Public Private Partnerships for financing of infrastructure development

1
Public Private Partnerships for financing of
infrastructure development

• Akash Deep
• Harvard University
• December 1, 2005

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Agenda

• The objective infrastructure development
• The mechanism public private partnerships
• The actor government
• The institution national development banks

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The need for infrastructure

• The impact of economic infrastructure on growth
  is substantial
• Canning and Benathan (2000) find that the rate of
  social return on paved roads is 2.5 times higher
  than the rate of return on capital in developing
  countries.
• Calderon and Serven (2004) find that
  infrastructure stocks have a positive effect on
  long-term growth, and a negative impact on income
  inequality

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but the shortage of financing

• Estimates arrive a need for infrastructure
  investment that are massive 450b per year
• Electricity 120b 2001-10
• Water sanitation 49b 2001-15
• China 200b 2001-10
• But current (56b) and expected future levels of
  investment are far short, making infrastructure
• A binding factor of production agriculture and
  manufacturing
• And detriment to the development of social
  infrastructure health and education

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The challenges of financing infrastructure
domestically

• Size Large, lumpy, inelastic projects
• Duration very long -- maturity mismatch can be
  problematic for local commercial banks
• Low volume of deposit mobilization
• Volatile depositor base
• Low level of credit provision to the private
  sector crowding out by government debt
• Limited capital market penetration
• Lack of non-government longer-term debt markets
• Lack of fiscal space

6
The challenges of financing infrastructure
globally

• Denomination local currency revenues cannot
  support foreign currency liabilities
• Distance Political risk
• Regulatory inadequacy
• Political feasibility

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Why must government participate in infrastructure?

• Significant positive social externalities
  requiring the socially optimal level of
  investment
• Rate of return inadequate for private capital
• Check on negative externalities
• Missing markets for credit, especially long-term
• Natural monopoly and need for regulation
• Ensuring affordability and thereby access
• Longer term perspective of development

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Public Private Partnerships

• Under a public-private partnership (PPP), a
  contractual arrangement is formed between public-
  and private-sector partners that involves the
  private sector in the development, financing,
  ownership, and operation of a public facility or
  service. In such a partnership, public and
  private resources are pooled and responsibilities
  divided so that the partners' efforts complement
  one another.
• Such a venture differs from typical service
  contracting in that the private-sector partner
  usually makes a substantial cash, at-risk, equity
  investment in the project, and the public sector
  gains access to new revenue or service delivery
  capacity.

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PPP variants

• Ownership
• BOOT build own operate transfer
• BOO build own operate
• Joint ventures
• Provision
• Leasing
• Operations or management contracts

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Creating distance from government Project Finance

• For private finance, need private assets
• Project finance involves creating a separate
  legal and economic entity with the primary role
  of setting up an organizational structure and
  obtaining the necessary financial resources to
  develop and manage a project.
• The main, and crucial, distinction from
  conventional corporate or public financial
  structures is that repayment to debt and equity
  providers depends solely on the capacity of the
  project to generate cash flows, with typically no
  recourse to the balance sheets of the sponsors or
  the resources of the government.

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Typical project finance structure
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Forms of public participation

• Direct
• Subsidies on investment or usage
• Debt
• Equity and mezzanine financing
• Bridge financing
• Indirect
• Contingent support

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Why PPP?

• Greater regulatory convenience
• Enhanced development capacity of the state by
  leveraging public money
• Mechanism for tapping into private money and
  efficiency
• Greater transparency requirements usually
  includes a competitive bidding process
• Lower financing costs
• Better risk containment and sharing
• Directed benefits through subsidies
• Better adherence to quality standards which might
  be hard to measure

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Concerns regarding PPPs

• Agency problems and moral hazard
• Risk allocation are transferred risks systematic
  or idiosyncratic?
• Service quality standards difficult to ascertain
  and may be under- or over-estimated at the onset
  of the contracts need for renegotiating
  contracts
• Inability of the government agency to pay the
  service charge due to future budgetary
  constraints
• Comparing with other alternatives Public Sector
  Comparator is too difficult to implement
• Renegotiation in a non-competitive framework may
  promote opportunistic behavior

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National development banks

• concerned with offering long-term capital
  finance to projects generating positive
  externalities
• Provider of long term financing
• Regulatory support and legitimacy
• Catalyst for other forms of private capital
• Developer of domestic credit markets
• Developer of local derivatives instruments
• A steady counter-cyclical financing source

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National Development Banks A conduit for public
participation

• Financed by government borrowings, NDBs
• Hold a diversified portfolio of governments
  stake in infrastructure projects
• Adopt a more professional approach to government
  participation
• Learn across projects and creating a repository
  of expertise and information
• Gain an inside view of projects at par with
  private investors and banks
• Maintain a sustained role lending legitimacy and
  continuity of public participation

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NDBs Questions

• Financial and economic performance of NDB
  investments
• Extent of complimentarily between different roles
  of development banks domestic capital markets
• Are there agency problems between the government
  and independent NDBs?
• What is the optimal distance from government?
• What are the forms of contingent support?
• Are alternative conduits of public participation
  financing more effective?

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PPP Typical risk allocation
Public Shared Private
Demand and Revenue Risks X
Design and Construction Risks X
Operating and Maintenance Risks X
Financial risks X
Legal risks X
Political risks X
Environmental risk X
Force majeure X