Jeff Delmon, Senior World Bank PPP Specialist and a regular blogger on the Getting Infrastructure Right blog platform, was featured in this episode of the Tell Me How podcast, produced by the World Bank's Infrastructure Global Practice. This is a great opportunity to hear Jeff unravel the benefits of bringing in the private sector, how the World Bank works with governments to make projects bankable, and considerations such as value for money, good communication, and managing expectations. You can listen in or read the transcript.
Roumeen Islam: This is the World Bank's Infrastructure podcast. In today's episode, we discuss public-private partnerships, commonly known as PPPs, and why they're important in a wide range of sectors.
Governments around the world in poorer and richer countries have worked with the private sector to do these investments and deliver services to their citizens.
Perhaps you know that the Suez Canal, constructed in the 19th century, had private funding and London's Heathrow airport’s, Terminal Five was the result of a PPP with the British Airport Authority. Well, all these partnerships come in a variety of forms.
The nature of the contract with the private financier depends on the project itself, but also on sector, country, and global market conditions. So, when should a government think about bringing the private sector into its investments and what factors are important in this relationship?
Well, let's find out how to approach this issue in the infrastructure sector.
Good morning and welcome. I am Roumeen Islam, host of Tell Me How. And my guest today is Jeffrey Delmon, an expert on infrastructure finance, a topic that you, no-doubt, have been hearing a lot about, as countries deal with the dual challenge of recovery from the pandemic and investing in a green future. He will be speaking about public-private partnerships in meeting our infrastructure needs.
Jeff Delmon: Thank you Roumeen, fantastic to be here!
Roumeen Islam: Very nice to have you. So, let me begin by asking you, Jeff, what exactly do we mean when we talk about public-private partnerships?
Jeff Delmon:, where the private sector entity undertakes some combination of design, construction, operation, and financing of an infrastructure asset.
They do so over a long period of time, so that you have the private sector building and then operating, for example, a road. The private sector designs and constructs the road, operates the road over a period of time, and provides financing for the construction of the road. That's the classic definition.
Roumeen Islam: I see. But the definition varies right from country to country.
So, it could be about both financing and management or a construction, or it might just refer in a particular case to just, say, construction for example. The public sector could finance the building of a road and the private sector would just be building it, right?
Jeff Delmon: Absolutely. There’s a huge variety of different structures and it may be that it's an existing road, and we're just expanding the road slightly.
It may be an existing road and we're bringing in tolling equipment or other mechanisms to manage the road more efficiently. So, the different structures vary widely. It also depends on the legal structure of the country that's hosting the PPP. There may be a PPP law or act regulation, or just a government policy that's driving the definition of PPP.
Roumeen Islam: Okay. Why do governments seek private participation in delivering infrastructure services? What's in it for them?
Jeff Delmon: Governments tend to want private sector to help them manage and develop infrastructure in order to gain access to private sector innovation, construction methodologies, efficiencies, new sources of financing.
Private sector brings a lot of capacities that government may not have. For example, there's an airport that I worked on in Russia in St. Petersburg, Russia, was called Pulkovo, and it was a very large investment, a 1.2 billion Euro investment.
This existing terminal needed to be torn down, rebuilt, restructured, latest technology, latest approach, but it wasn't just about the construction. It was also about operation. When you're managing an airport, the airports can leverage more revenues, bringing in more traffic, bringing in more tourists, based on the relationship with the airlines.
And so, by bringing in a private investor -in this case, one of the big German airport companies- they were able to bring that company's relationships with different airlines. They're also able to leverage more different kinds of revenues.
For example, duty free. When you walk into an airport and some of them are constrained and uncomfortable, some of them have these beautiful, massive shopping malls and it's those shopping mall type airports that bring in a huge amount of additional revenues. And that's what the private sector can bring.
Roumeen Islam: I'm not exactly sure why the public sector couldn't build the airport and just ask the private sector to come and have some shops in the terminal.
Jeff Delmon: That's actually one of the forms of PPP. So, you can split an airport between airside and landside. Actually, there's an airport in Bali in Indonesia, and the government didn't want to give away any of the airports.
And so, they just brought a private company in to manage the landside, the shopping area. And they turn the airport in this amazing… revenues increased by 300%. Just by having this private company come in and manage the commercial side of the airport.
Roumeen Islam: Alright. So, management can be much better, construction can be more efficient. They can be new technology brought in and then there's finance brought in. So, there are many aspects that you just mentioned.
