Fiscal risk in PPPs—What’s the problem & what to do?

The world is spinning around the coronavirus; who has capacity to care about fiscal risk, especially as it relates to public-private partnerships (PPPs)? Actually, a pandemic is a perfect moment to look at this more closely. COVID-19 brings infrastructure service disruption, which will inevitably lead to conversations on which party will bear related costs and to what extent. Governments will have to look at the fiscal implications of numerous infrastructure projects and make some tough decisions.

So, let’s walk through the basics.

The reality is that PPPs are sometimes perceived as a means for delivering infrastructure for free. A more accurate view is that they’re a way to overcome fiscal constraints, a tool to realize public investments when governments lack resources to implement projects. 

Some argue, perhaps rightly so, that sometimes governments enter PPP contracts without fully understanding their fiscal impact.

How so?

• Since long-term contracts postpone payment obligations and spread them over long periods, the fiscal consequences of PPPs are often overlooked in the short term.
• The full fiscal implications of PPPs become clear only once PPP-related payment obligations—from firm or contingent liabilities—affect the budget during operation.
• For countries that lack a long-term perspective on public finances, PPPs may look affordable due to their delayed budget impact.

Yet PPPs—if done for the right reasons and managed well—can help to improve the efficiency of public investment because the private sector can help execute projects on time and on budget, in addition to bringing efficiencies and innovation.  We know that governments need every tool in the infrastructure finance toolbox to meet their citizens’ needs for basic services. But it’s critical that tools are used responsibly. This is not always straightforward and often requires a balancing act.

There are several sources listed at the end of this blog that can help governments achieve this. Essentially, most agree that an ideal risk allocation for a project 1) provides value for money, 2) is affordable, with an acceptable level of fiscal risk, and 3) is bankable, that is, likely to attract private financing.

Introducing PFRAM 2.0

The IMF and World Bank recently updated a tool to help governments manage PPPs proactively—so that identified risks are allocated, managed, and priced correctly—and, ideally, so that they don’t materialize: the Public-Private Partnership Fiscal Risk Assessment Model (PFRAM) 2.0.

The two organizations have been using PFRAM since 2016 in the context of technical assistance; many developing-country authorities have also taken it for a spin. Version 2.0 incorporates much feedback, is easier to understand by non-PPP experts, and extends the tool’s coverage and functionalities.

When we designed the tool, I admit that a global pandemic was far from our minds. But COVID-19’s effects on infrastructure are those of a large economic crisis, so PFRAM is well-placed to help governments assess the effects of extreme revenue fluctuations and construction delays.  The tool can also help assess the impact of volatility in some economic indicators like inflation, interest rates, or foreign exchange.

The tool requires a minimum amount of information on the project, including:

• Contract parameters—when does it start and end?
• Funding—who pays?
• Financing—how will the project be financed? What portion will be financed by debt and equity?
• Asset details—what’s the value of the total investment, length of the construction period, expected useful life?
• Service to be provided—what’s the demand? Price per unit?
• Cost—what are the maintenance and operation costs?
• Guarantees, if they exist—does the government provide any debt or minimum revenue guarantee?

I’m also often asked whether PFRAM 2.0 is worth the bother for a small project. My answer is an unequivocal “yes.” We recommend that the risk matrix should be prepared in all cases. It’s important to go through this kind of assessment to avoid the pitfalls I mentioned earlier. But keep in mind: for most individual projects, the fiscal implications as a percentage of GDP will be very small (except in the case of a very big project in a country with a small GDP). Fiscal implications will be bigger when we assess a program of projects. And indeed, a holistic, programmatic approach to managing PPPs is best practice.

Of course, PFRAM 2.0 is no panacea. There’s a lot it can’t do, such as:

Justify a project’s economic or social relevance. PFRAM 2.0 doesn’t replace a comprehensive project assessment, nor does it constitute a cost-benefit analysis. It doesn’t assess the quality or relevance of a project or help prioritize a group of projects.

Ascertain a project procurement option. PFRAM 2.0 looks at the fiscal implications of a project when carried out as a PPP. It doesn’t look at the implications of the same project carried out with public financing.

Substitute for a complete financial project evaluation. PFRAM 2.0 doesn’t assess project viability, usually done through a comprehensive business plan that includes a detailed financial model.  PFRAM 2.0 provides some high-level presentations of the financial flows for the project company. However, they’re not meant to replace the financial model.

So project teams will still have their work cut out for them. But using PFRAM 2.0 will give them a tremendous head start.

We’re anxious to get word out about the tool—and also to receive feedback. Feel free to comment below or email me directly at dduarte@worldbank.org.

 

Additional sources for managing fiscal risk in PPPs

Section 3.3 of the World Bank’s PPP Reference Guide
Risk Allocation Tool developed by the Global Infrastructure Hub
The APMG PPP Certification Program and Guide
The World Bank’s e-learning on Infrastructure, PPPs, and Fiscal Management

 

This blog has been adapted from the World Bank’s new Quick Reads on InfraFinance series, click here for more.

 

Related Posts

COVID-19 & infrastructure: Why governments must act to protect projects

How will coronavirus affect public-private partnerships?

Is there a tradeoff between debt sustainability and infrastructure investment?

From the Kenyan Debt Office to Washington: Sharpening skills in PPP fiscal risk management

The PPP Reference Guide: Strengthening infrastructure governance through public-private partnerships

 

 

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This blog is managed by the Infrastructure Finance, PPPs & Guarantees Group of the World Bank. Learn more about our work here.