Public Private Partnerships for financing of infrastructure development

1. Public Private Partnerships for financing of infrastructure development Akash Deep Harvard University December 1, 2005

2. Agenda • The objective: infrastructure development • The mechanism: public private partnerships • The actor: government • The institution: national development banks

3. 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

4. … 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

5. 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

7. 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

8. 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.

9. PPP variants Ownership • B[O]OT: build [own] operate transfer • BOO: build own operate • Joint ventures Provision • Leasing • Operations or management contracts

10. 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.

11. Typical project finance structure

12. Forms of public participation Direct • Subsidies on investment or usage • Debt • Equity and mezzanine financing • Bridge financing Indirect • Contingent support

13. 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

14. 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

15. 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

16. National Development Banks: A conduit for public participation Financed by government borrowings, NDBs: • Hold a diversified portfolio of government’s 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

17. 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?

18. PPP: Typical risk allocation