Friday, Nov 21, 2014

Right reasons to get hitched

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.
Posted: August 2, 2014 4:10 am

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 continued…

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