Fiscal risk in PPPs—What’s the problem & what to do?
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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.
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 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
This blog is managed by the Infrastructure Finance, PPPs & Guarantees Group of the World Bank. Learn more about our work here.
Very much useful and appreciable
Fiscal risk is very often misunderstood when dealing with PPP arrangements. Off-balance obligations may entail a heavy burden for the government over the years, especially if the project doesn’t count on a fair balance between funding and financial sources. It would be importan to stress that major infrastructure projects unfold over decades, a portfolio of PPP projects will potentially overlap yearly payments. This may not have an impact on country debt, but decision makers should have in mind that, at the end of the day, it is the taxpayer who will be compelled to bear the financial burden stemming from the investment portfolio. Users will hardly pay for operation and maintenance costs. So, it is extremely important for the government to engage with projects that are really efficient economically (useful for the whole of society), which is the key to deliver Value for Money as well as Value for People and Value for the Future.
Truly an excellent article about a very important subject. Fiscal risks have always been a problem in PPPs as soon as expected events unfold jeopardizing vital revenue streams, the life blood of PPP projects. It is indeed likely that the recent pandemic will put many PPP projects on hold in the short term at least util the financial markets stabilize and governments can re-calibrate their revenues. However, it is clear that governments should continue to plan long term projects with the help of the PFRAM and carefully consider all worst case scenarios in their risk matrices. In the immediate term, many PPP infrastructure projects will be under financial stress and may have to be restructured to avoid early terminations for Force Majeure.
This is an informative piece of information. It has given me a different perspective on PFRAM including what it cannot do and the importance of what it can do, than I had before.
The Covid 19 pandemic has opened up eyes and how to think about the unforeseen risks and their implications as more often than not we are focused on what is visible to the naked eye.
Fiscal risk is not just to be understood by the existing Government regime. It is something that needs to be inherited by different teams / political party coming to power for years till the end of the project concession. A well thought out identification & sharing of risks - by the party most capable of handling the risk is critical. Once a risks falls into one party's court (in this case Fiscal risk falling into as a Sovereign risk), Government machinery should keep all departments well informed and all mitigation measures should be taken in advance y-o-y till the end of concession period