Tuesday, March 29, 2011

PPPs in plain English

PPPs are fundamentally changing public procurement by allowing the private sector to exercise greater control over, and often ownership of, public assets, such as land, roads and airports.
By Kapil Bajaj
Public-private partnerships (PPPs) usually refer to an ever-widening range of the ways in which ‘public procurement’ (or ‘government procurement’) can take place with the participation of the private sector.
The government uses public funds to provide many goods, services and infrastructure to the citizens. The publicly-funded goods, services and infrastructure may include food for the needy, passport services, education, hospitals, roads, bridges, airports, ports, electricity generation and distribution, petrol pumps, water supply, waste water treatment plants, etc.
Since the government cannot produce or provide everything on its own, it is a big procurer or purchaser of products and services from the market.
For example, it lets contracts to construct roads worth billions of rupee (or dollars) to builders operating in the market. It may award a contract to a private company to develop software for providing an online passport service or award a contract to a private caterer to run a canteen at a railway station for a fixed term.
These examples represent the age-old methods of public procurement, which usually involve ‘inviting tenders’ (i.e. calling for bids or offers from willing suppliers) to build a road or develop a software package or provide canteen services, evaluating the technical and financial abilities of the bidders, and then awarding the job to the bidder that can provide the best value for public money – usually the one who has offered to do the job at the lowest price.
A contract is then signed between the government/public authority and the private party (winning bidder), formalizing their agreement over the job to be done, quality standards, the price, the time-frame, penalties, and other terms and conditions.
(A contract used commonly in traditional procurement for getting a public facility constructed is ‘item rate contract,’ which requires the bidders to quote rates for individual items of work on the basis of a schedule of quantities furnished by the public partner. The design and drawings are usually provided by the public partner. The contractor bears little risk in these contracts except escalation in the rates of items. Another contract used in traditional procurement is ‘lump sum contract,’ which requires the bidders to quote a lump sum figure for completing the works in accordance with the designs and specifications of the public partner.)
Traditional public procurement, therefore, has always been a ‘public-private partnership’ or PPP; it is the coming together of a public authority and a private supplier in a contractual relationship with the objective of providing a part or whole of a public good, service or infrastructure.
(The term ‘partnership’ in PPP must not be confused with a ‘partnership firm.’ A PPP is not in the nature of a partnership firm.)
Since most of the public infrastructure, goods and services are provided with inputs from the private sector, they all involve PPPs.
(Aside from the usual examples of public procurement, a business whose shareholding is divided between a public authority and a private company is a ‘PPP’, more specifically described as a ‘joint venture’. A formal relationship between a government body and a voluntary, non-profit organization to provide a service to the citizens is also a PPP.)
Then how are modern-day PPPs different from the age-old PPPs that represent the traditional methods of public procurement?
The answer lies in the nature and scope of contractual relationships that public authorities and private partners are now entering into. The modern-day PPP relationships allow the private partner to play a much bigger role in the provision of a public good or service, over a much lengthier time-frame (up to 20-30 years), than is envisaged in traditional public procurement.
More importantly, the new and emerging PPPs allow the private partners to exercise greater control over -- and sometimes ownership of -- public assets (e.g. land and natural resources) than what the traditional PPP contracts permitted.
Private control or ownership of public assets has fundamentally changed the nature of PPPs as they have been known for long, particularly by introducing commercial principles in the provision of public services.
Also, the new PPPs have been allowing more direct dealings between the private service provider and the citizens/customers than has been the case in traditional PPPs.
The traditional PPPs restrict the role of the private partner to performing the job specified in the contract, even as the government partner continues to control and own all public assets used in the job.
Generally, the traditional way also means that public services are provided either free or at prices (‘user charges’) that are regulated by government orders; they also allow very limited amount of direct dealings between the private service provider and citizens/customers.
The newfangled PPPs usually allow the government/public partner to concede to the private partner the right to provide a service or infrastructure as well as to collect charges from the users, such as tolls from road users.
