer of 0.9% Investment Decisions: PBSs use independent consulting firms to survey rural areas to identify potential consumers and to of GDP, and the social benefits flowing design the electricity distribution network. These firms also from infrastructure investment would be calculate the revenue that is expected to be generated by each reduced to 0.9% of GDP, a reduction of proposed line, and the lines generating the highest revenue are selected first for construction. The list of lines to be constructed 1.1% of GDP. next year is disclosed to the public on the notice board of each Opportunities for corruption arise at PBS. These practices reduce the risk of corruption and nepotism most stages of the infrastructure project in investment decisions, and help PBSs to avoid constructing uneconomic lines. cycle. Corruption in the project preparation phase typically involves the choice of project location, choice of design, relocationandresettlementplans,andland that corruption tends to slow the rate of acquisition. Internationally, the majority of cases economic growth. Econometric studies by Mo involve corruption in the project implementation (2001) and Pellegrini and Gerlagh (2004) agree phase: particularly during procurement, but also in in the broad magnitude of this effect, suggesting the approval and payment of invoices. In addition that an increase of one point in the TICPI to collusion among bidders, infrastructure projects corresponds to an increase in economic growth are especially vulnerable to change order of around half a percentage point. For Vietnam schemes (bids are set artificially low to secure an increase of one point in the TICPI the contract, and subsequently adjusted by corresponds to the corruption level of Thailand, change orders) and the use of inadequate while two points roughly corresponds to the and/or inferior materials (e.g., road construction corruption level of Malaysia. Pellegrini and contractors cut costs by laying insufficient 82 Box 4.6: Opportunities for Corruption The following cases from the past decade in Vietnam problems for the company as it tried to meet the illustrate some of the possibilities for corruption in growing demand for mobile phones. Ultimately the infrastructure projects. company was cleared of illegal practices, but five In 1995 a former Minister of Energy was sentenced contracts awarded to a company run by the son-in-law to 3 years in prison for accepting side-payments for the of the Minister for Posts and Telecommunications were award of construction contracts for the 500 kVA north- cancelled. Sources: Vietnam News (2004), Vietnam south electricity transmission line. Source: Vietnam Trade (2004). Today (2002). The World Bank recently investigated 400 In 1997 tens of thousands of peasants in Thai construction contracts under six credits. No Binh province demonstrated against State abuse of irregularities in financial management or disbursements land-use rights, official corruption, unfair taxation, were uncovered, and the majority of works physically and compulsory labor contributions. Their two investigated were of satisfactory overall quality. principal grievances were additional local taxes (e.g. Nevertheless most bidding prices fell within a very a grass-replacement tax levied on flocks of more than narrow range, suggesting collusion between bidders. 30 ducks) imposed on peasants to finance There are possible explanations for this, such as state- overambitious government infrastructure projects owned bidding companies using the same official and the misappropriation of public funds for the costing norms. But if this is the case, it suggests an personal enrichment of Party officials. The official inadequate level of competition between these firms. report on the incident noted that a sewerage pipe Source: Vietnam Development Report (2005), p.97f. installed by the authorities cost VND 21 million, In April 2006 newspapers reported instances of whereas a pipe installed by the peasants cost only misdirection of funds in transport projects managed by VND 7.5 million, and that prominent rural officials Project Management Unit 18 (PMU 18). Many roads grew extraordinarily rich over the course of five and bridges constructed by the unit are reported to have years. Source: UNHCR (1998). quickly degraded due to inadequate materials used in In 2003 questions were raised about the award of initial construction. One bridge alone is reported to procurement contracts by VNPT, with media allegations have required VND 31 billion (US$ 2 million) to repair that 90% of the contracts handed out between 1998 and within one year of its completion. Reportedly, corrupt 2003 were to favored suppliers, and contravened laws officials were detected by their use of misdirected funds on tendering. During the investigation investment to place large bets on European football matches. contracts were frozen, posing network capacity Source: Thanh Nien News (2006). foundation and improper drainage, the results of presence of competition, in this case competition which might not be exposed until some time in the from mobile phone companies. future when potholes appear or when portions of The Government has placed greater the pavement wash away). emphasis on fighting corruption in recent Once projects are operational there are myriad years. The Government's main anti-corruption opportunities for low-level corruption, such as agency is the Government Inspection Office weigh-bridge operators who falsify truck weights (GIO). The GIO is governed by the Inspection and thereby induce excessive road deterioration, Ordinance (1990), the Law of Complaint and or technicians who assist in the theft of electricity. Denunciation (1998) and the Anti-Corruption The 2005 Investment Climate Survey found that Ordinance (1998). The General Inspector of the 17% of manufacturing firms reported that an GIO holds the rank of minister. But the GIO's unofficial "gift" to officials was required to obtain mandate is general, and there is an emphasis on an electricity connection. For a water connection responding to public complaints and the corresponding figure was 11%. For a mainline "denunciations", and reviews of civil servants' telephone connection, just 8% of firms reported assets. While the GIO has the power to inspect that a gift was required, suggesting that the compliance with the law by the executive possibilities for corruption diminish in the branch in all its areas of operation, it is not clear 83 that it is adequately resourced to perform the innovative means of combating petty forensic audits and physical inspections that corruption, such as corrupt meter readers. Box would be required to detect corruption in 4.5 presents examples of some specific infrastructure procurement. Reliance cannot preventive measures. simply be placed on the GIO to detect Effective competition is one of the best corruption. Systems for the detection of means of narrowing the scope for corruption. corruption should be implemented in all The 2005 PER-IFA provides a number of infrastructure agencies, particularly in the area recommendations to encourage competition in of procurement, with detected cases passed on procurement, including a requirement for to the GIO for prosecution. competitive bidding, preparation of standard The Government has endorsed the "Anti- bid documents, mass media advertising of bids, Corruption Action Plan for Asia and the and elimination of restrictions on the province Pacific" developed by the ADB and the OECD (and country) of origin of the bidding in the Anti-Corruption Initiative for Asia and companies. This needs to be supported by the Pacific (ADB/OECD, 2000). In its 2004 "Self evaluation criteria that do not allow the Assessment Report" under this initiative the exclusion of firms on spurious grounds. Government indicated that it had Competition in the construction industry could implemented measures to address most of the be promoted by a program of equitization: the areas of the Action Plan (ADB/OECD, 2004). A industry is currently dominated by state- draft anti-corruption law was issued for public owned enterprises that prepare their bids using comment in July 2005. Some of the proposed common public sector norms. articles require declaration of assets and Measures to promote effective competition incomes by public officials, encourage citizens need to be sustained by laws against collusion. to report instances of corruption, and require One of the priorities for Vietnam's Competition public agencies to report information to the Authority should be investigation into mass media. It is too early to assess the allegations of bid-rigging. A potential pool for practical effect of recent measures. recruitment of competition investigators could Nevertheless, a review focused on detection of be construction company staff involved in bid corruption in infrastructure could reveal preparation. additional potential measures, such as particular attention to change-orders, or 4.7. Recommendations improved systems for inspection of construction works. The recommendations for improving efficiency Happily, many of the measures of infrastructure services follow the structure of recommended in this chapter to improve this Chapter, addressing in turn public sector efficiency will simultaneously help to prevent reform, competition, private participation, corruption. Measures to promote greater regulation, and anti-corruption measures. As commercial focus, such as corporatization, stressed in the main text, competition offers the equitization, and privatization, will provide greatest incentives for ongoing efficiency stronger pressure on managers to identify improvements. 