Public Private Partnership (PPP)

 

Introduction

According to the United Kingdom Commission on Public Private Partnerships, ‘A Public Private Partnership (PPP) is a risk-sharing relationship between the public and private sectors based upon a shared aspiration to bring about a desired public policy outcome’. In the case of infrastructure, PPP generally refers to the Concession or Build-Operate-Transfer (BOT) contracts, or any variant of them, i.e., contracts where risks and responsibilities transferred to the private sector are much wider than in traditional public projects. Concession (BOT) is an exclusive right granted by the Government Authority, under which private sector builds an infrastructure project, operates it and eventually transfers the project to the government. Company continues to run the facility, and the government acts as the regulator, while being the owner of the facility.

As the name suggests, Public Private Partnership does not result in privatization. It aims to implement risk sharing structures between the public and private partners. A well designed PPP distributes the risk to the party that is best suited to manage it and does so at least cost. It is a means to achieve efficiency and quality in provision of public goods such as infrastructure and social services such as health, Education and other similar services. The private sector provides the required services and bears the associated risks, while the government provides the land, statutory backup, subsidies and tax breaks necessary for the successful implementation of the project.

The birth of Public Private Partnerships can be attributed to the mounting public debt in India during 1970s and 1980s due to the first round of oil price rise. Lack of public finance meant reduced expenditure on infrastructure as well as delays in the completion of indispensable projects. In such a scenario, the introduction of PPP was seen as a golden key that would allow a rise in capital expenditure in these projects along with the additional benefits derived from the private sector such as efficiency, cost reduction and timely completion of projects. Other benefits of PPP include accelerated and enhanced delivery of projects and wider social impact through efficient provision of public and quasi-public goods.

Rationale behind Public Private Partnerships

The rationale behind PPP is threefold:

1. Efficiency/Quality: Experience shows that efficiency/quality gains can be obtained through inclusion of the private sector in the provision of public goods. Private sector is expected to bring its “rigor” and “expertise” in the design, implementation and operation of a project driven by the desire for profits. Public sector (Authority) would undertake the responsibilities relating to statutory and procedural requirements of the projects.
2. Volume: Given the public finance constraints, PPP projects increase the volume of investments that can be delivered during a given time period. This increase is achieved through reduction in cost (capital & operational) and improved service delivery. Much of this improvement can be attributed to the private sector’s enhanced innovation, experience and flexibility. Thus, PPPs reduce the government’s capital cost which in turn helps to bridge the gap between the need for infrastructure and the government’s financial capability. Service delivery is improved by allowing both sectors to do what they do best. Government decides the policies while the private sector takes the responsibility for non-core functions such as construction, maintenance and operations.
3. Competition: This is a consequence of liberalization and deregulation policies. An opportunity for private players to enter in a long term investments in the Public Domain builds a sense of competitiveness among them as each player tries to capture a greater share of the pie.

Among the above three arguments, the “efficiency/quality” argument is the decisive one for PPP projects.

Public enterprises are mandated to provide all kinds of public and quasi-public goods and ensure a high degree of public accountability. However, it is normally felt that the public sector suffers from bureaucratic delays, red tapism and social (political) interference. Private enterprises, on the other hand, are basically motivated by profits and hardly invest in social services such as hospitals, schools, and highways.

Public Private Partnership projects ensure that a majority of the limitations of the public and private sectors are done away with. This is due to the ‘Risk Transfer’ from the public to the private sector which is the most critical element of all PPP projects. The goal is to combine the best capabilities of the public and private sectors for mutual benefit. For example, if a private company finances and builds a highway, it also assumes responsibility for the related risks.

A relatively stable long-term investment opportunity incentivizes the private sector to bear this risk. Besides this, the private sector brings about greater efficiency and innovation which could potentially increase revenues and reduce both the initial capital expenditure & operational costs.

A clear distinction should be made between PPP mode and privatization. These two are completely different terms with distinct implications. While a PPP project is funded and operated by virtue of a partnership between the government and one or more private sectors companies, privatization means a radical and irreversible change in the way a service is provided and in the ownership pattern. Under privatization, the government loses its control over the privatized enterprise and the private player then aims for profit maximization and is not accountable to the public.

Unlike private projects where prices are generally determined competitively and government resources are not involved, PPP projects typically involve transfer of public assets, delegation of governmental authority for recovery of user charges, private control of monopolistic services and sharing risks and contingent liabilities by the Government. Typically, a private sector consortium forms a separate company called “Special Purpose Vehicle (SPV)” to develop, build, maintain and operate the asset for the contracted period. This ensures that the actual project development phase experiences as few hurdles as possible.

Current Scenario

India has had more success in attracting private investment in the public domain of infrastructure since 2006 than any other developing country. However long-standing policies in most other South Asian countries are beginning to bear fruit as well. South Asia has seen a recent surge in investment commitments to infrastructure projects with private participation. While infrastructure in South Asia attracted only 5% of the total in 1995-2005, its share grew to 13% in 2001-06. In 2006, the share rose to 19%. Since the onset of global financial crisis in the late 2008, the long term financing to sustain the development of infrastructure has become difficult to obtain in many developing countries. However, India has remained impassive to a great extent to such issues.

India has seen a rapid increase in private investment in infrastructure since 2003. Its PPP program has grown rapidly in the past five to six years. Although, PPPs are more exposed to interest rate volatility, Indian PPPs did not suffer much during the financial crisis due to prudent policies pursued by it.

