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Should the public sector guarantee private sector financing for PPPs?

The financial crisis and subsequent credit crunch has greatly reduced the options available to governments regarding PPPs. The reason is very simple: There is no longer enough money available for long-term private infrastructure investment. However, I see this as a temporary situation, as the rationale for PPPs remains as strong as ever. 

In the meantime, governments in many countries are in the middle of procuring large PPPs and therefore in need of solutions to the temporary dislocation in credit markets. More and more governments have been turning to public sector guarantees of private sector loans for PPP projects as a way to overcome shortfalls in available financing.

The question is: Is this solving the problem? There are voices that say this doesn’t make sense, why should the public sector guarantee a loan by the private sector? Isn’t the rationale behind PPPs to get the private sector to put its own capital at risk?

I would say that such a guarantee does make sense. First of all, the public sector doesn’t engage in PPPs primarily to secure financing. If the public sector is doing PPPs for the right reason, then it is for the expertise, innovation and motivation that the private sector can deliver. Private financing has never been cheaper and was never the source of the value in PPP projects.

But then, when we talk about moving some key risks to private sector, are we being honest? With a guarantee, aren't we failing to transfer risks to the private sector? The answer is that private sector participants in PPPs continue to invest equity—which is still at stake—while the debt is the risk of the banks that finance the project.

During the current financial crisis, the banks have not been forthcoming with loans for PPPs, or they require additional security in the form of guarantees of their loans. The only party that can provide such a guarantee on the market today is the government. A few examples of this kind of guarantee:

  • The French government has been "allowed to guarantee loans on priority projects implemented through PPPs entered into before 31 December 2010, up to a global ceiling of €10bn."
  • The Spanish ministry of infrastructure initiated special financial guarantees for PPP projects (mainly for high speed trains) for an estimated amount of 15.000 M€
  • In Australia, the main problem is the unavailability of long tenor debt, with recent projects being financed using 5-year mini-perm structures. Governments have proved willing to share in the refinancing risk at the maturity of these financings. The State Government of Victoria has underwritten the senior debt syndication of its A$5 billion desalination project, in the expectation, that the bank club supporting the winning bidder will be able to sell down to members of the bank club that supported the losing bidder.
  • The Portuguese government is reportedly providing a Euro 800 mil. guarantee to the Litoral Centro highway concession and will also guarantee the Pinhol Interior concession project.
  • Even prior to the financial crisis, Kazakhstan used debt instruments guaranteed by the government to finance PPPs with the goal of “encourag[ing] participation of pension funds in the system”. Currently, the law enables the government to provide guarantees both to the concessionaire for infrastructure bonds within the limits of the concession agreements and to loans attracted to finance concession projects. According to the professionals participating in the PPP process, the government’s accounting process in the fiscal budget will include subsidies or co-funding as state investments, while the guarantee will be considered as a public debt.

Will taxpayers get their money’s worth from these guarantees? One past example suggests the answer is “yes.” In 1994 Korea launched the Infrastructure Credit Guarantee Fund (KICGF) to facilitate private participation in infrastructure. In response to the Asian financial crisis in 1998 Korea provided even more support for its PPP policy, and one of world’s largest and most successful PPP programs was launched as a result.

According to the IMF:

The [Korean] government announced a fiscal stimulus package in response to the financial crisis with more than 15 percent of the envisaged investment to be carried out through PPPs. The package is accompanied by measures to reduce financial burdens on PPPs, smooth interest rate changes, and shorten project implementation. The measures introduce: (i) lower equity capital requirements on concessionaires (5–10 percent); (ii) for large-scale projects, higher ceilings on guarantees provided by the Infrastructure Credit Guarantee Fund (50 percent); (iii) help in changing equity investors for some projects; (iv) compensation for the preparation of proposals to encourage more vigorous competition during bidding; (v) sharing of interest rate risks with concessionaires; (vi) compensation for the excess changes in base interest rates through grading of risks at the time of the concession agreement; and (vi) shorter periods for readjusting benchmark bond yields.

And it seems that Korea was quite happy about using this type of instrument even in financially difficult times.

Comments

Submitted by Mariana ABRANTE... on
Should the public sector guarantee the private sector financing for PPPs? The short answer is NO, the public sector should not guarantee PPP project financing. The long answer reminds us that financing conditions will get much tighter after the credit crunch, and that if Governments insist on doing all the planned projects, they will have to sweeten the deals with guarantees, availability payments, shorter tenors, etc. At some point, the demands of "bankability" may threaten the principles of "budget sustainability". A very slippery slope...

Submitted by David Wright on
I agree entirely with Mariana. The feature that distinguishes PPPs from Design and Build plus outsourcing is the fact that there is private capital AT RISK against poor performance. Without the capital at risk a PPP project will be the worst of both worlds: higher financing costs without the transfer of sufficient risk to outweigh those costs. This is a good example of government by desperation!

Submitted by Zack Shittu on
While it may be easy to come to a simple NO conclusion from a distance, it will make all the difference in a developing country (often viewed by investors as potentially high risks) for the public sector to guarantee private sector financing of PPPs. Guarantees (sweeteners) offer a cushion of additional comfort and further risk mitigation. When packaging projects for private sector financing, the guarantees do not only come as “baits” but also as a commitment by the government. From my experience working in an emerging market, investors often look for guarantees as a vital component to making investment decisions. While this may appear desperate or far reaching, that is the reality projects in developing countries live with to gain financing.

I totally agree with Zack that in developing countries, one may need to take a slightly different perspective. In Pakistan, for instance, major PPPs in infrastructure have been a rarity, owing not only to political instability but also to low risk appetite of local financial institutions. I would therefore like to suggest that in developing countries, the public sector may selectively guarantee private sector financing, in priority areas. Moreover, in certain high-risk sectors, the government may need to go a step further by either assuming the principal credit risk or providing some form of risk guarantee to catalyze the PPPs.

Submitted by Enrique Fuentes on
The guarantee is perfectly acceptable and contributes to an efficient use of Government resources as long as it is properly designed to cover a specific and temporary situation in which the private sector is charging an inefficient risk premium. This would be the case for the availability of debt in the worst part of the credit crunch in developed economies, or for demand / revenue collection risk in developing countries with no experience in PPP¡s. We must not forget that the efficiency of such guarantee for the Government must be compared against the use of direct Government funding, and by combining guarantees with private financing the Government gets three disctint advantages: (i) it generates a direct financial revenue from the guarantee fee,(ii) the Government commitment is recoverable once the risk situation has improved and the private sector cancels the guarantee, and (iii) it allows to get more infrastructure assets per $ or € committed. To achieve this goals, (i) the guarantee should be partial (up to a reasonable & efficient leverage) leaving sufficientequity at risk, so that there is an incentive for projects to be rational & profitable, and (ii) the guarantees should have a cost that, while being lower than the risk premium that the guarantee is intended to cover (so that it is effcient to use the guarantee to reduce the project cost), is sufficiently high compared to the long term likely premium so as to provide an adequate incentive to refinance and cancel the guarantee once the situation that originated the inefficient risk premium has disappeared.

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