84 (4.1) Undertake governance reform sofSOEsw hich provide infrastructure services,to (M ) provide a greater com m ercialfocus (ie profitm otivation).Such reform s should includesubjecting theSOEsto thenew Unified EnterpriseLaw ,and could include additionalm easuresassuggested in section 4.2.W heretheGovernm entseeksnon- profitable objectives to be achieved,itshould explicitly purchase non-profitable servicesfrom theSOEs. (4.2) Review the possibilities for SOE reform in transportservice com panies and for (S) corporate restructuring ofVN PT'sancillary service providers(such asequipm ent m anufacturers), having regard to the provision of stronger incentives for com m ercialperform ance,separation ofpotentiallycom petitiveoperationsfrom the core natural m onopoly operations, and introduction of com petition for such operations. (4.3) Increase directcom petition in telecom m unications,by relaxing foreign ow nership (S) constraints,and openingthem arkettoallforeign entrants,notjustAm erican firm s. (4.4) Introduce com petition betw een portterm inals,including com petitive stevedoring (S) services,on apilotbasisin atleastoneport. (4.5) Require stock m arket listing,including full com pliance w ith all stock m arket (S) procedures,foranyinfrastructurefirm thatisequitized. (4.6) Revise the BOT Law to ensure that com petitive bidding is the usual form of (S) procurem ent,to develop proceduresforsubjecting unsolicited bidsto com petitive bidding, and providing criteria and processes for rare instances w here non- com petitivebiddingm ightbeappropriate. (4.7) Conductpilotexercisesin theintroduction ofprivateparticipation by m eansother (M ) than BOTs.Exam ples could be a m anagem entcontractforw aterservices foran under-perform ing w ater utility,and a landlord portoperation w here the public sectorretainsresponsibility forinfrastructureand privateoperatorconductsdaily operations.The pilotexercisesshould be w elldocum ented to ensure thatlessons can belearntforw iderapplication acrossVietnam . (4.8) Develop a regular benchm arking program for services beyond w ater,including (S) portperform anceand perform anceofelectricitydistribution businesses. (4.9) Encourage m oves to settariffs for greater costrecovery across allinfrastructure (S) sectors. (4.10) Conductthorough econom ic review s oftariffstructures in telecom m unications, (M ) electricity,w aterservices,and transport,w ith aview to developing structuresthat ensurethegreatestsocialw elfareforagiven levelofrevenue. (4.11) Establish a non-m inisterialregulatory agency fortelecom m unications,responsible (M ) for the prom otion of com petition and investm ent. Consider the institutional possibilities for regulation oftransportand w ater as discussed in section 4.5.4. Ensure that regulatory institutions are provided w ith adequate financial and hum an resources. 85 hum an resources. (4.12) Conduct a review of corruption in infrastructure services, w ith a view to (S) identifying particular areas that are prone to corruption and m echanism s for im proved detection. (4.13) Adoptm easuresto prom ote com petition in procurem ent,asrecom m ended in the (S) 2005PER-IFA. (4.14) Accelerateequitization in theconstruction industry. (M ) (4.15) Assign infrastructure construction com pany bid-rigging as a m ajor priority for (S) investigationsbytheCom petition Authority 86 5. Poverty Issues (i) In rural areas, with relatively high concentrations of poverty, simply increasing public investment in poor provinces is a low transaction cost means of targeting the poor. Road and water investment are particularly well adapted to reducing poverty in the poorest rural provinces. (ii) In urban areas, geographic targeting of investments will only be effective with a fine degree of poverty mapping, and quick responsiveness to shifting settlement patterns, demanding greatly improved planning competence at municipal level. (iii) In both rural and urban areas, targeting can be improved with the aid of non-geographic criteria aimed at identifying the poor. In general, there is a trade-off between the transaction costs involved in identifying the poor and the effectiveness of targeting. (iv) In addition to targeting, a further criterion for evaluation of public support for the poor is the extent to which costs of service delivery (and hence the need for public support) are restrained. Output-based aid is designed to provide incentives to keep costs down. C hapter 1 reviewed the progress that poor flows instead to the non-poor. Vietnam's Vietnam has made in reducing poverty rural areas tend to have high concentrations of through a growth-led strategy, and poverty, permitting geographic targeting. In noted that at the same time inequality between urban areas, the poor and non-poor may tend to regions has increased. Access to infrastructure be more geographically mixed, requiring either services has improved across all quintiles, but a finer geographic mapping of poverty and/or the poorest quintiles have benefited less than alternative targeting mechanisms for delivering other quintiles. Where poverty was once assistance to the poor. Of course, even within relatively equally spread across the country it is rural areas, targeting could be improved with now more concentrated in difficult to reach additional criteria for identifying the poor. mountainous areas, and new pockets of poverty are emerging in peri-urban areas. Vietnam's 5.1 Rural Poverty Comprehensive Poverty Reduction and Growth Strategy signals the government's The high concentrations of poverty in rural dissatisfaction with these trends and an areas permit simple geographic targeting as a intention to address the issue of growing means of channeling public funds to the poor. inequality while maintaining a focus on growth Much is already known about the sorts of as the best means of poverty alleviation. projects that reduce poverty in the provinces Programs that seek to address poverty where public funds are spent. usually contain an element of targeting. Public Using provincial data on agricultural funds are wasted when money intended for the production, rural non-farm employment, 87 poverty, and government investments, Shenggen Fan, Pham Lan Huong and Trinh Quang Long (2004) developed an econometric model to estimate the marginal returns in agricultural growth and poverty reduction to various types of government spending. The results reveal that government investment in agricultural research has the largest poverty reduction impact, immediately followed by road investment. Very little is actually spent on agricultural research so in practice road investment has a higher total return. Education Telecommunication access for all is also found to yield positive, albeit lesser, reductions in poverty. 37 Larsen, Pham and Rama (2004) have studied the benefits of rural roads are significantly the effects of investment in transport, water and larger in poorer provinces than in the richer electricity, and find that provinces with greater ones.38 This finding was also reflected by investment in transport and water projects tend Larsen, Pham and Rama (2004). to see greater reductions in provincial poverty Unfortunately there is no evidence from rates. The effects of electricity projects tend not Vietnam concerning the contribution of to be concentrated in particular provinces. telephone access to poverty reduction. A recent Deolalikar (2001) found that rural road paper suggests that an extra 10 mobile phones projects in Vietnam had a significant poverty per hundred people boosts economic growth by reduction impact. The establishment of a new 0.6%.39 The linkages from phones to growth are road in a village raised the per capita income of through shortening the "economic distance" to a household by 30 percent between 1993 and markets (farmers can get a better idea of market 1998, after controlling for other factors, such as prices, do deals with distant merchants, household size and education. Moreover, the facilitate job-finding, permit rapid transfer of spatial location of roads increased the funds, etc). The telecommunications section of household probability of moving out of this strategy suggests ways to increase rural poverty by 68 percent over the same period of access to telecommunications services, which time. In parallel, rural roads expanded school could thus be expected to help reduce poverty. enrolment of children at all levels, and Summarizing the available findings, road improved the utilization of public health and water investments are good means of services. Furthermore, Deolalikar found that targeting particular provinces in which poverty 37. Among all types of government spending, the authors found that agricultural research has the largest return on poverty reduction­for every billion dong spent, 339 poor people would be lifted above the poverty line. Road investment yields the second largest return, with every billion dong spend on roads lifting 132 poor people above the poverty. Education investment has also favorable returns, with every billion dong spend on education lifting 76 poor people above the poverty line. 38. Deolalikar (2001) found that the positive effect of roads on household living standards was more pronounced among the poorest provinces and fell rapidly with an increase in provincial level of income. 39. Fuss et al (2004). 