Overview of PPP in Infrastructure

Why use PPP?

As mentioned in the previous section, PPPs offer the public sector potential cost, quality and scale advantages in achieving infrastructure service targets. However, PPPs are different to the traditional public sector route and these differences require adaptation of approach and capabilities in the public sector. There are also some new costs associated with PPPs.

The advantages and challenges of PPPs are outlined below. In general, in a well-designed and supported PPP the advantages will outweigh the disadvantages.

Advantages of PPP

The advantages of PPP include:

• Access to private sector finance
• Efficiency advantages from using private sector skills and from transferring risk to the private sector
• Potentially increased transparency
• Enlargement of focus from only creating an asset to delivery of a service, including maintenance of the infrastructure asset during its operating lifetime
• This broadened focus creates incentives to reduce the full life-cycle costs (ie, construction costs and operating costs)

All of these provide strong reasons in favour of using PPPs in India and elsewhere.

Access to private sector finance
India has a very large infrastructure need and an associated funding gap. PPPs can help both to meet the need and to fill the funding gap. PPP projects often involve the private sector arranging and providing finance. This frees the public sector from the need to meet financing requirements from its own revenues (taxes) or through borrowing. This is an advantage where the public sector is facing limits on how much capital it can raise, as in India. By shifting the responsibility for finance away from the public sector PPPs can enable more investment in infrastructure and increased access to infrastructure services.

Using private sector finance also allows the public sector to move large capital expenditure programmes ‘off balance sheet’. This has been a motivating factor for PPPs in countries where the constraint on finance is a government commitment to a borrowing (ie. public debt) cap.

Note however that the issue of the appropriate accounting treatment for the long-term commitments associated with PPPs has generated a lot of discussion in some countries (eg. United Kingdom). There has been a call for the long-term payment stream to be disclosed in government accounts so as to provide an accurate picture of the actual public sector funding position. Further background information on the accounting treatment of PPPs is available in Phase 4 of the PPP Process module.

Higher efficiency in the private sector
A well designed and managed PPP should take advantage of the potential for efficiency gains from using the private sector.

Increased efficiency is driven by three features of well designed PPPs:

• The allocation of risk and the associated performance rewards and penalties create incentives in the PPP contract that encourage the private partner to achieve efficiency at each stage of the project and to introduce efficiency improvements where possible. By shifting risk onto private partners the public sector is able to limit its own exposure to cost escalation.
• PPPs can be structured so as to create a whole-of-life focus in which the private partner designs the project to take account of the link between construction and operation so that the cost will be minimised over the project’s lifetime. A private partner who in addition to designing and building the project will also provide the ongoing operations and maintenance management has an incentive to ensure that the design and construction facilitate efficient O&M. By contrast, if one set of contractors is employed for design and construction and other unrelated contractors for O&M they will each take a narrow perspective, considering only the point efficiencies in their component and not taking account of the interactions between the two.
• Competition is introduced during the bidding stage, thereby bringing the benefits of market procurement (this is a kind of “competition for the market”). As long as the project is well specified in terms of the output requirements (rather than specifying the inputs) then each private sector bidder has an incentive to produce an innovative response and to minimise cost.

Increased transparency in the use of funds
The key to increased transparency and reducing opportunities for corrupt practices is the release of information to the public domain, for use in the media and by interested and concerned individuals, NGOs, and the private sector participants themselves.
A well-designed PPP process can bring procurement out from behind closed doors. The PPP tender and award process should be based on open competitive bidding following international best practice procedures.

A PPP policy framework usually includes the creation of an oversight agency such as the PPP Cells already created at the Centre and in many States in India. These agencies often have an MIS role and can help improve the transparency of PPP procurement.

Complexities in PPPs

A PPP is not a panacea for all the public sector’s funding and infrastructure problems and PPPs are not always the most appropriate procurement option. The following are noted complexities in PPPs. Most of these can be minimised under certain circumstances and through careful management of the PPP design by the Sponsoring Authority. This requires public sector capacity (experience and expertise) to manage the PPP process.

Complex procurement process with associated high transaction costs
The PPP project must be clearly specified, including allocation of risk and clear statement of the service output requirements. The long-term nature of PPP contracts requires greater consideration and specification of contingencies in advance.

The tendering and negotiation process is a costly exercise. Transactions advisors and legal experts will typically be required.

Contract uncertainties
PPPs often cover a long-term period of service provision (eg. 15-30 years, or life of the asset). Any agreement covering such a long period into the future is naturally subject to uncertainty. If the requirements of the public sponsor or the conditions facing the private sector change during the lifetime of the PPP the contract may need to be modified to reflect the changes. This can entail large costs to the public sector and the benefit of competitive tendering to determine these costs is usually not available.

This issue can be mitigated by selecting relatively stable projects as PPPs and by specifying in the original contract terms how future contract variations will be handled and priced.

See the National Audit Office report on making operational changes to PFI contracts in the UK for examples of the types of changes experienced in PPPs there and for suggestions on how changes can be implemented cost-effectively and quickly.

The Suitability Filter, which is one of the tools included with this toolkit, includes a question on how easily measurable and definable the project outputs are. Projects with precisely measured and defined outputs are less likely to run into contract disputes.

Enforcement and monitoring
Once it enters the construction and operation phases, the success of the PPP from the public perspective will depend on the ability of the sponsor to monitor performance against standards and to enforce the terms of the contract.

Phase 4 of Module 2: PPP Process Guide covers contract enforcement and monitoring.

Difficulty in demonstrating value for money in advance
Ideally, a project should be procured as a PPP on the basis of a clear demonstration that it provides value for money (VFM) compared with public sector procurement. However, it is difficult to demonstrate VFM in advance due to uncertainties in predicting what will happen over the life of the project and due to a lack of information about comparable previous projects.

However, the standard for VFM is different in India to more economically developed countries such as Australia or the UK. In those countries there is a much smaller funding need. In India, many projects procured in the public sector, experience time and cost  overruns, and hence it is likely that well-managed private procurements will deliver savings. Furthermore, the funding gap is far greater than the Public Sponsor can meet by itself. In this case, it  may sometimes not be a question of public vs. private procurement, but rather the choice between private procurement or none at all. If this is the case then the focus should be on making a careful assessment of alternative project options to be sure that the projects that are selected are the best ones economically and financially.