Archimedes famously said: “Give me a lever long enough and a place to stand, and I can move the Earth.” To lift a heavy object, there is a choice: whether to use leverage or not. A task can be performed, say to plan & implement a metropolitan scale urban public transportation system; directly – risking injury or say incompletion or loss – or one can use a lever, say a financial leveraging aid, to transfer some of the weight, and then lift the object that way. Using leverage is simply the art and science of getting much more done with the same, or less effort. Thus by applying the concept of leverage in any field, including the rapidly growing transportation sector, one can accomplish very much more than one can without it. Without leverage, the efforts can be very hard, and the rewards or returns are limited by the initial investment one puts in. With leverage, it’s possible to break this connection and, in time, achieve very much more in comparison with the previous scenario.
Leverage is a process that involves borrowing resources that are paired with existing assets and utilized to bring about a desired outcome to a project. Leverage normally designates a strategy simply for arranging better finances & resources for investment, in which the borrowed capital, or any other debt, is invested with the expectation of hopefully yielding a higher return to equity. In essence, leverage strategies potentially offer a superior return prospective or opportunities, although these strategies are mainly intended for investments with high risk tolerances. With leveraged investing, a larger initial investment can result in greater overall growth of the investment. It is evident that this strategy is only lucrative when the return is equal or larger than the total cost of the funds borrowed. Even if the direct return only equals the interest charged on the loan borrowed for investment in a particular scheme or a project, an implementation firm still stands to benefit since the investments acquired will produce return over and over, again further on down the road, as present in case of many transportation projects running under the Build-Operate-Transfer scheme. Additionally, leverage can provide a direct line of funds if a good business opportunity arises in a time when the firm has no funds of its own available to invest.
It often happens that the government faces some critical issues related to the funding or financing of large scale urban transportation projects, as this process is very cumbersome due to the expensiveness of the capital investments on the transportation infrastructure & the recurrent expenditure occurring on the maintenance & up keeping of the project. Thus, apart from a heavy initial investment, it also requires continuous stream of financial resources till the returns from the project start to repay the original incurred cost. These issues can be effectively tackled by applying appropriate financial leveraging strategies according to the nature, type & potential outcome (both good as well as worst case) of the transport project/scheme. Some available leveraging strategies of finance are parking fees, land value capture, land tax, public private partnership and advertising at city/ local level; fuel taxation & vehicle taxation etc. Land Value Capture is one such important method for arranging the finances, which is based on the change in the land values due to the potential outcomes of a transportation project. This method of leveraging has been implemented in many cases across the globe & in one such case of a metro corridor in Copenhagen, Denmark, it recovered around 45% of the construction cost apart from the fact that the real estate tax contributed about 16% to the metro system. Also, the private sector can also be involved in the process in various ways, for example, as in Build-Operate-Transfer (BOT), Build-Own-Operate (B00) and Design-Build-Finance-Operate (DBFO) schemes. Some good examples of public transport using PPPs are Bangkok mass transit system, Jerusalem light rail transit and Astana light rail transit.
But, like the opposite side of a coin, there are common risks involved as well as here, leveraged investing can magnify both losses and gains, i.e., the gain or loss experienced will be magnified relative to the performance of the investment done on a project. Also, the degree of financial leverage required to achieve the desired outcome will vary, based on several factors like maintaining a favorable leverage ratio between available assets & resources in hand & the amount of acquired debt, the degree of financial leverage inherent in the proposed deal etc. Operating financial leverage is another factor to consider. In its broadest application, this factor has to do with the positive or negative impact that the leveraging process is likely to have on the general operation of any project that is initiating the proposed strategy.
The focus of any type of leveraging is usually to better the financial position of an entity or agency responsible for the execution of a project in some way. Often, the approach is employed when there is a very good chance at success and that success can be significantly increased in terms of a return by augmenting existing resources with others that are borrowed for the short term, like in the cases of a large scale urban transport project. As with any type of growth strategy, it is a good idea to investigate the potential outcomes of any financial leveraging strategy before engaging the strategy. This means looking at worst case scenarios as well as what gains could be achieved under the best of circumstances.
Anugrah Anil Nagaich
III Year B. Planning
Annual NOSplan magazine 2012