88 levels are high. As discussed in Box 5.1, proportion of road spending to be allocated to Vietnam has made a considerable effort to rural roads. In addition, a mechanism is needed provide access to roads in rural areas, but there within provinces to assist the poorest appears to be a case for an even greater communes in financing road maintenance. Box 5.1: Road Investment--A Case for Further Expenditure Redistribution The clear developmental benefits of investment in government policy objective of providing all-weather rural roads have attracted every major donor and access to every commune in the country, rural ministry. Rural roads projects, or projects which transport projects are planned and implemented under include rural roads components, are currently being the responsibility of the provincial governments. Once implemented through the Ministry of Transport (MoT), the roads have been built, the ownership is transferred Ministry of Planning and Investment (MPI), and to the district authorities for management and Ministry of Agriculture and Rural Development maintenance. (MARD). The Government funds rural roads either Since 1999, the number of communes still through budget allocations to provinces (which have lacking access to district centers has been reduced by discretionary power to apportion revenues to districts more than half, from over 600 to 269 (2.6 percent of and communes) or through national poverty-targeted the 10,500 communes). Notwithstanding the programs, such as the Hunger Eradication and Poverty progress made and the effort to re-direct expenditure Reduction program (HEPR) and the national Program towards the poorest areas, there is still a case for for Socioeconomic Development in Communes in further expenditure redistribution: although per Especially Difficult Circumstances (Program 135)40. capita road length is 3 times higher in the poorest Similarly, donors fund rural roads projects either provinces because of lower population densities, through stand-alone transport projects or, increasingly, expenditure per kilometer is two thirds that for richer through community-driven development (CDD)-type provinces. Moreover, there is still significant projects. Communes also have the option to levy fees discrepancy in the level of access among regions, as (i.e. toll roads) to finance road projects. While the seen in Figure 5.1. primary goal of road investment is supporting the Since the communes are expected to be financially self-sufficient, they are virtually excluded from the integrated state budget. Some of the poorer communes in a district may obtain assistance from the district with their transport expenses. However, communes tend very often to levy a `tax' or rely on voluntary contributions to cover part of the operational or capital expenses of rural road. Heavy reliance on local contributions implies that the system is to some extent regressive. As a result, richer communes tend to have more leeway to finance road access and better quality roads than poor communes. This calls for additional central support for road development in targeted regions to correct the current disparities in the level of access among regions. Source: PER-IFA. 40. "Essential infrastructure" (including basic road access, schools, health centers, clean drinking water systems, electrification, markets, post offices, and irrigation) forms the core of key poverty-targeted programs. 89 5.2. Uruban Poverty While the percentage of population classified as poor in predominantly rural provinces is higher, the absolute number of poor is greater in cities and urbanized provinces. The official percentage of urban poor declined from 25% in 1993 to 6.6% in 2002.41 However, if unregistered migrants had been included, it is likely that the percentage of urban poor in 2002 would have been closer to 15%.42 The Poverty targeted rural water supply investments housing of about 25% of the urban population in 2002 was classified by government as slums or temporary housing. In seeking to reduce rural poverty through The number of poor in cities will increase, at road and water investments the Government is least in the medium term, as more of the rural likely to face two particular challenges. Under poor migrate. This provides both opportunities the current decentralization arrangements, and challenges in reducing poverty. The increased resources can be transferred to the economies of scale that underpin the existence poorest provinces but there is no guarantee that and growth of cities mean that poor people can the funds will be spent on the priorities be lifted from poverty more cost effectively in identified at national level. So, for programs urban areas than in rural areas. But on the other with a particular poverty focus, there is a need hand, the poor and non-poor may be more for mechanisms to encourage project selection evenly mingled within cities, potentially at the provincial level consistent with incurring greater transaction costs in nationally identified objectives. Matching identifying the poor for purposes of targeting funding for particular project priorities may be public spending. one way to mold provincial priorities in the When the urban poor are spatially desired fashion. concentrated, policies to address poverty can be The other challenge that may emerge in focused on particular locales (for example, peri- coming years is that remaining extreme poverty urban areas or slums). Within these areas, may be concentrated in remote areas where installation of basic networks can be subsidized conventional infrastructure services may be with a lower level of cost recovery than would particularly expensive to provide. Where the normally be the case, and some services costs of service provision are prohibitive, the specifically targeted at the poor can be installed solution may be to rely on incentives for (for example, public stand-pipes for water supply), infrastructure connections could be emigration from the remote areas. There are subsidized. also a variety of alternative technologies for Poverty considerations provide further provision of basic services in remote motivation, if it were necessary, to enhance communities. municipal planning capacities. The poor are 41. Vietnam: Growth and Reduction of Poverty ­ Annual Report of 2002-2003. 42. World Bank, Project Appraisal Document for the Urban Upgrading Project, 20 February 2004. 90 Before After Improving basic infrastructure in low income areas likely to be concentrated in areas of new Compare the effectiveness of spending on settlement. Accordingly the burden of non- infrastructure as a means of alleviating responsive planning and slow infrastructure poverty as compared with spending on provision in newly settled areas is likely to fall education, health, or direct cash transfers particularly on the poor. Planning which does (social security). not recognize the presence of unregistered Decide whether to subsidize consumption migrants is also likely to have an adverse or connections or both. impact on the poor. Decide whether subsidies are to be Where the poor are distributed relatively permanent or simply transitional. evenly within the general urban population, Determine the financing source: cross- alternative methods of targeting the poor subsidies or budget funded. should be considered. Such alternatives are Determine how much the scheme will cost, discussed in the next section. including administrative costs. Assess the scheme on targeting 5.3 Designing Subsidies effectiveness: that all the poor actually receive the subsidies (coverage); and that Addressing inequality through investment public funds are not wasted by directing planning is a broad-brush policy: aiding a poor subsidies to the non-poor (leakage). region through infrastructure investment will In comparing between different ways of aid many individuals who are not poor. There helping the poor, it is useful to know how much are also many poor who live in regions that are each scheme costs. On this criterion schemes rich on average. which rely on direct fiscal grants can be A review of Vietnam's subsidy policies in preferred to cross-subsidies, because the cost is the infrastructure sectors would be useful, to immediately obvious to all, based on budgetary examine the cost and targeting effectiveness of allocations. Where cross-subsidies are used it is the existing subsidy mechanisms and to desirable that the implicit cross-subsidies be consider whether those mechanisms could be valued and noted in public accounts, thereby improved. In designing any infrastructure facilitating comparison with alternative subsidy scheme there is a need to: schemes. 91 consumed. One such quantity-based subsidy 5.3.1 Quantity-Based Consumption Subsidies is an increasing block tariff, as used by water One common method of subsidizing and electricity utilities in Vietnam.43 The idea consumption is based on the quantity is to provide a small quantity at a low price-so Box 5.2: Targeting Effectiveness of Increasing Block Tariffs Komives et al (2005) have developed a measure of the targeting mechanism would deliver 40 percent of the targeting effectiveness of a subsidy. Their indicator, , = subsidy to the poor. This is no better than a random is defined as the share of subsidy benefits received by distribution of subsidies across the population, or a the poor divided by the proportion of poor households universal subsidy that delivers equal benefits to all. The in the total population: rationale for most subsidies is to address poverty, and it is wasteful for subsidies to be delivered to the non-poor. A SP value greater than 1.0 implies that the subsidy is progressive, while a value less than 1 implies the subsidy = SH is regressive (the rich benefit more than the poor). PH An analysis of increasing block tariffs in 10 developing countries (see diagram) found that they all performed worse than a random distribution of subsidy funds where Sp is the amount of subsidy funds received by ( <1). Reasons for this are that many of the poor do poor households, SH is the total amount of subsidy not receive subsidies because they are not connected, funds received by all households, P is the number of and because those who consume greater quantities poor households, and H is the total number of also receive greater total subsidies. households. Countries surveyed are: Cape Verde, Guatemala, A value of 1.0 for implies that the subsidy distribution Honduras, Hungary, India, Peru, Rwanda, and São Tomé is neutral with the share of benefits going to poor & Principe for electricity; and Cape Verde, India households equal to their share of the population. For (Bangalore), Nepal (Kathmandu), and Sri Lanka for example, if 40 percent of the population is poor, a neutral water. SP W = SH P H Source: Komives et al (2005). 43 The residential price per kWh of electricity is around 4 cents for the first 100 kWh per month and 10 cents for any units over 310 kWh per month. The price increases in blocks of consumption, hence the name "increasing block tariff". 