EIB Papers Volume 13. n°1/2008 - European Investment Bank

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PPPs offer new opportunities to finance public infrastructure and enhance efficiency but they generate substantial fiscal risks. 138 Volume13 N°1 2008 EIB PAPERS 5.2. Public-private partnerships Another challenge for fiscal and macroeconomic policy in the NMS is the increasing use of PPPs in infrastructure investment. PPPs refer to arrangements in which the private sector supplies infrastructure assets and services traditionally provided by the government. Most PPP definitions point to three key characteristics: (i) private execution and financing of public investment; (ii) an emphasis on both investment and service provision by the private sector; and (iii) risk transfer from the government to the private sector. The World Bank (2007) reports that annual total investments in PPP infrastructure projects have increased from USD 29 billion in 2001–03 to USD 44 billion in 2004–06 on average in NMS. 13 PPPs offer new opportunities to finance public infrastructure with potential efficiency gains. It is often argued that, through private-sector management and innovation, as well as more optimized risk allocation, PPPs provide better value-for-money than public procurement of the same assets and services. Yet, the delivery of net benefits in PPPs requires sufficient efficiency gains to cover (i) the typically higher private-sector borrowing costs; and (ii) the significantly higher transaction costs, 14 which are passed on to the government. PPPs usually also generate substantial fiscal risks. PPPs can be used to move public investment off budget and debt off the government balance sheet by financially constrained governments without value for money consideration. In particular, NMS may have an incentive to use PPPs solely to by-pass fiscal controls due to the constraints of the Stability and Growth Pact and the lack of strict rules in accounting and reporting. But even if not recorded immediately in deficits and debt levels, PPPs do create future liabilities and do not alleviate the intertemporal budget constraints unless they generate net efficiency gains or facilitate additional resource mobilization, such as through user fees. Fiscal risks can be compounded further by inappropriate institutional arrangements and inadequate government expertise to identify, quantify, and manage the complexities involved in PPPs. As a result, governments can end up facing large fiscal costs down the road (Box 3). Reaping the benefits and managing fiscal risks from PPPs requires a sufficiently strong legal and institutional framework. Clearly, political commitment and good governance would be overarching conditions for the success of PPPs, while pervasive corruption would be a serious obstacle. Furthermore, fiscal risks from PPPs are more likely to arise when investment projects are of poor quality; the legal and fiscal institutional frameworks are weak; and PPP accounting and reporting systems do not transparently disclose their fiscal implications. Hence, reaping the potential benefits of PPPs (and minimizing their fiscal risks) requires governments to strengthen the overall framework for public investment planning; develop the legal and institutional framework to handle PPPs; and implement transparent accounting and reporting (see Corbacho and Schwartz 2008 for a full discussion of fiscal risks and PPPs). First, PPP projects should be integrated with the government’s investment strategy, its mediumterm fiscal framework, and the budget cycle. PPP projects should be part of the government’s investment strategy within a medium- to long-term budget framework and be pursued only when they offer value for money compared to standard public procurement. This will typically involve 13 Data refer to total annual investment committed at contract signing for infrastructure projects that resemble PPPs on the basis of some key characteristics (see World Bank 2007 for details). 14 Higher transaction costs arise from the complexity of PPP contracts compared to traditional public procurement. Recent EIB studies have shown that total transaction costs (bidding and negotiation) during the procurement stage average 10 percent of a project’s capital value. See Dudkin and Välilä (2005). Higher transaction costs led the United Kingdom to set a floor on the size of PPP projects of £21 million. Brazil’s PPP law also sets a floor on the size of PPPs.
Box 3. PPPs and fiscal risks: Selected experiences in the highway sector in NMS Fiscal risks in the implementation of PPPs in the highway sector have already manifested themselves in several NMS. One problem that has plagued PPP implementation in this sector is related to overoptimistic demand projections. The upward bias in projections is partly due to the inherent technical difficulty of projecting traffic flows. However, moral hazard is also likely to play a role, since bidders have an incentive to overestimate demand and promise low tolls, while counting on renegotiations once the contract has been awarded because infrastructure projects are often too important to fail. Limited government capacity in evaluating PPP proposals and a the lack of a clear PPP legal framework often imply costly renegotiations for the government. The experience of Hungary illustrates some of the problems that can result from overly optimistic traffic forecasts, overestimation of users’ willingness to pay, and inefficient risk allocation. Hungary’s M1 Highway PPP came to be heralded as the Euromoney magazine “finance project of the year 1995.” It quickly became clear that traffic forecasts had been too optimistic. There was a strong diversion of traffic to a toll-free parallel road. Moreover, several litigation procedures were initiated against the consortium holding the concession. By the time construction ended, the private partner had suffered important financial losses. In 1999, the project was renationalized. Similarly, in the case of the M5 Highway, also a PPP, the original contract was renegotiated in 1995, only a year after it was signed, to provide minimum revenue guarantees. When the first stretches of the M5 were opened, traffic was at 85 percent of the original forecast, requiring compensation from the budget. The contract was renegotiated again in 1997 with the government fully assuming the traffic risk. Poland’s experience with PPP projects in the highway sector has also been mixed. A 150 Km stretch of the A2 highway, for example, was awarded in 2000 as a 40-year concession including the right to levy tolls. However, demand was lower than expected, as most freight transporters bypassed the tolled stretch of the highway. This situation led the government and the concessionaire to negotiate compensation payments. Similarly, a 35-year concession for a 152 kilometres stretch of the A1 highway – which was awarded in 1997 – did not reach financial close, leading to the concessionaire’s request for governmental support for the project. Another example of the fiscal risks involved in PPP implementation is provided by the Czech Republic, where several attempts to implement PPPs in the highway sector have failed. An early attempt to implement a toll-based concession for the D5 highway (from Prague to the German border) was abandoned as it became evident during the tendering process in 1993 that demand for the toll road would be too low to ensure cost recovery. In 2001, the government directly awarded a concession for a 80 Km long stretch of the D47. However, criticism of the direct concession award and overpriced remuneration led to cancellation of the contract. As a consequence, the government was forced to pay about EUR 20 million for breach of contract. Source: Based on Brenck et al. (2005) a first-stage decision on whether a particular project is worthwhile based on standard project appraisal techniques such as cost benefit analysis, and a second-stage decision on whether the project should be undertaken as a government investment or as a PPP. To ensure full accounting of their fiscal implications, PPP projects should not be allowed to move forward outside the regular budget cycle that governs other investment projects. Governments should first see if a project is worthwhile and only then decide whether to undertake it as a PPP. EIB PAPERS Volume13 N°1 2008 139
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Preface This year the European Inve
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Different types of government inves
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Infrastructure accounts for one-thi
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A common feature for the new member
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The share of transport in governmen
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The proxies are subject to caveats.
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The shares of infrastructure and ho
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There have been marked differences
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Government transport investment has
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Transport and other infrastructure
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References 54 Volume13 N°1 2008 EI
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In some countries a shock to public
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Table 1. Some VAR studies (publishe
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The ratio of private capital to GDP
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There is no systematic pattern for
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High variability of the public-capi
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Has the impact of public capital on
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Productivity of public capital incr
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Most taxes are distortionary in tha
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