The 'Public' factor in PPP

FE Team | Published: February 13, 2013 00:00:00 | Updated: February 01, 2018 00:00:00

Fida Rana Governments around the world have been increasingly relying on private sector's investment to develop infrastructure projects in sectors such as electricity, telecommunication, water, transportation, healthcare, education and many more. Through an arrangement popularly known as Public-Private Partnership (PPP), state authorities in many countries are offering long-term concessions to private investors for developing and running certain public-domain infrastructure projects on commercial terms. Independent Power Plants (IPPs) are commonly cited examples, where government pays commercial price to purchase electricity from a private power plant over an extended period - long enough to allow private investors to recoup their investment with a return. Application of PPP scheme now extends beyond the sphere of large infrastructure projects; many countries have successfully made use of PPP for delivering small and medium-scale projects for supplying potable water, running local healthcare centres and providing primary education etc. Well tested over time, PPP model is likely to continue to encompass more areas that have traditionally been considered to be in purely public realm. PPP projects, particularly in infrastructure, are capital-intensive in nature, requiring large scale funding. This makes PPP projects heavily dependent on bank loans. The spur of PPP projects in many developing countries started in the early 1990s when international and regional banks, including development financial institutions, started large-scale lending for infrastructure development mainly by way of supporting PPP projects. To pave the way, those countries went through a number of policy and regulatory changes, making the country conducive for PPP investments. The journey from purely public domain towards a mixture of public and private provisioning of infrastructure projects has never been an easy one anywhere, including those countries that now boast of hosting a roaster of successful PPP projects. Countries have to wade through multiple hurdles--changing the mind-set of policy makers to allow private investors in certain sectors of the economy, making necessary regulatory changes, creating favourable investment and tax regime, developing public sector capacity to deal with such investments and strong political support, to name a few. Not necessarily these changes have to take place sequentially, but all these are necessary ingredients for a successful journey towards PPP led infrastructure development. In parallel to these broad level changes, each PPP project needs specific attention during conceptualising, designing, floating and finally implementing stages. Making a project 'bankable': Global best practices suggest that a fundamental step towards successful PPP projects starts with a transparent and competitive selection process while choosing a private investor for the task. Stakeholders to a PPP project, who are indeed many, consider this as an essential ingredient in making a project 'bankable' - where banks are likely to lend. A project awarded based on considerations not openly recognised and addressed by all stakeholders would likely result in selection of a private investor not best qualified for the job. Opaque selection process also renders a project vulnerable to litigations and even termination by subsequent regimes. More often than not, these projects find it difficult to raise loans from banks resulting from delayed implementation and in some cases even abandonment of the project. Lenders are hesitant to tag themselves to projects that have not graduated through a transparent procurement process. While a transparent procurement process sets the ground, other factors need to play their roles and one such factor is the optimal risk mitigation arrangement. Every PPP project entails some risks - those are related to construction, technology, operation and legal, financing etc. A well-structured PPP project distributes these risks in the right proportion between public and private entities, thus dictating what risks the government will bear and what will be left for private investors. Easier said than done, this exercise perhaps consumes bulk of the preparatory tasks on the part of the public entity before bringing a PPP project on the table, even before selecting a private investor for implementation. If not well thought out, it may become tempting for the concession granting authority to pass over bulk of the risks to private investors. This temptation seems not so uncommon among many public entities which are relatively new in designing PPP projects. Win-win risk sharing arrangement: The fundamental principle that governs a win-win risk sharing arrangement is to allocate risks to the parties who are best able to handle it. A private investor cannot mitigate risks stemming from macroeconomic issues such as exchange rate fluctuations, inflation and the like. Similarly, a public entity cannot take the risk of poor performance of a PPP project, because it is the private investor who operates the project, not the public entity. If the risks are not allocated to the right parties during the project conceptualisation phase, the ultimate consequences are the inability to find bankers willing to lend to the