92 that the poor can consume a minimal "lifeline" maximum of 15 cubic meters per month. The quantity at a low price-and to set higher proportion of water that is subsidized for each prices for subsequent quantities-to assist in household is determined by the household's cost-recovery. estimated income. The subsidies are intended to But there are both errors of exclusion and ensure that no household spends more than 5% inclusion in these schemes. Frequently the of its income on water. The water companies poorest consumers are not connected to send one bill to the household customers and utility services, and so do not benefit from one to the municipal government. Municipal the subsidy of the lifeline tariff. And among governments are given grants by the central those who do have utility connections, the government to cover the cost of subsidies. The non-poor also receive the subsidies for their advantage of this scheme is that there is less initial quantities so that much of the value of leakage of subsidy funds to non-poor the subsidy goes to the non-poor. households than with increasing block tariffs. International evidence suggests that these On the other hand, the transaction costs of sorts of subsidies typically provide the non- determining eligibility are higher than in a poor with a share of total subsidy payments scheme where eligibility is determined by the which exceeds their share of the population quantity consumed. (Box 5.2). The use of quantity-based subsidies In Honduras, Wodon et al. (2003) found that assumes that the poor consume less than the more than 80% of the subsidy in a lifeline rich. This may not be true if, for example, the electricity consumption program went to the poor have larger families or if poor families non-poor. The same study found that housing share a common connection. characteristics were a more accurate predictor In addition to being poorly targeted, of poverty than the quantity of electricity consumption-based subsidies have in practice consumed, suggesting that housing often served to undermine the financial viability characteristics would be a better criterion for the of infrastructure service providers. Frequently, allocation of public funds to alleviate poverty. low quantity consumers pay less than full cost, high quantity consumers pay for their 5.3.3. Connection Subsidies operational and maintenance costs, and the enterprise fails to recover full costs. If quantity- Connection subsidies are frequently preferred based subsidies are to be used, the prices should as a subsidy mechanism, since it is usually the be calibrated to be consistent with cost-recovery poorest who lack connections to infrastructure, or explicit budget funding should be provided and because the fiscal burden is not recurrent. to fund the subsidized consumption. When taxpayer funds are used to finance infrastructure connections, Vietnam is 5.3.2. Alternative Criteria for Targeting effectively subsidizing connections. A more targeted subsidy scheme is Program An alternative to quantity-based consumption 135. Created in 1998, Program 135 provides a subsidies is direct means testing. In Chile, series of grants to finance small-scale households' incomes are assessed based on a infrastructure investments, given to the most survey in which households interested in difficult and remote communes. Over 1998-2000 receiving subsidies can take part. The subsidy around VND 760 billion in grants were spent. In can cover between 25% and 85% of an eligible using the grant communes can choose from a household's consumption of water, up to a list of infrastructure projects. Out of 2,274 93 Finally, enhanced access to micro-credit can help the poor to meet connection charges. 5.3.4. Transitional Subsidies Some subsidies are designed as transitional measures, typically to give greater time to consumers to adjust to higher tariffs, or to obtain public acceptance of higher tariffs by first providing better services. For example, in Guinea in the early 1990s the government entered into a 10 year lease agreement for the School built under Program 135 supply of water by a private company. Before reform the price of water was US$ 0.12/m3. It was estimated the average tariff would need to proposed projects under the scheme in 2000, rise to US$ 0.76 to cover costs. The government 39% were for roads, 27% for school building, was committed to the tariff increases, but 19% for small-scale irrigation, 7% for water wanted them to proceed gradually to lessen the supply, 5% for electrification, 1% for health speed of adjustment for consumers, and also to center building, and 0.5% for local market allow the private sector the time to show service building (Yukio, 2000). Communes obtaining improvements before the tariff increases were the grants must have at least 40% of households apparent to consumers. During a transitional classified as poor. The Vietnam Development period of six years, the government paid a Report 2004 suggested that the criteria used to decreasing proportion of the consumers' bills. identify poor households are fairly accurate. Thus, the private company received the tariff Efforts could be made to better target increase immediately (thus covering its costs), connection subsidies to the level of households but the effect on consumers was delayed. The where there is some attempt at cost recovery for scheme allowed the government to escape from connections. The existing Hunger Eradication and a cycle of recurrent subsidies for consumption, Poverty Reduction (HEPR) program includes a thereby limiting the total cost of the subsidy. scheme for the allocation of "poor-household If, for example, municipalities discover certificates" which could be used as a criterion for resistance to the current goal of full-cost connection subsidies. Alternatively, Vietnam could recovery in water services, or to paying for an abandon a policy of subsidizing infrastructure increase in the coverage of sewerage systems, a subsidies and connections, and simply give cash to transitional form of subsidy may help to build those with poor-household certificates. public acceptance of higher tariffs. Connection charges are a barrier to the objective of expanding access. It is possible to treat the costs of connection as part of the 5.3.5. Output Based Aid enterprise's general fixed costs, and to recover Output based aid (OBA) is a strategy for using them through consumption prices. This policy explicit performance based subsidies to can be thought of as a cross-subsidy from the complement or replace user fees in the delivery currently connected to those who are not of basic services (see Box 5.3). A classic OBA already connected. scheme involves competitive bidding among 94 Box 5.3: Output-based Aid: Tying Subsidies to Service (transferring the implementation risk to the private sector). OBA is "explicit" in Delivery for the Poor that it ensures explicit recognition of why the subsidy is being provided, who is Two output-based aid (OBA) schemes, one in Cambodia and the other in Paraguay, utilize local private operators to deliver receiving the subsidy, who is providing it, water to the poor. The operators--selected under least-cost what activity is being subsidized, and the subsidy bidding--are assured payment for connecting the poor, amount of the subsidy.44 It is but are for the most part paid after service delivery. The two performance-based because it links the schemes utilize different forms of targeting--proxy means testing and geographic targeting--to help ensure that subsidies payment of service providers to their go to the intended recipients. delivery of specified services, or outputs. In Cambodia, it was decided that subsidies would be This linkage to output transfers targeted directly to individual households: of the 13,000 households in the four towns, the 3,000 poorest households (as performance risks to the service provider, determined by a community-administered survey and verified providing strong incentives to ensure the by an independent consultant) would receive a subsidized outputs are achieved at least cost. connection. In Paraguay, aguateros (small-scale water entrepreneurs) which usually only operate in peri-urban areas, An OBA scheme is being developed teamed together with local construction companies to provide for the Ho Chi Minh City water utility. water services to poor rural communities. The scheme would provide incentives to In the Paraguay case, un-served rural areas and small towns the utility and its private contractors to where most residents are poor were selected to receive the reduce leakage and connect targeted subsidies. In addition, the very poorest customers were given poor customers. The service providers the option to provide labor during construction as part of their payment to the service provider. will be paid for connections made only after demonstrating that leakage levels have also been reduced. private operators for the right to provide a service 5.4. Recommendation (encouraging cost reductions in service Recommended actions are: provision), and payment of the subsidy only when the requisite outputs have been achieved (5.1) Develop a subsidy strategy for each infrastructure sector,identifying w hether (S) subsidies are to be delivered to the poor,and ifso,how bestto m axim ize the benefitsofthosesubsidies.Ensureacross-sectoralassessm entofthesestrategies,to ensurethatthem ostefficientsubsidydeliverym echanism sareused,and thatthere isnotunnecessaryduplication ofsubsidiesacrosssectors. (5.2) Incorporate equity objectives into the planning process,and provide a m eans of (M ) prioritizingprojectsand allocatingadequatefundstoachievetheseobjectives. (5.3) Develop m echanism satprovinciallevelto ensurethatadequateroad m aintenance (M ) fundingisprovided tocom m unes. 44. Contrast OBA with subsidies implemented through increasing block tariffs, where many people may not realize any subsidy is occurring and would usually be surprised to hear that users with high consumption levels receive greater subsidies than low consumers, and where the total amount of the subsidy is very difficult to calculate. 95 (5.3) Develop m echanism satprovinciallevelto ensurethatadequateroad m aintenance (M ) fundingisprovided tocom m unes. (5.4) Review utility pricing schem es to ensure that equity objectives are actually (S) achieved atm inim um costtotheutilities. (5.5) W hen subsidies are used in the delivery of infrastructure services, consider (M ) specifying outputsasthecriterion forsubsidy (eg num berofnew connections,not am ountofm oney invested)and considerw hethercom petition can be used in the deliveryofthesubsidy(tom inim izecosts). 