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Public-Private Partnerships:

Risks and Opportunities

Jess Seade

Fiscal Affairs Department

International Monetary Fund

Medellin, Colombia

February 2005

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Why are PPPs

of interest to the IMF? The choice of infrastructure projects or their mode of

financing is not our concern;

But investment as a whole is, and with it publicexpenditure and the control of debt.

The IMF, with support from the WB and IDB,launched the pilot project on public investment(including frameworks and experience on PPPs) insome ten countriesfour of them in Latin America

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Outline of the presentation

Public investment trends during 1970-2000

The macrofiscal situation and the role of PPPs Preliminary results from pilot project: common

problems and fiscal impact

Statistical treatment and disclosure Final thoughts: use with caution

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Public Investment Trends,

1970-2000 Significant variation of trends in public investment

(as a share of GDP) across countries and regionsover the last three decades (see next slide) Fell to historically low levels in a number of OECD countries (by a

factor of 3 to 2) and, more sharply (2 to 1) in Latin America

In the latter, in addition, high degree of volatility

The decline in public investment observed Has been offset only in part by private investment Is related to a trend towards privatization of key sectors (e.g.,

telecommunications)

Might also be a consequence of a more precise classification ofcurrent and capital expenditures.

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Public Investment Trends in Advanced OECD5 Countries and

Selected Latin American Countries, 1970-2000

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1

2

3

4

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1970 1973 1976 1979 1982 1985 1988 1991

United Kingdom

OECD countries 1/ United States

Germany

Italy

Advanced OECD

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2

4

6

8

10

12

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1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000

MexicoArgentina

Chile

Brazil

Average for selected Latin

American countries 2/

Latin America

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1/ Simple average for: Australia, Austria, Belgium, Canada, Denmark, Finland, France,

Germany, Ireland, Italy, Japan, Norway, Portugal, Spain, Sweden, the UK, and the US

2/ Simple average for: Argentina, Brazil, Chile, Colombia, Ecuador, and Mexico

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Current macro-fiscal picture Public debt still over 40 percent of GDP in most of

Latin America Above that level in 15 countries in 2002 (inc. Argentina,

Brazil, Colombia, Ecuador, Mexico, Peru, Uruguay,Venezuela), against only 9 in 1992

These debt levels do not include pension liabilities norcontingent liabilities

Countries priority: control and reduce debt

Fiscal Responsibility Laws or other frameworks imposelimits on expenditure growth, deficits and debt: Brazil,Peru

Medium term public debt reduction goals: Brazil,Colombia, Peru, Uruguay...

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Where Does this Leave

Public Investment?

Concern: that limits on the overall fiscal

balance may unduly constrain scope to financepublic investment in infrastructure.

Alternative / complementary approach: involve

private sector in public investment including through PPPs

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Why PPPs? Private sector management and innovation should lead to better value-

for-money. However, efficiency gains will depend critically on theright allocation of risks between the private and the public sector.

Private financing can support increased infrastructure investmentwithout adding to government borrowing.

PPPs might be preferred to outright privatization because of politicalfactors, control over strategic industries, public good elements, anddegree of monopolization.

But in sum, if the private sector is to pay yet the public sector tocontrol, could this be a mirage?

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What are the concerns? PPPs may be chosen over traditional public

investment and government supply of services

in order to move public investment off budget and debt

off the government balance sheet

yet leaving the government facing considerable fiscal

risks, huge potential costs.

Do we have the tools for the proper accounting

and reporting of the fiscal implications of PPPs?

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PPPs in Practice:

Variety of Experience Brazillimits on PPP-related spending

Recent legislation limits annual cash PPP related spending to 1 percentof revenues

Colombiasimulation of costs of contingent liabilities Colombia developed a framework to estimate and provide for

contingent liabilities (Law 448/98).

The law requires all public entities both at the national andsubnational level to estimate contingent liabilities from PPPs

Moreover, all of these entities have to budget according to thisvaluation of contingent liabilities

Chile too estimates and analyzes contingencies

Peruwork is just beginning towards establishing a registryof contingent liabilities

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PPPs in Practice:

some common problems1

Frequent instances of renegotiation

Incentive to private bidders to offer lowball bids in thecompetitive phase;

They know they should be able to renegotiate later: in the context of a bilateral monopoly, between the government and

its private partner;

and where the governments legal resources and information willbe more limited.