Now, do you think that infrastructure-related PPPs are different from those in other sectors?
Jeff Delmon: There's such a fantastic variety of types of PPP.
And there are definitely different approaches taken in different sectors. In healthcare, in education, we have all these different approaches to delivering services of different types. And there's a huge amount that infrastructure PPP learns from other social sector and other sector PPPs.
Roumeen Islam: Now, when we're speaking about health or education, you have infrastructure there as well. They're not that different across sectors.
If you're going to be building a building, constructing an edifice, you could do it in any sector, and you'd have similar problems or not.
Jeff Delmon: I think the problems are very similar, the challenges are very similar, but the solutions are very different. Let me give you an example.
The government of India has these old fortresses, beautiful old historical buildings, but they're crumbling. So, what do you do? And they bring in private investors to rebuild the buildings, but somehow you need to leverage revenues out of that so that the private sector can get its revenues. So, you create beautiful hotels and private residences in part of the property, and then the rest of the property is open for public access and the gardens and all the rest.
That raises the same issues that would drive an airport PPP or port PPP. But actually, the approaches are quite different and the things that you can learn, one from the other [are] fantastic. So, the structures and the issues are all very similar, but the solutions and the design and the models that we use are quite different.
Roumeen Islam: Do PPPs mostly involve some financing by the private sector, or are they generally only management contracts?
Jeff Delmon: Depends on the approach to PPP that you're using, but there's generally a desire by government to bring in new sources of capital. And so private financing is very attractive.
There are, however, some structures where the amount of private financing is quite limited. You want the private sector to bring enough money so that they have money on the table. They've got some skin in the game. So that if things go wrong, they are motivated, incentivized, to push past those challenges and find solutions.
Roumeen Islam: So, Jeff, who are the parties engaging on two sides of a PPP contract?
Jeff Delmon: As we said, there is public and private. On the private side, you'll have the project company. The project company is usually made up of a construction company, an operator, but you may also have financial investors. You'll have a whole group of private entities that bring together all the different capacities and abilities that will drive development of the project.
On the public side, it may be an SOE, it may be a utility, it may be a line ministry or a government entity. It may be a ministry of finance, or, maybe, a local government.
But don't forget that there are a number of other parties involved in a PPP. Anything from insurance companies and regulators, access to lands you're going to need, and most importantly is the local community. The people that really benefit from the project that are on the ground, that live with this project day to day, are one of your most important counterparts, they're also one of your most important enablers.
Those people can give you an understanding of project risk of project success that no one else will be able to. So, that's a critical point.
Roumeen Islam: Basically, they're the ones that are going to be using the service. That's where the demand comes from, and where sometimes the payment comes from, as well, so it’s critical.
So, going back to infrastructure, if we were going to classify different PPPs, how would you do it? What would be the key parameters that you'd be looking at?
Jeff Delmon: Let's see when you're looking at a PPP, there are a couple of different questions you need to ask yourself, even from the very beginning, when you're first analyzing a structure and trying to think of the best solution to bring to the table.
First of all, is this a new asset or an existing asset, and that will change the dynamic completely. Is it a new construction? Am I building a new road? Or am I taking an existing road and expanding it? And the risks involved with the private sector, the risks that the government's going to need to bear, will be very different, new asset to existing asset
Roumeen Islam: But it is much larger for the new one, right?
Jeff Delmon: Relatively speaking, yes. If you build a whole new road of a four-lane road, it's much more expensive than taking a two-lane road and expanding it to four. The volume of capital is very different, but also the risk is very different.
Roumeen Islam: I was talking about the risk. The risk must be much greater for an unknown road, right?
Jeff Delmon: It depends because you'd be surprised how little data there is on existing assets. For instance, water projects have massive problems. Water distribution projects, there are all these pipes underground. No one has any idea where they are. No one has any idea what quality they are. You'd be amazed because a lot of these systems were built a hundred years ago, fifty years ago.
Roumeen Islam: And there’s no record of any of this!
Jeff Delmon: For a lot of the ones we work on, there's no record and people don't even know how much pipe is there, much less how good a shape it is. And so, as a private company you're coming in, they don't even know how many consumers they have.
I worked on a project in Tanzania and the private sector was told “you have 100,000 customers”. They arrive on day one and find out they only have 50,000. Because the other 50,000 customers had either moved or had passed away or were no longer customers and it's not that the government is trying to cheat them. It's just that they just didn't know. And so, they gave them their best guesses as to how many people they had.