96 6. Reform Prioritization I t would be difficult to implement all of the Another way of prioritizing reforms is on recommendations identified in this report the basis of reform bottlenecks: identifying simultaneously. The Government, as with where there is capacity to manage reforms governments everywhere, has limited capacities and the complexity that can be managed at a to manage reform; some of the reforms given time. recommended here, particularly those advancing private participation in 6.1 International Competitiveness infrastructure, may pose political challenges; and some may face public resistance, Sections 1.2, 2.3.1, and 4.1 present a range of particularly any recommendations that would international comparisons, indicating the result in price increases. The most politically industries where Vietnam performs less well challenging reforms can be dealt with using than its regional competitors. Among the access pilot programs: political difficulties may be indicators presented, Vietnam lags in terms of surmounted when reform effectiveness can be sanitation and teledensity. Regional efficiency demonstrated. In other areas, choosing which comparisons suggest room for improvement in reforms to focus on for early attention, the terms of unaccounted water, Government could be guided by various telecommunications labor productivity, the possible criteria, including: price of international telephone calls, electricity If Vietnam's businesses are to be transmission and distribution losses, and road internationally competitive, Vietnam's maintenance financing. infrastructure should be broadly on par with If the government's focus is on business its regional competitors. Regional competitiveness, business inputs such as comparisons can provide a basis for telecommunications and electricity are assessing where Vietnam lags. Surveys of particularly important. Inadequate road business attitudes can also provide maintenance can reduce competitiveness, by suggestions about the particular areas that increasing the time and expense of transporting businesses find important. goods to market. Some idea of the potential benefit of An alternative perspective on what is different types of reforms can be obtained important for competitiveness can be provided through basic economic modeling. Such by business perceptions surveys. The World estimates can suggest which infrastructure Bank's investment climate surveys asked small, industries are likely to give rise to the medium and large manufacturing businesses greatest benefits, and hence warrant the about 18 potential constraints to their businesses. greatest attention. Modeling can also be Transport and electricity were ranked the 3rd extended to distributional analysis, to help and 4th most severe constraints. Transport is Government determine who are the seen as a major or severe constraint for 24% of winners and who are the losers from manufacturing firms, and electricity is a major or different reforms. severe constraint for 19%. Transportation is seen 97 as a greater constraint in Vietnam than in be price and quality. As argued in Chapter 4, neighboring countries for which these surveys the best solution to these problems may be have been undertaken (see Figure 6.1). Figure 6.2 greater competition. Greater competition would sets out the reasons why infrastructure is rated a help to drive down prices, and would provide business constraint, for firms that rank consumers with a choice in the event that they infrastructure as the most or second-most had problems with the quality of services from important constraints on their businesses. particular providers. For electricity, the main problems are perceived to be the price and the quality. Sixty 6.2 Estimates of Reform Effects percent of firms consider the price of electricity to be excessive. In fact, EVN is Simple economic modeling techniques can reasonably efficient in terms of cost, and a requirement for EVN's sustainability is that tariffs cover costs, so that there is little to be done about these concerns in the short term. More significantly, forty-one percent of firms are concerned about the poor quality of electricity services. Power outages and surges are estimated to cost manufacturing firms the equivalent of 3.2% of their sales. About a third of firms have bought generators to Source: Vietnam Investment Climate Survey (2005) cope with EVN's unreliability. On average, generators cost around VND 79 million (US$ 11,500) each to purchase, and cost VND 1,649/ kWh to operate (about 10 cents/kWh, or twice EVN's average tariff), so that unreliability imposes substantial costs even for those with generators. These concerns suggest that investment in increased generating, transmission and distribution capacity, as well as reductions of system losses, are the main priorities for electricity. Source: Investment Climate Survey (2005), feedback from firms rating specific In telecommunications, the infrastructure sectors as either the 1st or 2nd highest priority for infrastructure main problems are perceived to improvements. 98 provide an alternative means for the The purpose of these examples is to illustrate government to determine its reform priorities. the technique of simple modeling to assist in Table 6.1 summarizes results from simple setting priorities. For tariff reforms, modeling of possible reforms in the water and assumptions about the level of prices can be transport sectors. The models measure the determined by reference to existing cost additional consumer surplus obtained over benchmarks, such as the cost of operations, several years, as a result of hypothetical maintenance and new capital costs. For cost reforms. Details of the modeling assumptions reductions, assumptions can be made about and methodologies are given in the annexes to possible room for efficiency improvements by the Water Supply and Sanitation Strategy and reference to international experience. Consumer Transport Strategy volumes. demand can be simply modeled with Care should be taken in interpreting the knowledge of international estimates of the results in Table 6.1. The simple models used do price elasticity of demand, the current level of not capture the full benefits of the assumed consumption, and knowledge of the historic reforms. For example, the results for water do growth rate of consumption. Using such not include public health benefits. The results assumptions, an idea can be obtained of the for road maintenance are calculated on the basis relative magnitude of the benefits of different of the value of time saved and vehicle damage sorts of reforms. avoided, and do not adequately include the The modeling techniques are more difficult boost to growth that is provided by improved to apply to institutional reforms or cross- road networks. More detailed models could, sectoral reforms. But usually, such reforms can however, be prepared with better knowledge of be mapped into either expanded investments, specific reforms proposed in Vietnam. avoided costs or some sort of cost or price Table 6.1: Benefits of Possible Reforms Sector Reform Net Present Value Benefits of Benefits ($) (% GDP) Water (i) 40% increase in urban water tariffs over 4 years, reinvested $2.2 billion 0.7% to expand water connections. (ii) 40% increase in urban water tariffs over 4 years; & 25% $5.1 billion 1.3% decrease in energy costs over 2 years; & reduction in average capital costs to the top performing quartile of water utilities; with extra revenue reinvested to expand water connections. Roads (i) a budget adequate to maintain roads in their current $2.5 billion 0.7% condition is spent on maintenance (ie around $73 million annually compared to current expenditure of around $39 million). (ii) an optimal maintenance budget (around $93 million) is $6.3 billion 1.8% spent, in which the greatest net benefits of maintenance are achieved. Note: The assumed reforms generate a stream of net benefits, which are discounted at the rate of 10% to give the net present value. Benefits as a % of GDP are calculated as the simple sum of the annual benefits, divided by the sum of annual GDPs for the relevant period. Annual GDPs are calculated using the 2003 figure of US$ 39,157 million, projected forward at a growth rate of 7%. 99 change in individual sectors. For example, Such a measure could give a sense of the value institutional reforms that give rise to improved of the proposed institutional reform, in terms of planning processes might help to eliminate the avoiding similar losses in future. sort of problems encountered when SOCBs lent Upper and lower bounds to reform benefits to transport projects that had not yet obtained can be calculated, to give an idea of the range of financing approval. The value of losses incurred possible reform benefits when the exact by SOCBs and construction companies could be outcome is difficult to determine. A specialist computed in present value terms, relative to the institution, such as Australia's Productivity situation that would have occurred if the Commission (Box 6.1), could be established to problematic projects had not been undertaken. help in the ongoing task of identifying potential Box 6.1: Modeling the Benefits of Reform in Australia In the early 1990s the Council of Australian competition policy reforms were having an adverse Governments (CoAG), comprising the national, state, effect on rural areas. The same CGE model and "outer and territory governments, established a review of envelope" methodology was used to assess the effects national competition policy. The resulting report of a subset of NCP reforms of particular relevance for recommended wide-ranging reforms to increase rural areas. The report presented results disaggregated competition systematically across the economy. Also by regions. Overall, the report found benefits of 2.5% under consideration by CoAG at the time were of GDP from the