In India, typical concessions encourage Judicious Mix of Debt & Equity. Thus, raising adequate equity finance tends to be the most challenging aspect. PPPs have relied heavily on commercial banks for their debt-financing. However, long-term financing also exposes the banks and financial institutions to the risk of asset-liability mismatch. An active bond market can increase the flow of long-term funds and reduce reliance on banks, hence is a frequently used option. The long term Institutional financial markets for infrastructure projects is in an evolution stage.

PPP in India

Government of India recognizes that there is a significant lack of infrastructural facilities in different sectors and this is hindering economic growth. But development of infrastructure requires large investments that cannot be undertaken out of public financing alone and hence government is committed to promoting Public Private Partnerships (PPPs) to attract private capital. Government also recognizes that infrastructure projects may not always be financially viable because of long gestation periods and limited financial returns and thus financial viability of such projects have to be improved through Viability Gap Funding (VGF).

PPP projects are being implemented both on VGF Model and also on Annuity Model. In case of Annuity Model, the concessionaire is paid semi-annual annuities for a period of normally 15 years (30 semi-annuity payments) to cover the cost of construction, capital related costs and the maintenance cost of the project which the concessionaire is obliged to undertake for the 15 year period. In case of VGF projects, government provides upfront capital subsidy to the extent of 40% of the Total Project Cost (TPC). In case of PPP projects TPC assessed at 1.25 times of the civil construction cost. 25% of civil construction cost is provided towards escalation, pre-operative expenditure and Interest During Construction (IDC).

Institutional Structure : Empowered Institution (EI) is an institution authorized by the Government for the purposes of PPP appraisal. The proposal for seeking clearance of the Empowered Institution has to be sent to the PPP cell of the Department of Economic Affairs. The proposal is then submitted by the PPP cell to the Empowered Institution for consideration and ‘in principle’ approval. Once cleared by Empowered Institution, the project becomes eligible for financial support by VGF.

Support of Government of India/States : The amount of VGF is the lowest bid for capital subsidy, but subject to a maximum of 20% of the total project cost. In case the State Government proposes to provide any assistance over and above the said VGF, it shall be restricted to a further 20% of the total project cost.

Process : The Private Sector Company is selected through a transparent and open competitive bidding process where competition is on the basis of the amount of VGF required by a Private Sector Company for implementing the project where all other parameters are comparable. Within three months from the date of award, the Project Sponsor (State Government) presents the project for final approval of the Empowered Institution.

Constitutions : Prior to the disbursement of VGF, the Empowered Institution, the Lead Financial Institution and the private sector company enter into a ‘Tripartite Agreement’. VGF is disbursed only after the private sector company subscribes and expends the equity contribution required for the project and will be released in proportion to debt disbursements remaining to be disbursed thereafter. VGF is released to the Lead Financial Institution as and when due by Empowered Institution. The Lead Financial Institution is also responsible for regular monitoring and periodic evaluation of project, particularly for the purposes of disbursing the VGF.

PPPAC : Government of India has formulated guidelines for appraisal and approval of PPP Projects of Central Government. These guidelines provide for payment of a maximum of 40% of TPC as VGF grant to the concessionaire. Unlike, the state government projects, subsidy of central government projects (VGF grant) is fully provided by the Ministry, sponsoring the project. For this purpose, PPPAC has been constituted as the APEX approval body with Secretary, Department of Economic Affairs as chairman and represented by Department of Legal Affairs, Environment and Forests, Planning Commission, Expenditure and the Administrative Ministry of the project.

Difficulties with regard to PPP

When public finance constraints are real and severe, the alternative is to postpone investment or cancel it altogether. In such a case, the PPP option should be exercised provided it yields a satisfactory rate of return on Equity. However, there are some reservations about the PPP option:

First, PPP projects are sometimes handicapped by the requirement of greater and more transparent accountability as compared to public projects. PPPs and public projects are not treated equally as regards performance. For instance, if construction costs and delays are well over expectations, PPPs are immediately liable whereas consequences for public projects are often much less dramatic and hardly visible.

Second, PPP projects empower the concessionaire to use public assets for building infrastructure projects and to levy and collect user charges for the use of public goods but still government remains responsible and accountable for delivery of services to the users. These projects, therefore, require close monitoring. Parameters of monitoring would include assessment of performance, levy and collection of user charges on the basis of approved principles, remedial measures, etc.

To gauge the effectiveness of PPP projects, a cost-benefit analysis can be conducted to compare a PPP option with a purely public alternative. Also, few points should be emphasized while opting for a PPP project. First, procurement procedures should be efficient. Negotiations should not be long and expansive. Second, private players should be given enough incentives to operate efficiently without abusing their monopolistic position. Third, PPPs should not impinge on other important issues in terms of efficiency and Public accountability.

Concluding Remarks

According to a Planning Commission document, approximately 8% of the GDP is to be invested in infrastructure covering telecommunications, electricity, transportation, water supply and irrigation sectors to ensure their development. Such investments should be made strategically to ensure efficiency. PPP projects are relatively beneficial in terms of volume, efficiency and competitiveness and are a success in times of financial constraints though accompanied by their own set of difficulties and drawbacks. Thus, PPP projects can only be successful if they are planned with due care and diligence, taking into account all possible contingencies.

The author is a post graduate student of economics from Delhi School of Economics. She has worked as an Intern in the PP & Infrastructure Division, Planning Commission and wrote this article based her experience there.