Roumeen Islam: But this makes a huge difference to the project. If your consumer's are cut by half, then you have a totally different project.
Anyway, but let's move on. One form of differentiation is whether it's a new or existing asset. What are some of the others?
Jeff Delmon: The type of service delivery. And going back to my water project example, if I've built a dam and I'm treating water and I'm delivering it to a utility, so I'm just delivering it to the water utility and the water utility then takes it to the individual consumers. That's a pretty easy relationship. I have a contract with this one big company. They pay my bills, I'm done.
More complicated is when you ask the private sector to treat the water and then deliver it to individual households. And you can imagine the difficulty of collecting money from individual households, making sure where the leaks are, figuring out what the services are. When it's government, really the consumer relationship is very different than when a private company comes in and has to do with those users.
Roumeen Islam: In what way?
Jeff Delmon: It depends on the country to be honest. In some countries, users don't dare cross the government. Because the government will come down hard on them. In other countries, governments don't bother with collecting bills. And so, they don't bother coming after. And then when the private sector comes in, people aren't paying their bills. They're not expecting to pay their bills.
And this terrible private company is coming in and asking them to pay for the water they're receiving. And that creates all kinds of tension, frustrations, it becomes very challenging.
Roumeen Islam: What you're saying is the success of some of these projects really depends on the pre-existing norms and culture in a country.
And if you don't take those into account, you can have a big problem. This is why you were talking about local communities earlier as well.
Jeff Delmon: Absolutely. And in many cases, government tries to use PPP to change those norms: “I want people to pay for water and I'm going to use the PPP to force them to pay, cause this private company is going to force them to pay.”
Roumeen Islam: And? What happens?
Jeff Delmon: Oh, it's a disaster generally.
Roumeen Islam: It doesn’t work, right?
Jeff Delmon: Which is why we try to do as much early work as possible. We try to spend as much time on the ground, working with the community, working with the government, working with potential bidders so that we get all this stuff out of the way in advance and we deal with all these questions early.
Roumeen Islam: Now, can we talk about some of the other differences?
Jeff Delmon: One of the different questions you need to ask is whether it's a new or existing business. If it's a new business, you've got a clean slate. That's a new company that's being created.
If it's an existing business, you're taking an existing entity that's already being operated and you're asking the private sector to come and help you manage that existing company. And that company is going to have employees, it's going to have liabilities. All of those things need to be passed on to the private sector.
Another issue that you might want to look at is the source of revenues. And this goes back a little bit to what we talked before about the relationship with consumers. If you're asking a private company to deliver services to a public entity and collect money from the public entity for the services rendered, that's a very simple relationship: One big entity to another.
If you're asking a private company to come in and collect money from consumers, from users across the country, that becomes a much more complicated question.
So again, our water company, if I'm just collecting from the utility, that's easy. If I'm collecting from individual consumers, what is the history of collecting from them? Do they pay their bills? What do you do if they don't? Can you actually disconnect people? And that's a terrible situation to be in. So, all of those things you really need to look at carefully before you structure the PPP.
Roumeen Islam: Yes. You know, during the pandemic, the government actually asked companies, both public and private, not to cut off electricity, even when consumers couldn't pay their bills. There was a moratorium on payments in several countries, actually.
Anyway, let's move on to the financing of PPPs. Does the private financing share vary considerably? And when might you want a higher share?
Jeff Delmon: Yeah. So, this is a tricky question, but a really important one. When we look at the balance between public and private financing for a project, it's the balance between creating a project that is sufficiently financially viable for the investor, but also sufficiently financially viable for the government.
The government needs to get value for its money. Any public money that's invested in a PPP needs to deliver value to government, right? We want to see value for that money, it needs to make sense. It needs to not create too much risk in a particular fiscal risk for government. And at the same time, the private sector is going to be driving the same question to make sure that the amount of money it brings results in a revenue stream for the private sector.
The trick is that often we get very focused on short term and we get a little blind to what happens down the road. And so, the fiscal risk that you're creating for government can be very difficult for government to manage in the medium to long-term.
Roumeen Islam: I'm sorry, could you explain that a bit? Why is that different from what they're bearing in the short term?
Jeff Delmon: The perception. I understand what I'm going to be paying this year, I understand what I'm going to be paying next year because Governments work on budgets that are relatively short term. If you think about your budget position in five years, 10 years, 15 years, you don't know where you're going to be, and you don't know what “expensive” looks like.
