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A headlong rush into PPPs will only leave a trail of disputes, renegotiations, corruption.

Published:August 2, 2014 4:10 am
PPPs become a fashion in euphoric times, when the disciplining forces of financial markets get relegated. PPPs become a fashion in euphoric times, when the disciplining forces of financial markets get relegated.

By: T.V. Somanathan and Gulzar Natarajan

The conventional wisdom in India on public-private partnerships (PPPs) is that they help governments raise capital to meet large infrastructure investment targets. But this rationale for promoting PPPs does not stand on strong foundations.

There are three potential reasons for supporting PPPs. First, they enable governments to access more capital without visibly breaching fiscal targets. In a sense, PPP is “off-balance sheet financing” for the government. Second, PPPs help governments recover costs, at least partially, from specific users instead of from general taxpayers. For example, a toll road concession would capture some portion of the willingness to pay among its users. Nothing prevents governments from charging tolls for their own investments but it is politically more difficult. Finally, a PPP could generate real efficiency gains. The public sector is constrained by rules of due process, transparency and political accountability in personnel, procurement and administrative decisions. Free of these constraints, the private sector may bring about greater operational efficiency through, say, reduced losses in supply of electricity or water, efficiently run public transit systems, infusion of new technology into power generation, and so on.

However, there is ample evidence from across the world that would appear to refute the first (financing) and second (cost recovery) arguments, leaving the last (efficiency) as the only compelling rationale for a PPP contract.

A PPP operator’s revenues come either through periodic payment from government or fees collected from users. For any financial assessment of a PPP contract, it would be useful to compare the net present values of all the payments liable to the PPP operator over the full project life with the life-cycle cost, if the asset were constructed and maintained in a traditional public procurement mode, the public sector comparator (PSC). The lower cost of capital for government borrowings confers on the PSC a distinct advantage. Further, the incomplete risk-transfer from government to the private provider, typical in such projects, leaves the government exposed to several uncertainties. There is a high probability of re-negotiations on any risk materialisation, whose outcome in all likelihood would favour the private provider: witness the recent decision of the Central Electricity Regulatory Commission to allow private power companies to pass on to utilities unexpected higher imported coal costs (contractually supposed to be borne by the power companies).

The political economy surrounding user charge revision makes its implementation troublesome. Numerous examples from across the world of stalled toll or tariff increases due to political opposition illustrate this challenge. Such controversies invariably erode the institutional credibility of PPPs contracting, thereby increasing risk premiums and ultimately the cost of future projects.

This leaves us with efficiency gains. After years of experimentation, the pioneers of the PPP model — Australia, Canada and the UK — have all embraced efficiency gains as the touchstone. Many have adopted a “value for money” analysis, involving fiscal (inclusive of risk adjustments) and physical (like time savings or environmental damages) benefits and costs, so as to quantify the net social benefit from the contract. They provide a better foundation for PPPs.

These approaches face their own difficulties. The quantification of future benefits and costs and the estimation of appropriate interest rates to discount them is an inexact art rather than a precise science, and can justify more than one course of action. Further, technological obsolescence is a risk — the benefits of efficiency gains can end up being too small and shortlived, whereas taxpayers bear the consequences for too long. Also, many PPP contracts involve natural monopolies. Without careful regulation, the efficiency gains may not be shared with the public and may be completely appropriated by the private concessionaire. The recent scrapping of the airport user development fee for Hyderabad airport using a more comprehensive pricing model so as to protect the interests of passengers and airlines is an example.

Nevertheless, where efficiency gains are possible and can at least partially be appropriated for the public, they form the only truly substantive justification for a PPP. The other justifications are essentially financial sleight-of-hand, though, arguably, accounting jugglery may have its uses in raising finance in the short run.

This primacy of efficiency gains does not sit well with the prevailing Indian paradigm on PPPs, which strongly emphasises the financial and cost recovery aspects, leading to several distortions. There is limited incentive to invest in efficiency improvements that are critical to lowering construction and operational costs and improving quality of service. Developers’ incentives become aligned exclusively to maximising returns, often at the cost of higher longer-term operational costs. Firms have the incentive to maximise their upfront returns, especially from the construction phase. The recent trend whereby developers of National Highways Authority of India (NHAI) road projects have sought to monetise the asset and exit the project amplifies this moral hazard. A PPP that seeks to optimise efficiency gains should have three features. First, it should take a life-cycle perspective of the project structure, costing and financing. This enables the least distortionary project ownership pattern, smallest life-cycle project cost and the lowest cost of capital. Second, its risk allocation should create the incentives that enable the realisation of efficiency gains. Accordingly, a private partner can better manage (than a public agency) operational risks in a public transport system or fuel-price risk with a power generator. Third, these projects should have performance indicators (with financial consequences), linked to service-delivery that are rigorously monitored and enforced.

PPPs become a fashion in euphoric times, when the disciplining forces of financial markets get relegated to the backseat. Aggressive risk assumption, optimistic bids and incomplete contracts invariably result from such euphoria. As the new government embarks on its ambitious infrastructure investment programme, aggressively courting private investments, it would do well to bear these lessons in mind. A headlong rush into PPPs, driven by short-term considerations of substituting public with private capital, is most likely to leave a trail of disputes, renegotiations and corruption. A calibrated push with the private sector involved for the right reasons may, on the other hand, make a lasting contribution to development.

The writers are IAS officers. Views are personal

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