Setting unduly harsh conditions at the outset, or arriving ata contract without enough research and preparation onterms and assumptions, will more easily lead tocostlyrenegotiation.

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PPPs in Practice:

some common problems2

Broad guarantees, which end up being costly.

Example 1: early Colombian PPP contracts

often included large demand guarantees by thegovernment that were subsequently triggered

and entailed substantial fiscal costs (first generationof road concessions; energy contracts)

Example 2: residual debt on the Mexican

highways bailout even today stands at 2

percent of GDP.

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PPPs in Practice:

some common problems3

Procyclicality of guarantees: minimum income

transfers are needed precisely when government

revenues weaken Rigid contracts and high demand on regulator;

for example, some contracts set monetary

investment targets, leading to: unnecessary investments;

regulator auditing amounts spent rather than services

rendered

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PPPs in Practice:

some common problems4

Legal complexities

E.g., proliferation of guarantees: is a financial obligation

senior to a minimum income guarantee?

Many projects have been based on overly optimistic

demand assumptions.

a government creates the jobs and cuts the ribbon; it is future

governments that will need to acknowledge and pay the debt; minimum revenue guarantees facilitate excessive (demand)

risk-taking;

lobbying by builders.

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PPPs should be preferred to direct public

investment if they lead to efficiency gains

Two key tests the UK uses, which Chile has adopted and should be morewidely used in Latin America, are: Value for money: emphasize need and quality of services, in addition to cost; and,

Public sector comparator: compare PPP with public provision alternative.

The standard of services to be provided by PPPs can be specified in thecontract

Appropriate sharing of risks between public and private sectors required

Is there adequate competition in the bidding process, and in the

subsequent provision of services? A suitable regulatory framework? A strong institutional framework?

The fiscal implications of PPPs need to be appropriately accounted forand disclosed.

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Pilot studies: broad lessons

Scope for learning from leaders (Chile, Colombia)

Prudent legislative approach (Brazil, Colombia)

Careful contract design, effective regulation

Least present value of revenues approach Pro: rules out ex-ante unprofitable projects. But:

Incentives to efficient management are mixed; and,

There may be a case for projects with a circumscribed public

good component to be financed with a subsidy. The approachshould therefore not be exclusive.

Full assessment and disclosure of fiscal risks.

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Accounting: standards not yet

established There is no general accounting and reporting standard for PPPs.

Existing standards (ESA 95, GFSM 2001): Cover cash payments by and to government, the transfer of PPP assets to

government, and the calling of guarantees;

But they do not appropriately cover entering into a PPP; treatment oftenbipolar: treat either as purely private or purely public.

We do not agree with the (Eurostats) treatment of a project asprivate if construction and/or availability risks are assumed, asthis, for instance, leaves out (from the public sector) minimumincome guarantees.

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Interim approach:

disclose and anticipate costs

Wide and complete provision of information:

The PDV of expected future payments under PPP contracts should bereported as memorandum item to the balance sheet;

Government guarantees should be disclosed as required under theIMFs fiscal transparency code; in particular, in budget documents andmulti-year programmatic documents;

PPP contracts should be disclosed. This should include future paymentsunder signed contracts.

Risks undertaken by the government should be taken intoaccount in analyzing debt sustainability. For example: Including estimates of guaranteed income costs in appropriate scenario

analysis, and,

Treating PPPs liabilities as public debt in other, stricter scenarios.18

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Conclusion:

PPPs can be useful ... There is a role for private partners who do take on

risks.

Choose a PPP when it delivers high-quality services

at lower cost than government.

Efficiency gains have to be clear and large enough to

cover higher private sector borrowing costs.

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... but caution is needed in their use

Some guarantees may be needed for viability; but excessiveguarantees dull incentives for efficient behavior

Set qualitative limits like in Brazil (at least initially)

The reporting and classification of the project spending is aseparate question, with evolving standardsbut alwaysdisclose!

And above all, never choose a PPP because of the way it may beclassified, in order to show a lower government deficit today: itcan lead to much larger costs down the roadand with lesscontrol.

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