There's a tendency to be very optimistic: “We're going to be collecting more and more taxes. Our economy is exploding. This is all going to work really well.” There's also a tendency to say, “that's the next government's problem.”
And which is very true for the private sector as well. We tend to be very “short-termist.” We look at where we're going to, what we're going to get now and in the medium term. The long-term, no need to think about it.
Roumeen Islam: What are the types of financial instruments used, and typically who finances these projects?
Jeff Delmon: I'll give you the simple version because there are a huge number of incredibly complex different financial instruments.
They're basically equity and debt and government contribution. So, government contributes from its side. It may contribute debt, it may contribute equity, it may contribute subsidies. Private sector contributes equity and debt. The equity holders are taking project risk. They get the upside, but they also lose money if the project doesn't work well.
Lenders only get their interest. So, lenders don't get upside if the project works well. They only take the risk of downside of a loss if the project does not work well. So, lenders tend to be incredibly conservative. So, you have a nice balance of debt, which is very conservative, equity, which is much more aggressive, and government, which is driven by a whole different set of incentives.
Roumeen Islam: But a lot of governments give guarantees to private investors. Could you talk a bit about this? And do you see this more in certain types of countries, rather than others?
Jeff Delmon: Guarantees are quite commonly used, but they're also very difficult to use well. The guarantees are basically the government absorbing certain risks in the project that the private sector is not able to manage well.
I will give you an example. On a typical toll road, if you're asking the private sector to take the risk that they're going to attract enough traffic onto this road to make their money, the private sector is going to say, “look, we don't control traffic. We don't drive any of the policies that would make for more traffic. We don't tell people how much tax we're going to put on petrol. We don't tell people what it costs to drive a car. We don't create competing roads or competing transport links. So how is it that we can manage this traffic?”
So, often for toll roads, governments provide guarantees against traffic levels. If traffic is too low, the government provides a guarantee to top up the amount of revenue to meet that risk.
Roumeen Islam: I hear you, Jeff, that the private investors come in, either with equity or with debt, they lend to government. But eventually, as we were saying earlier, this financial investment has to make a return and to be paid back.
So, in terms of where this money eventually comes from, I guess there are only two sources, the users or the government. Does the type of funding used depend on the particular type of service being provided or on something else?
Jeff Delmon: I would say it's users or taxpayers, because governments have very few sources of revenues outside of taxpayers.
And at the end of the day, it comes down to government policy, which is more appropriate for the value, the cost of a service to be spread out over just those people that benefit from the service, or should we spread out over the entire population?
And it depends on the government, it depends on the service. I personally have a bias toward people that benefit should pay. But it depends very much on the system.
Roumeen Islam: There are also some distributional issues that the government has to handle. So, you can't always have people that benefit paying as much as people that may not benefit.
Some things have to be financed by general tax revenues, for example, if you're worried about distribution of poverty.
Jeff Delmon: Yeah, absolutely. I guess the other side of that is also the incentives. So, if the beneficiaries are being subsidized, will they act as a counterpart in the PPP as effectively?
So, if I'm looking to the community as the third leg of my stool, and that community is getting services that are heavily subsidized, will they value the service enough to be a partner? But you're absolutely right.
Roumeen Islam: But you bring up a very good point there Jeff about valuing the service and the incentive to use it according to its value.
Now, PPP contracts have several features that need to be customized to the particular project and also to the country. And as you mentioned earlier, they're just extremely complex. So I'm thinking, is it worth the cost?
Jeff Delmon: It's a very good question. And a really important one to ask very early on. Think carefully about what you're doing before diving into it. There are some projects that aren't worth it. It's too much, too difficult, too much cost upfront. And it's not that every project should be done with PPP. In fact, the majority of projects are publicly financed. PPP only addresses a certain slice of our infrastructure needs.
Second, your lawyer is your friend. Bring in good people to advise you early and to think about these issues so that you design it well, and third, be creative. For instance, there are small projects that you do. Municipalities have very small projects that they want to deliver with the private sector.
You can pool those projects together so that when you fund or you pay for these experts to come in and help design, you can have them design 20-30 projects all at the same time.
Roumeen Islam: That's some excellent advice. But I also understand that there are instances of these arrangements not working out.
So, could you speak briefly, broadly about why this might be so. I'm sure there are many reasons and we're going to need another podcast for that, but if you could just lead us in that direction, broadly speaking.
Jeff Delmon: That's really good question.