project and going back to negotiation table for re-designing of the PPP contract. PPP funding is a long term engagement by banks -typically they provide funding up to seventy to eighty per cent of total project cost for a term that can extend as long as fifteen to twenty years. Before deciding on such long-term and huge investment in any PPP projects, banks should make sure that they do not get involved in a project that lacks comfortable risk sharing protocol. Consider the case of mega US$ 9-billion Gebze-Izmir toll road project in Turkey, which faced a major setback when the lenders assessed that some risks that are left for private parties are too big to manage. KGM, the concession granting authority, despite being owned by the government, was unable to give enough comfort to lenders about KGM's ability to make termination payment, if it occurs. The lenders group requested the government to either replace KGM or provide an explicit guarantee for termination payment. Protracted negotiations ensued, leading to months of delay. The risk sharing structure was redesigned before it finally received the bankers' nod. Encouraging private investors: Some countries which are exploring PPP opportunities in a relatively untested sector, can even offer to accept some additional risks by the government that are otherwise taken by private investors in matured PPP markets. Investors and lenders equally can be hesitant to invest in a country and sector with no strong precedence of PPP projects. To encourage private investors, the government sometimes provides additional support to mitigate certain risks. Supports can come in the form of guaranteeing a minimum level of revenue or providing a softer loan known as Viability Gap Funding (VGF), or even a combination of both. In the late 2010s, the government of Pakistan introduced a number of incentives to tap its vast potential of wind energy resources through PPP investments. Most notable of those incentives is the so-called 'wind risk' guarantee: if wind does not flow at a certain speed, causing the private wind mill not producing enough electricity, the government agrees to compensate for the shortage of revenue. Flow of wind depends on natural forces, and only after gathering historical meteorological data, coupled with production data from wind power plants in a geographical area, can help investors to choose a suitable location for setting up new wind power projects. In matured markets such as the USA or Europe, such decisions are relatively easy to take due to well documented meteorological information, and presence of numerous wind projects that are in operation. In Pakistan where no wind projects have been tried before, private investors were not willing to set up a wind mill purely on the strength of meteorological data. So the government decided to introduce the 'wind risk' guarantee incentive and was able to implement more than 200 MW wind plant within a few years. Consistency of state policy: Last but not the least, the need for continuity and consistency of state policy and treatment towards PPP projects is of paramount importance. Political differences should not make a PPP project suffer, and such action may spread a chilling effect. If the risks are not allocated to the right parties, the ultimate consequences are the inability to find bankers willing to lend to the project and going back to negotiation table for PPP contract redesigning among potential private investors. By the very long-term nature of PPP projects, their lifespan can easily overlap subsequent political regimes. Incidents are not uncommon where a new political regime scraps a PPP project undertaken by a previous regime--PPP concessions are cancelled, projects are retendered, new conditions are imposed and so on. These actions not only affect the projects on target, but the perception of investors about a country's investment climate also suffers. Investors lose confidence and subsequently new PPP projects will struggle to attract private investment. Take the case of the largest private sector investment in the Maldives. Undertaken as PPP, the project was awarded to GMR, which also operates India's biggest airport in New Delhi, and Malaysia Airports Holdings Bhd to upgrade the airport and operate it for 25 years. In the middle of project implementation, the country went through a political upheaval which ultimately ousted then-President Mohamed Nasheed from power. After taking office, the new government terminated the concession agreement citing irregularities in the award of the contract. The parties are now fighting over cancellation and compensations in Singapore court. Whatever be the outcome of the legal battle, future PPP projects in the country will face considerable challenges to attract private investors. In PPP projects, stakes of all parties involved are high. A pure commercial venture or industrial project may or may not see the success and the owner will bear the loss. A failed PPP initiative will have multiple impacts--failure to deliver an essential service to people, enormous loss of time and resources invested by public and private entities, and weakening the investment climate perception of a country among private investors, to name a few. The 'Public' component of 'Public Private Partnership' paradigm has a bigger role to play to make a PPP venture successful. fida2000bd@gmail.