Here too, the user charges are regulated, but the private partner is allowed full cost recovery and a rate of return on his investment.
Since the new PPPs are used in risky infrastructure projects and rely on a large proportion of borrowed funds, the private partner(s) often forms a separate company, called ‘special purpose vehicle (SPV)’, to execute the project and insulate the parent firm from the risks of the venture.
It is the SPV that signs the contract (or concession agreement) with the government. If the project were to fail, only the SPV would incur the losses and be liable to pay off the loans, not the parent firm(s).
(Large infrastructure projects can have debt-equity ratios of up to 90:10, which means as much as 90 per cent of the funding could come from borrowings and only 10 per cent from the pockets of the concessionaire. It is also important to note that funds borrowed by private entities are invariably much more expensive than funds that a government can arrange because lenders perceive more risks in lending to the former.)
The SPV may also engage subcontractors to build the facility, maintain it, and collect user charges over the period of the concession.
The public partner may provide some financial support to the SPV by subscribing to some of the equity capital of that special company. The government may also provide some amount of grant to make a PPP project ‘commercially viable’.
The government may also bind itself to repaying the loans partially or fully if the contract were to be terminated prematurely.
The government may also guarantee a minimum revenue to the private partner in order to mitigate ‘demand risk’ (fluctuation in the number of users of, say, a road), but may also provide for revenue sharing if the demand exceeds a certain threshold.
In addition, the government provides various tax incentives to the PPPs. The various forms of government involvement in a PPP project is obviously a big attraction for the lenders.
The new PPPs are supposed to transfer some amount of risks inherent in a project from the public partner to the private partner. A private partner willing to assume more risks also negotiates a higher rate of return in the contract.
Thus, an important thing to look for in any PPP project is how fairly risks and rewards have been allocated between the government and the private partner.
In traditional public procurement or older PPPs, in contrast, the public partner bears almost all the risks; the risk borne by the private partner is limited to the extent of performing the job laid down in the contract.
Described below are three kinds of the new PPP modes that have been used in India.
1. The lease contracts provide a means for the private partner to purchase the income streams generated by publicly owned assets in exchange for a fixed lease payment to the public authority and the obligation to operate and maintain the assets. Lease contracts transfer commercial risk to the private sector partner, as its ability to derive a profit is linked with its ability to reduce operating costs, while still meeting designated service levels.
2. The BOT contract requires the private partner (‘concessionaire’) to design and build an asset (say, a road), operate and maintain it, and eventually transfer it back to the government partner at the end of the specified term, which can last for 20-30 years.
A project is financed by either the public partner or the private partner. In India, the private partner is required to finance the project and is either paid a rent for the use of the facility or allowed to collect user charges.
3. Build-own-operate-transfer (BOOT) concession is a variation of the BOT model except that the private partner also ‘owns’ the facility and finances the project, thus assuming risks relating to planning, design, construction and operation of the project.
(It is important to realise that ‘ownership’ even in BOOT concessions in India does not mean an unfettered property right; it’s usually limited to that of exclusive operation and thereafter transfer of the facility to the private partner.)
Thus, from a simple outsourcing of a job that traditional procurement has been, PPPs of the present times have evolved into complex legal contracts, allowing deeper private involvement that may cover financing, designing, constructing, owning and operating a facility. The number and kinds of PPP that can exist are limited only by one’s imagination.
Worldwide, the advocates of public-private partnerships have cited limited budgetary funding available for public services and infrastructure as the reason why governments should increasingly promote PPPs.
Thus, PPPs are being promoted on the promise that they will help governments “leverage” their scarce budgetary resources to attract larger private investments into providing, expanding and improving public services and infrastructure.
Another promise is that PPPs will infuse private sector expertise and efficiency into public services and infrastructure.
It is intuitive to realise that the PPP policy represents the new form of privatisation, which is perceived to be politically less controversial than the policy of outright privatisation of public assets.
(The article, ‘PPPs in Plain English’, was first published in Governance Now magazine, October 1-15, 2010 issue)

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