In a water project I worked on in Africa, the two sides, the private sector and the public sector, were having problems. They were mad at each other. They were angry about different things. They both saw the other as being at fault. But they didn't want to talk. They were too embarrassed to raise these issues with each other, and just got worse and worse and worse, and finally exploded. And it ended up with the government putting the private sector CEO and CFO on an airplane in handcuffs and sending them back to their country.
Often the expectations are unrealistic. So, if you don't do your homework first, and you're expecting the PPP to deliver something, that's unrealistic. Or the private sector is expecting a PPP to be really easy or really profitable, and they haven't done their homework.
You've got to think carefully about what your expectations are and design the project to deliver realistic deliverables.
Roumeen Islam: I guess it's not just expectations in the broad sense, but really about doing the proper technical analysis. The proper economic analysis, the financial analysis of the projects.
And in that sense, you mentioned earlier overoptimism, thinking that the growth in users would be much higher, for example, than they actually end up being. But how do developing countries, having limited capacity, not that much data, limited experience, how do they manage with PPPs?
Jeff Delmon: In developing countries it's tricky. Frankly, it's tricky in developed countries, but in developing countries, where you have even less capacity, where you have even less experience with public and private sector working closely together, it requires much more. So, we have to be more cautious. We have to be more careful. We have to do more work upfront.
There are a lot of development partners who are out there wanting to help. So, they take the experience they have from their home country and they bring it to the benefit of the developing country. They'll bring funding to provide advisors and technical capacity, training…
There's a lot of work that can be done to slowly build up the capacity of these developing countries. But you just have to be really careful and deliver properly and simply as possible. Don't try to be overly clever and overly complicated.
Roumeen Islam: So particularly at the beginning, you'd want to start with simpler, maybe even smaller projects, getting to know the country and then, over time, building it up.
And I guess because the initial costs of getting to know the environment because they are kind of high, you might see investors going repeatedly back into the countries they already know, rather than investing in new countries, which might end up being very profitable for them.
So sometimes that happens, I presume.
Jeff Delmon: Absolutely. And the trick is that ideally you use smaller projects and build up your experience, but it's hard to spend all this money to develop a PPP capacity, to do small projects. And also, governments often most excited about the big, huge projects. That's what gets their attention. And that's often the project that they don't want to fund using their own money for. They want to use private money for, so [they say] “let's do PPP on these big, massive, politically-driven projects.” It's really difficult to get that balance, right?
Roumeen Islam: There are many issues on both sides.
Now, is there a lot of PPP financing from local investors in low- and middle-income countries?
Jeff Delmon: Unfortunately, generally speaking, no, this is the ideal. We want to develop local capacity. We want to bring in local and regional investors. That's far more interesting from a developmental perspective, but also from a cost perspective. Local finance is in local currency. And so, it matches your currency for revenues.
If you've got your toll road and you're earning money in local currency, but your financing is in US Dollars or Euro, you take that exchange rate risk, which can be really, really, expensive. And so ideally use local currency, but local banks won't know how to finance these kinds of projects and may not have the capital. Local investors won't have the experience.
So usually, we fold those local investors and local financiers into consortia, and we require foreign investors to bring in local partners. And that slowly builds up the capacity locally.
Roumeen Islam: By “we”, you mean the World Bank working on projects.
Jeff Delmon: People advise, anybody will do this, right?
Roumeen Islam: And also, I guess that means building up the domestic financial sector.
Jeff Delmon: Absolutely. And both capital markets, and debt.
Roumeen Islam: Thank you. So that was a lot of information and I learned a lot from you, Jeff. Thank you. Is there anything you'd like to add before we end today?
Jeff Delmon: Just that
Roumeen Islam: Thank you. Thank you very much, Jeff.
Jeff Delmon: Thanks.
: Well, listeners, here are some things we learned today. Firstly, the term public private partnership is used to refer to a range of agreements between governments and the private sector, such as private management, design, or construction and financing of investment to support the provision of public goods and services.
Secondly, some important features need to be considered in these arrangements as they influence the risks and complexity of each contract. Namely, whether the private sector is investing in a new or ongoing business, investing in a new asset or improving an existing one, whether it has to deal directly with the ultimate consumer, households, or just the government, and finally, what is the source of revenue for the private entity.
Thirdly,Finally, and how clearly the rights and responsibilities of the different parties are outlined in the legal contracts and how well managed they are.
Thank you and bye for now.
If you'd like to suggest topics for the future, please email us at [email protected]. We look forward to hearing from you.
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