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.