subset of reforms, and indicated that sectoral reform programs, including the establishment current adverse effects felt in rural areas were the result of national competitive markets in electricity and gas, of economic trends independent of the NCP. implementation of a national approach to road In 2005, the Commission conducted a review of charging that would reflect damage to road surfaces by the actual effects of the NCP to date. The Commission heavy vehicles, and a pricing and trading system for found it difficult to separate the effects of the NCP from water resources. many other factors influencing economic outcomes. Together, this group of reforms became known as To provide a partial indication, the Commission the National Competition Policy (NCP). sought to quantify the economy-wide gains from Implementation of such wide-ranging reforms had productivity improvements and price changes many potential benefits and costs, including greater observed over the 1990s in the electricity, gas, urban efficiency, but also possible job losses from water, telecommunications, urban transport, ports, restructuring, other distributional impacts, and effects and rail freight sectors. The modeling indicated that on the fiscal relations between the national and sub- productivity and price changes had boosted Australia's national governments. GDP by 2.5%. Prior to agreeing to implement the NCP, CoAG In many of the sectors studied in 2005, NCP and requested a review of its likely effects from the related reforms are acknowledged to have been key, Productivity Commission, a government body with but there have been other influences driving specialist economic skills in assessing the effects of productivity improvements so in this sense the benefits potential reforms. The Productivity Commission used a are over-estimated. On the other hand, the modeling computable general equilibrium (CGE) model to does not cover all areas encompassed by the NCP estimate the effects of the proposed reforms. The basic reforms; does not include effects since 2000 (the approach was to assume that greater competition introduction of a VAT in 2000 complicated analysis would lead to cost reductions as infrastructure and after that year); and does not make allowance for the other industries approached international best dynamic benefits of more competitive markets. The practice. The Commission found the reforms were Commission considers that the full benefits are likely to increase Australia's GDP by about 5.5%, an considerably larger than the figure obtained from the "outer envelope" estimate of likely benefits. This report modeling exercise. helped to gain inter-governmental support for Source: Productivity Commission (2005). adoption of the NCP in 1995. In 1999, political concerns were raised that the 100 reforms and measuring their likely effects, not Procedures are required in which inter- only in infrastructure but across the economy. departmental consultation occurs prior to high- level decision-making. The consultation should 6.3 Capacity to Manage Reform be designed to achieve the greatest consensus possible at lower levels, highlighting any In every country there is a small handful of remaining areas of dispute for resolution by people who are closely involved in making the high-level decision-makers. For such a system major reform decisions. Where countries differ to work, lower level bureaucrats must develop is in the definition of what is a "major" decision. policy skills so that ministers can have When the Prime Minister can confidently confidence that results presented to them will delegate reform decisions to ministers so that all not require re-visiting. In turn this requires that of the details will be sorted out before reform bureaucrats are taught to question existing proposals are presented to the legislature, the policies, to compare them with potential country's reform capacity is multiplied alternatives, and to identify welfare- manifold compared to the situation where the maximizing policies. The possibility of Prime Minister must approve every detail along questioning policies may pose difficulties. But the way. And a much greater reform capacity is the alternative is limited policy skills in the obtained where ministers can confidently bureaucracy, limited ability to delegate the delegate decisions to the bureaucracy, development of policies, and a limited number providing only occasional guidance and of reforms that can be developed approvals on key decisions. simultaneously. In Vietnam, sectoral ministries can be entrusted to prepare the major outlines of 6.4 Principal Reform Priorities reforms that will improve the well-being of the country's citizens. But as identified in Chapter 2 Supposing that each relevant ministry is on planning, when cross-sectoral issues arise the capable of managing at least one major reform Government does not have good procedures for priority, combined with insights from the other ensuring that adequate and timely consultation two suggested methodologies for assessing and coordination occur. This is likely to act as a priorities, provides a basis for identifying those brake on any sectoral reform efforts. priorities. Whatever the existing ability to delegate policy-making, as senior decision-makers in 6.4.1 Central Ministries Vietnam review the priorities for infrastructure reform they must consider the ability of each In the central ministries of Finance, Planning infrastructure ministry to manage multiple and Investment, and Construction, a major reforms. Some of the reforms require priority should be the development of coordination, requiring a special role for central improved mechanisms for project selection, ministries such as Finance, or Planning and monitoring, and evaluation. The central Investment. Because of the capacity- ministries could take the lead in cross-sectoral intensiveness of coordination roles, only a few capacity building to improve the quality of reforms requiring coordination can currently be project feasibility studies and monitoring and implemented. These capacity constraints will evaluation activities. The aim should be to guide the priorities in choosing which proposed obtain high quality economic analyses reforms to pursue. indicating expected and attained rates of 101 economic return. These estimates should be help to improve the overall alignment of used as central criteria in selection of projects Vietnam's investment approvals process with for public financing approval. its socio-economic development goals. Chapter 3 has highlighted the need for a A major challenge for the Transport better integration of financial planning with Ministry is to develop institutions that can other aspects of planning. A mechanism needs measure maintenance needs, procure to be found by which available taxpayer funds maintenance services at least cost, and ensure are allocated to infrastructure projects where adequate financial resources to pay for these necessary, by which taxpayer funds are not services. There are numerous indications that involved where not intended, and which inadequate attention is being paid to provides financing alternatives for socially maintenance, with very high returns available profitable investments where taxpayer funding from spending on maintenance. But improved is not required. These processes should be tied information is the first step towards to results frameworks providing strategies that recognizing and resolving the problem. link individual projects to development goals, In electricity the greatest challenge is and which should be prepared by sectoral providing sufficient capacity to satisfy growing ministries. demand. While the magnitude of the public Reforms of capital markets identified in investment program will increase relative to Chapter 2 will require a series of reforms, many earlier years, the bigger challenge will be within the responsibility of the Ministry of attracting large scale private investment in IPPs. Finance. Among these reforms, preparing the The Ministry of Industry needs to put major way for private infrastructure investment is a efforts into project preparation, ensuring particular priority, given the proposed competitive international bidding, and ensuring importance of the private investment in the an appropriate allocation of risks between the electricity sector and for its potential role in public sector and investors. financing and improving efficiency in other The telecommunications industry has sectors. Here the Ministry of Planning and become a highly competitive, privately Investment will have a key role. Reform of the managed industry in many, if not most, BOT legal framework is one step, but much countries around the world. Competitive better project preparation and improved industries have outperformed state monopolies regulatory institutions will also be required. on a host of measures. The reform priority in Efforts to build regulatory expertise could begin telecommunications for Vietnam should be with improved emphasis on rules-based increasing the level of competition, through regulation within the public sector. increased private sector involvement and improved regulatory arrangements ensuring appropriate terms of access to VNPT's network. 6.4.2 Line Ministries In water and sanitation, the priorities are Each ministry responsible for an infrastructure driven by Vietnam's development objectives. sector should prepare a results framework for Table 2.3 of the Water Supply and Sanitation the sector, linking development goals, Strategy volume sets out different targets for strategies, and key performance indicators. Any access to improved water and sanitation, defined proposed investment projects should be by Government sector strategies, the CPRGS, the mapped into at least one of the identified Vietnam Development Goals, and the strategies. These results frameworks would Government's Environment Strategy. Whichever 102 of these targets is sought, much greater for an increased role for public financing of investment is required in the sector. Tariff sanitation and wastewater treatment. Enforcing increases for water will help in meeting the the new obligations to increase water tariffs is the investment needs for water services. But private highest priority in the sector, but the next priority willingness to pay for sanitation is significantly is obtaining higher state budget funding for less than the public benefits. There is justification investment in sanitation. 