The dangers of relying on PPP
With private investments failing to pick up speed, and
with its own finances under strain because of increased payments, the
government has to budget for its employees. The Union government is
likely to emphasize public-private partnership (PPP) projects to make up
for a shortfall in investment spending in the Union budget, according
to a recent
Mint report.
In
theory, the idea seems attractive: PPP investments can spur
infrastructure development and growth without much fiscal pain. The
actual experience of many countries, including India, however, suggests
the need for greater caution.
It is easy to
understand why policymakers are turning to the PPP route in India
despite its pitfalls. One of the most important fetters to India’s
economic development is the dearth of quality infrastructure. The
country’s performance in infrastructure is worse than its overall
performance vis-à-vis top performing countries, according to the latest
Global Competitiveness Rankings released by the World Economic Forum,
showed a
Mint analysis published last year.
The
12th five-year plan made by the erstwhile Planning Commission had
targeted an investment of Rs55.75 trillion (at current prices) for the
period 2012-17. A policy brief prepared by its successor, the NITI
Aayog, notes that there has been an estimated shortfall of 30% in
infrastructure investment during the first two years of the 12th plan
period, and estimated it would continue in the third year as well.
Because
of the high expectations for investments through the PPP route, the
shortfall is higher on account of the private sector than the public
sector, the figures being 43% and 20%, respectively.
The reason for the lacklustre performance by PPPs go beyond usual market conditions. PPP projects have been
mired in issues
such as disputes in existing contracts, non-availability of capital and
regulatory hurdles related to the acquisition of land. To be fair, PPPs
are not facing problems in India alone. Across the world, the record of
PPPs has been very mixed, according to a wide body of research.
The
involvement of private firms in infrastructure building or other public
sector activities through contracting is not a new phenomenon. What
distinguishes PPP from such models is the fact that the private sector
is given a role in planning the project and risk sharing, which takes
place on the lines of a build-operate-transfer,
build-operate-own-transfer or build-operate-own model. For example, the
government can decide to get a highway built by a private firm, which
can recover its costs by levying tolls on user vehicles for an agreed
period of time.
While these models can be used
to describe simple PPP projects, there are many in which the expected
revenues might not be sufficient to recover the costs. In that case,
there is a clause of capital grant from the public sector partner to
ensure profitability, referred to as viability gap funding.
In
more complex and capital-intensive projects, the government might share
the capital cost to attract private partners who might not be willing
to undertake the entire investment themselves.
What is the justification for this increased role for the private sector, from being mere contractors to partners? A
2004 paper
by economists Jean-Etienne de Bettignies and Thomas W. Ross at the
University of British Columbia on the economics of PPPs lists nine
reasons that have been used to justify their use.
Allowing
for private sector participation can generate more efficiencies by
creating more competition, realization of economies of scale and greater
flexibility than is available to the public sector, the authors
suggest. The PPP route is also seen as an attractive alternative in
developing countries where governments are faced with constraints on
borrowing money for expensive projects and may not have the required
expertise in planning or executing large projects.
Private
firms such as large transnational corporations often may have
significant expertise and efficiency in implementing such projects
because of previous experience. Another advantage highlighted by the
proponents of PPP projects, especially in infrastructure, is that their
costs can be recovered from those who use them, rather than putting the
burden on everybody, which would happen if it were to be financed by tax
collections.
There are differing views on the novelty of this concept as well as its virtues. A
2007 paper
on the international performance review of PPPs suggests that in many
cases, classification of projects under the PPP category might simple
comprise a “language game” by governments who find it relatively
difficult to push privatization, or when contracting out is more
difficult politically.
The authors also argue
that some of the promised benefits under the PPP route might get
jeopardized due to what they term as the private finance initiative tail
wagging the planning dog to make such projects investor friendly by
guaranteeing greater profits.
The paper lists
many reasons why PPPs might not lead to unambiguous benefits, such as
the lack of independent evaluation or limited ability of auditors to
question government policy, wrong assumptions about future income stream
that form the premise of the project, and inaccurate estimate of risk
transfers from the public to the private sector.
Many
studies have pointed out that some of these problems might get
compounded due to the fact that in many PPP projects, the public sector
partner is a local or decentralized entity, which is ill-equipped to
meet the requirements of designing and supervising the project or
handling disputes that arise later.
An apt
example of such a case is the experience of a road bridge—popularly
known as the DND flyway—connecting New Delhi with Noida, one of the
first large infrastructure projects taken up under the PPP route in
India.
A
2007 review
of the project commissioned by the Planning Commission concluded that
the promise of a 20% return over the cost of project and not equity to
the private party in the contract led to a perverted cost-sharing model
with large gains for the private operator over a long period. The study
further notes that the terms of the contract were such that the private
party had no incentive to cut costs in the project.
The
study observed that many of the loopholes in the original contract
might have been because of the lack of experience on the part of the
public sector partners in planning and executing PPPs.
A similar problem was underlined in a
2008 paper by Satish Bagal,
then associated with the Mumbai Metropolitan Regional Development
Authority, which states that government departments are ill-equipped to
handle even simple cash contracts, let alone complex PPP negotiations
that involve designing long-term contracts and handling numerous
uncertainties.
In many instances, it is not only
the public partner that is left holding the can but also the banks that
provide funding to such projects. With a contraction in development
finance institutions in India, commercial banks became the main source
of credit to long-gestation infrastructure projects, both private and
PPP.
Non-realization of loans to infrastructure
projects is believed to comprise a large chunk of the non-performing
asset portfolio of public sector banks in India. Here too, the reasons
might be systemic, as was
pointed out by K.C. Chakrabarty, then deputy governor of the Reserve Bank of India, in May 2013.
Chakrabarty
noted that an over-reliance on debt and lack of substantial equity
stakes for the private firms create a situation where the promoter has
little “skin in the game” and limited motivation to work towards the
success of the venture.
While
private firms accept stringent terms of PPP contracts with great
alacrity, they lose no opportunity for renegotiating contracts (e.g., by
citing lower revenue realization or unexpected rise in costs), in
effect garnering a larger share of public resources than originally
planned. This creates a problem of moral hazard since it becomes common
knowledge that a firm can bid low and recover later just by demanding
the renegotiation of a contract. Rather than being an exceptional
clause, renegotiation has become the norm in PPP projects in India.
In a 2014
Economic & Political Weekly article,
Indian Economic Service officer Kumar V. Pratap argued that a large
number of such cases are because of “opportunistic behaviour” by private
sector partners who indulge in aggressive bidding and portray bloated
gains to public sector to garner contracts and then try to renegotiate
contracts. Pratap argued that in order to create a healthy PPP policy
environment, the government should cancel such contracts instead of
entertaining renegotiations in the spirit of market discipline, which is
the basis of private sector participation in such projects.
Pratap
also underlined the importance of separating the role of independent
regulators from those who are involved in formulating the terms of
contracts, referred to as model concession agreements. The thumb rule
for awarding PPPs has to be value for money from the government’s
perspective, the very premise of PPPs, which has been undermined in many
projects, the article argues.
The
recently published report
by the committee on PPPs headed by Vijay Kelkar accepts many of these
criticisms and recommends tweaks in the way PPPs are designed, with
greater emphasis on user services rather than fiscal savings.
The
report emphasizes the “criticality of setting up of independent
regulators in sectors that are going in for PPPs”. It also suggests that
with adequate trust between public and private partners, it is possible
to make PPPs work in India. Yet, rebuilding trust will not be easy
after a decade of mismanagement.
The past decade
has been one of failed experiments with PPP projects. It is time to
learn from those mistakes if we are to avoid repeating them.
