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Journalism of Courage
Special Purpose Vehicles SPVs are currently in fashion as an innovative means for catalysing investment, particularly in infrastructure. With 350 billion worth of investment in infrastructure needed over the next 5-6 years, and fiscal responsibility and budget management FRBM limits loosely in place, SPVs give the government some flexibility to invest. They also attract private co-investors.
But not so long ago, SPVs made headlines for very different reasons 8212; as the off-the-balance-sheet entities Enron used to camouflage its true position.
Here8217;s where prevention is better than cure.
Government-sponsored SPVs seem to be proliferating, and there8217;s speculation that the budget will unfold yet another mega SPV for public-private partnership. Some packages drive in approvals together for a project, others facilitate project finance by removing some part of the revenues from a project from the city, state, or central government budget.
But SPVs can add to overall macroeconomic vulnerability in several ways that are hard to monitor. For example, guarantees extended to raise funds for IDFC or India Infrastructure Finance Co IIFC create explicit contingent liabilities or government obligations triggered by particular but uncertain events.
SPVs can increase vulnerability by encouraging false optimism: Government backing means something even when it isn8217;t explicit. Fitch8217;s investment grading of Power Finance Corporation PFC in January, for example, was based on its assessment of the strategic importance of the company to the government of India and the 8220;support that is likely to be available to the organisation should it be in distress.8221; This seems a general phenomenon: Ratings of SPV creditworthiness depend on sponsors8217; creditworthiness, even though sponsors are not legally committed to support the SPV.
SPVs also create convenient opportunities to sweep existing problems under the rug. For example, among the reasons private investment does not enter public infrastructure projects in India are delays in land acquisition, politicised user charges, complicated permit processes. These need to be dealt with at government level, rather than government simply assuming the risk.
Finally, SPVs are only as safe for the government as their project appraisal and selection method. If an SPV selects projects on political or even just inept appraisal but raises money based on implicit government guarantee, it becomes a hidden fiscal grenade.
In choosing projects, competitive bidding is the gold standard, but bidding is only as good as the incentives to bid sincerely. With viability-gap funding, for example, the up-front mechanism is to provide a capital grant to the bidder quoting the lowest amount for capital subsidy. This makes sense in general. However, if the bidding is done strategically in the hope of renegotiating later 8212; if and when the bids prove too low 8212; or seeking additional funding from the government sponsor, the process is considerably weakened.
The larger SPVs, like IDFC and IIFC, seem to be set up to minimise risk and are professionally run. It8217;s the smaller SPVs, and those that may come up in future, that may prove risky. A public SPV code to encourage transparency and discipline could prove that much-needed stitch in time.
SPV proposals should clearly state why the entity is necessary, in terms of function in public finance or attracting investors. Moreover, SPVs offering explicit guarantees should have additional burden of explanation: What kind of risk is the guarantee offsetting and what kind of risk is the government shouldering?
SPVs are 8216;special8217; in enhancing comfort, mitigating risks and strengthening private investor confidence. They are, however, not a panacea for other much-needed reforms. Short-term financial engineering is no substitute to more durable improvement in our investment climate.
Regular columnist N.K. Singh and Dr. Jessica S. Wallack, a professor of economics at University of California, are collaborating on a book on infrastructure reforms in India. Essays based on their research will appear every fortnight