103 ANNEX 1 Scope for Greater Competition in Infrastructure Sectors Roads competition from the road industry. Internationally, "competition for the market" National roads are managed by the Ministry of has been introduced in many countries through Transport, with half delegated to Provincial concessions for regional railway companies. In Departments of Transport. Local roads are the United Kingdom the railways infrastructure managed by District Departments of Transport (the rails and stations) have been separated into and Commune People's Committees. a separate company to allow for competition Competition is used to procure road between service companies (operating the construction, but the competition is between locomotives and carriages) over the same lines. state-owned companies who use the same This introduction of direct competition has been norms to prepare their bids, and typically controversial, because there are economies of prepare similarly priced bids. This suggests coordination of rail operation and service either collusion in their bids or that a greater operation in a vertically integrated company. number of competitors is required to produce An alternative approach with the same vigorous competition. objective of competition between service Competition for the market can be introduced operators is to retain a vertically integrated for toll roads (to construct and/or simply entity, but to impose a duty to provide third maintain roads), either through direct tolls or party access to new service operators. "shadow tolls" in which the government pays the Vietnam is currently debating the choice operator for each vehicle that uses the road. Such between separating infrastructure from train competition can be used to lower the total cost of services, or whether simply to oblige VNR to roads since the toll road operator has an incentive provide access to its network for third party to find the optimal mix between construction and operators. maintenance costs-lower construction standards imply higher maintenance costs. Waterways Railways Vietnam has 8,000 km of commercial waterways, 70% of which are managed by Vietnam Railways Administration (VNRA) Vietnam Inland Waterways Administration, under the Ministry of Transport develops with the remainder managed by provincial investment plans. Vietnam Railways Departments of Transport and Departments of Corporation (VNR) operates 2 passenger Agriculture. Ports and landing stages are companies, 1 freight company and a group of operated by provinces. Management of large regional infrastructure administrations. There is barges is a mix of private and SOE, while thus no competition within Vietnam's railways smaller boats are usually privately operated. industry, although the railways as a whole face There is little charging for the use of waterway 104 infrastructure, limiting the scope for At present the introduction of competition competition. into the ports sector is not on the agenda. It The importance of internal waterways in would be possible to concession a major port on Vietnam is rare internationally, so there is a pilot basis. The presence of alternative ports relatively little international experience to draw would serve as a safeguard in the case of failure, on. While not physically impossible, but it is more likely that the introduction of a concessioning of stretches of waterways would strong competitor would stimulate pose great practical difficulties in gathering improvements in regional port performance. revenues to cover maintenance and ongoing investment. More promising as revenue-raising Electricity devices is higher charging for use of ports and for boat registration, measures that do not A high level of competition is possible in require competition for their introduction. electricity markets, with the most advanced Maintenance contracts should be procured countries possessing spot wholesale markets in competitively. which the price of electricity and dispatch order is determined every few minutes by Ports competition between multiple generating companies, and individual households can Vietnam has 80 ports. The major ports of Hai choose their supplier of electricity. Phong, Danang, Saigon and Can Tho are Transmission and distribution remain regulated operated by VINALINES, while smaller ports natural monopolies in all systems. Competition are operated by VINAMARINE, both of which in generation and retail supply eliminates the are SOEs. Limited competition exists in the need for governments to regulate these prices. industry. Consideration is being given to the Moreover, price serves as a signal of impending development of a deep sea port to serve Ho Chi capacity constraints, inducing new investment Minh City, and the development of a trans- when required. The hope is that market signals shipment hub. will provide for more efficient capital International experience illustrates several expenditure than public sector planning, but it mechanisms for introducing competition into is probably too early to evaluate the strength of the port sector. Competition for the market can this claim since such highly competitive be introduced by concessioning individual markets have not been operating for long, and ports to the firm offering the highest sum to the only in a few countries. government, or lowest tariff for shippers. With Vietnam is a long way from such a business adequate surface linkage multiple ports can model. Competition has been introduced in a compete directly with each other. For example, minimal way through competitive bidding for Ho Chi Minh City could be served from Saigon an independent power producer (IPP) at Phu Port or by shipping to Can Tho and completing My 2.2. In this model the "single buyer" (EVN) the journey by rail or road. Finally, in large signs a long term "power purchase agreement" ports with multiple terminals, individual (PPA) with the private firm that bids to provide terminals concessioned to private operators can electricity at the lowest price. In this way compete directly with each other. In general, competition helps to lower the price of direct competition yields greater performance electricity obtained by EVN. IPPs also help in improvements than competition for the market. diversifying financing sources. EVN plans in 105 coming years to procure around 50% of the EVN in its role as single buyer. EVN's conflict of required new generating capacity using IPPs. It interest would deter private investment in makes sense for Vietnam to expand the use of competing generation companies. These IPPs in procuring expansion of generation transitional challenges are discussed in more capacity, but greater use of competitive bidding detail in the Power Strategy volume. should be used in procurement than in the past, and as mentioned in the financing section, tariff Telecommunications increases are needed to ensure that EVN has the financial capacity to pay for the procured Internationally, mobile telecommunications electricity. and even fixed line telephony have become Vietnam has plans for the introduction of highly competitive industries. Unfortunately, greater competition in three phases. In the first Vietnam is lagging behind international best- phase, commencing in 2009, generators would practice. State-owned VNPT dominates the bid to sell electricity into a power pool, with sector, with a 90-94% share of the entire telecommunications market (including EVN as the single buyer. In the second phase, segments such as equipment construction and commencing around 2014, large consumers installation). It dominates fixed line telephony such as distribution companies or major in all its forms: local, long-distance, leased lines industrial firms would be given the right to and international services, and through two make bilateral contracts with generators, subsidiaries, Vinaphone and Mobifone, avoiding EVN as the single buyer. And in the dominates mobile telephony as well. third phase, commencing around 2022, retail Nevertheless there is an official intention to customers would be given the right to choose promote competition. Vinaphone and their supplier of electricity. Mobifone, despite a common parent, do seem to The competition provided by these reforms compete, perhaps in part because they have will unleash strong forces for efficiency business cooperation contracts with different improvements in the electricity sector, in both foreign partners. Four SOEs have been licensed operations and in system expansion. But there to enter fixed and mobile markets: SPT, Hanoi will be several difficulties in managing this Telecom, Viet Power Telecom, and Viettel. transition. In moving to competitively These four companies already have a small determined prices for electricity in a situation of presence in the fixed line market, because they capacity shortage, market prices are likely to be have traditionally had their own private very high resulting in large rent transfers to the networks. They are just beginning in the mobile generation companies. In the short term there is market. SPT is present in Ho Chi Minh City a need for considerable investment in capacity, only, and is 18% owned by VNPT; Hanoi and IPPs will be needed to help supply the Telecom is present only in Hanoi; Viettel is an capacity. But IPPs require reassurance about the SOE owned by the military; and Viet Power tariffs they will receive. Plans to move to Telecom is owned by EVN, the electricity uncertain competitive pricing may deter private utility. investment (notwithstanding that those tariffs It is perhaps too early to judge the recent could be quite high). Finally, the current plans introduction of competition from SOEs. But seem to envisage ongoing ownership by EVN of progress is likely to be