What is the cost of money?
THE Padma Multipurpose Bridge (PMB) project was designed to be funded by donors such as the WB, JICA, ADB etc. After a scandal of alleged corruption by some people associated with project preparation the WB withdrew its commitment and other donors followed. The project is now being funded from own resources of the government by diverting scarce resources from other priority projects in health, education, and renovation in roads, ports and railways etc. It seems the scandal not only delayed the start of the project it also increased the fiscal burden of the government. Is this a done deal or is there still scope to obtain low cost funds from China as the contract has been awarded to a Chinese firm? This was mentioned by Dr. Farashuddin in an interview by The Daily Star recently.
Why are such mega projects funded from donors?
The main reason is that donors can raise low cost funds globally and also have commitment to economic growth in a developing country such as Bangladesh. Frankly speaking, such mega projects have low IRR because of mismatch of input costs and output revenues. Inputs such steel, cement, construction equipments, etc. are bought mostly from international markets which are more costly as the embedded cost of labour is much higher in those markets. On the other hand, the users of the bridge will be local people — farmers, fishermen, labourers, small traders in agriculture sector and retailers of essentials items, bus riders, etc.
Cash flows from the project and the impact of discount rate
Any standard text book on corporate finance gives the relationship between discount rate and the present value of a project. That is, the higher the discount rate the lower is the present value. On the other hand, the longer the life of the project the lower will be the present value of future cash flows. That is why mega projects such as PMB will give much lower present value of cash flows even if the discount rate is low. Needless to mention, higher discount rate and longer life drastically reduce present value and make projects non-viable.
The following table shows the discount factors of an annuity of one dollar at different discount rates and maturity:
The figures in the table are amortisation factors for loans given by financial institutions. The present value of the cash outflows on an investment project is divided by the factors under different rates and maturity. For example for a cash outlay of Tk.1000 @1% for 10 years the annual net cash inflow required is 1000/9.4713= Tk. 105.582, for 40 years it is 1000/32.8347=Tk.30.455. The corresponding figures for 10% discount rate are 1000/6.1446 =162.77 and 1000/9.7791=102.25. It can be seen that annual cash flow requirement is 102.25/30.445=3.36 times higher just due to higher rate of discount. That is the crux of the problem as it would be impossible for PMB to generate 3.36 times higher cash flow earnings, with other things remaining unchanged. If PMB is funded from high cost funds from domestic sources its interest burden will need to be covered from budgetary allocation in the future. Already, the total interest burden in FY 15 was estimated at 16% of the total revenue forecast.
In conclusion, it should be restated that the government should not take a rigid stand on financing PMB from own resources as it is against national interest. It should try to find alternative low cost sources from donors and other fund surplus countries in the Middle East countries, and China in particular.
M. Shamsul Haque: The writer is a financial analyst.