slow with VNPT generation assets. It is not credible to expect dominating the market. The success of equal treatment of its generation subsidiaries by interconnection regulation will be crucial to 106 the success of the new entrants, since if the ownership is capped at 49% and 45% dominant firm refuses or impedes access to respectively, so even less investor interest can its network, customers of new entrants will be expected when these markets open at the end have few numbers they can call. There is of 2005 and 2006 respectively. Investors prefer currently no transparent process to set or to control management decisions if they are to appeal interconnection disputes or rates. It invest large sums of money. also remains to be seen whether competition between SOEs can be maintained. In a Water and Sanitation rapidly growing market, risks of business failure are lessened, but failures can still The main possibility for the introduction of occur. There is little reason for the competition in the water and sanitation sector is government to bear this risk. through competition for the market (e.g. for Stronger levels of competition, and hence management contracts, leasing, or concessions). greater likelihood of efficient services and rapid Internationally, concessions and leases have growth in consumer access, could be achieved held great promise for water supply systems, by further opening the market to private but have been difficult to implement in practice. investors, including foreign firms. Through a Fewer difficulties seem to have been Bilateral Trade Agreement, United States firms encountered in the concessioning of bulk water have gained preferential access to Vietnam's treatment plants, and indeed Ho Chi Minh City telecommunications market. It is intended that signed a BOO contract for the construction of a other nationalities will obtain access to the new water treatment plant (Thu Duc) in March market in the context of Vietnam's planned 2005. Smaller water distribution systems WTO accession, possibly in 2006. But even the operated by independent operators in Vietnam access obtained by United States firms is typically have not been competitively bid, but unnecessarily restrictive. Although US firms communities could, in principle, use already have the right to up to 50% ownership competitive bidding. Direct competition is of firms offering value-added telecoms and possible in the water vending market, although internet services, few firms have entered these vendors typically provide service at a higher markets. For mobile and fixed line services US total cost than piped water. 107 ANNEX 2 Infrastructure Regulation Benchmarking benefits of service provision, while simultaneously preserving the financial A light-handed form of regulation consists of sustainability of the service (that is, still publicly revealing information, so that the allowing a "normal" profit for the firm). Many public can compare their service provider with countries have found it politically attractive to service providers elsewhere in the country. For set infrastructure prices below cost, but have instance, publicly revealing the price of water at then struggled to finance maintenance and new utilities across the country can motivate investment. Accumulated international consumers and local officials to ask why their experience suggests the fundamental utility charges high prices, and to push for importance of setting cost-covering tariffs. improved efficiency to keep costs down. This In recent years Vietnam has generally shifted sort of regulation does not rely on infrastructure prices towards cost-recovery bureaucratically mandated pricing, simply on levels-at least to the level of operations and public pressure. It can create a sort of maintenance costs, in industries in which prices competition between utilities, whose managers are charged. The challenge for the future is to would like to be ranked as among the best in the gain a greater contribution from users towards country. Benchmarking can be applied where investment costs, to reduce the fiscal burden of there are many firms providing similar services. infrastructure investment. There is an efficiency A benchmarking program is currently run reason for doing so: taxes distort the economy by the Water Supply Association, and appears and impose deadweight losses over and above to have been helpful in generating performance the direct cost of taxation to consumers. By improvements across the country. Similar shifting the burden to user payments these programs would be possible for ports and for deadweight losses are avoided. Simultaneously, electricity distribution businesses. Greater imposing additional costs on consumers attention could also be applied to international reduces demand and hence the total cost of comparisons as a spur to improved service provision, reducing the financing performance. requirements. Once cost recovery, including capital costs, is broadly achieved, price regulation can be used Price Regulation as a tool for providing incentives for improved Left to their own devices, infrastructure efficiency, particularly for private operators monopolies could set prices well above cost, in who are sensitive to profit. Box 4.3 discusses order to maximize their profits. To protect broad approaches to setting prices. Rate-of- consumers from this abuse it is usual to fix return regulation provides weak incentives to prices by regulation. The challenge is to set operators to reduce their costs, because they prices as low as possible to maximize the social earn the same rate of profit regardless of system 108 performance. In fact, it may lead to a system type of wiring to be used, qualification of with excessive capital investment, because technicians, vehicle safety inspections), greater investment leads to a higher total profit. environmental standards, provision of On the other hand, there is uncertainty information to consumers, or liability for associated with the periodic re-setting of price- unsatisfactory services. Usually, higher quality caps, and this uncertainty leads to a higher cost standards imply higher costs. Quality standards of capital. This higher cost of capital needs to be may be particularly important when private reflected in higher initial tariffs. Internationally, operators are employed, because cutting quality the tendency seems to be to favor price-cap can help to lower costs and improve profits. regulation, since the long-term cost reductions Where such temptations exist, it is important are judged to outweigh any initial risk that an appropriate effort be devoted to quality premium. inspection and enforcement. It is important, Standard discussions of price regulation however, that cost implications be considered tend to focus on the overall level of consumer when quality standards are devised. Setting tariffs. For purposes of financial sustainability quality standards at a level desired by the urban and investor interest this is clearly very elite may render services unaffordable to the important. But there are also many possible majority of the population. tariff structures that can achieve any given level of revenue. Depending on how tariffs are Regulatory Institutions structured (eg decreasing/uniform/increasing block tariffs, connection charge versus volume In any regulatory system there is a need to charge) differing levels of consumer welfare can monitor and enforce compliance with the rules. be achieved. Setting price structures to ensure In even the most rigid regulatory system with that for a given level of revenue the greatest clear rules on performance standards and how social welfare is achieved (potentially including prices should be calculated, there is a need for a welfare weighting for poor consumers) is a specialist staff with skills in areas such as subject that is well treated in theoretical auditing, accounting and law. In most economics but has been neglected by regulatory regulatory systems there is also an element of practitioners. Nevertheless, specialist skills discretion, in areas such as how prices should required for this task can be contracted and the be set (see Box 4.4), what firms should be information requirements are not impossible. allowed to enter a market (eg the licensing and Generating welfare improvements through allocation of spectrum to new mobile price structure changes simply requires utilities operators), or in deciding appropriate technical or governments to take an interest in the issue. or environmental standards. In such systems, This sort of reform does not rely on utilities' there is a need to supplement monitoring and profit incentives, and is thus equally as relevant enforcing skills with policy skills, including for public and private regulated firms. economic analysis to determine the potential social costs and benefits of alternative policies. Regulation of Quality Where private investment is sought, the international tendency is to entrust the exercise Regulation of the quality of infrastructure of discretion to specialist regulatory services can take many forms, such as minimum institutions, independent of both ministers and output standards (eg hours of service, water regulated firms. While ministries design the pressure, water quality), input standards (e.g., overall system, decisions within the rules are 109 treated as technical matters to be interpreted appointment; appointing regulators for fixed by skilled technical specialists in accordance terms and protecting them from arbitrary with pre-specified guidelines which should removal; and providing the agency with a strike a fair balance between investors' and reliable source of funding, usually earmarked consumers' interests. Decisions by ministers levies on regulated firms or consumers. Checks are typically viewed by investors as being and balances are required to ensure that the driven by short-term political considerations, regulator does not stray from its mandate or and thus present greater risk of regulatory become grossly inefficient. Measures to expropriation. 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