By Maurice Pedo, Ph.D
In the past few years, privatization has formed a vital part in structural reform in most emerging market and developing economies. While engaging privatization, governments seek to one, realize benefits in economic efficacy due to the ever diminishing economic performance of public institutions and second, to enhance the financial situation, especially if a government is reluctant or lacks the capacity to continue to finance deficits in the public sector.
The macroeconomic effects of privatization in emerging markets developing economies like Kenya is pegged, in part, on whether earnings are domestic or foreign in nature, capital mobility degree, and the exchange rates. Generally, the effects of an upsurge in deficit funded by privatization revenues would resemble earnings from a debt-financed fiscal expansion. Use of earnings to decrease debt from external sources provided for an automatic sterilization of what may be sizable capital inflows linked to privatization. It is worth noting that domestic liquidity is influenced by fall in domestic debt. These weaknesses in the privatization of the 1990s in developing economies therefore lead to the new concept of infrastructure financing of Public Private Partnerships (PPPs).
According to World Bank, Public Private Partnership is a contract between a public party and a private party for the development or significant upgrade or renovation and management of a public asset in which the private party bears significant portion of the finance at its own risk, and remuneration is significantly linked to performance or the demand or use of the asset or service so as to align the interests of both parties.
Public assets include public works are subject or dedicated to public use, or concomitant to the provision of a public service. Public assets are often referred to as public infrastructure, using infrastructure in the broad sense, as is the type of public asset being normally procured under a PPP. The Oxford English Dictionary defines infrastructure as “The basic physical and organizational structures and facilities, for example, buildings, roads and power supplies needed for the operation of a society or enterprise”.
There are three basic motives for PPPs and infrastructure finance. The first and the one that is discussed most often is to tap private capital markets to finance badly needed investments and infrastructure. A second motive, which is often not acknowledged but is often important, is the transfer of resources in a way such as always to remove immediate budget issues of government. And the third motive is to incentivize real efficiency gains. Real efficiency gains are transformations that allow for production of more reliable or better outputs for the same inputs. And they are distinct from transfers, which just involve the transfer of resources from one party to another without necessarily making their use more efficient.
The above motives tend to be associated with three different types of PPPs. The first is a concession to build, operate, maintain and transfer a new facility, such as a new toll road or a new wastewater treatment plant. In the case of these types of PPPs, the more primary motive is to tap private capital markets to gain funds needed for the investment, although, efficiency gains and transfers may be involved as well.
As per the World Bank’s APMG Guide, there is often confusion between privatization and PPPs. There is however a clear difference between these two forms of private sector engagement. In its true sense, privatization involves the permanent transfer to the private sector of a previously publicly-owned asset and the responsibility for delivering a service to the end user. However, a PPP necessarily involves a continuing role for the public sector as a “partner” in an ongoing relationship with the private sector.
The Guide further states that confusion can arise because sometimes the term “privatization” is used more broadly; for example, to mean any form of private management. When used in this way, the term can apply to a wide range of arrangements, including PPPs. However, in its true sense under the broader sense, PPPs are not privatizations. By definition, privatization in its true sense is not an option for governments to procure new infrastructure, as privatization implies the infrastructure has already been constructed.
World over, PPPs have been useful in procuring both infrastructure and services, only and only if the PPP model is applied well. It is a better tool to deliver new or upgraded infrastructure. In this way, the greatest possible value from this procurement option can be extracted in order to help countries to fill the infrastructure gap by accessing more private capital and expertise in an efficient and programmatic manner.
Tapping private capital markets is problematic because the government can borrow from capital markets itself directly, rather than having to borrow through the medium of a concessionaire. It is important to understand that partnerships are not a form of free finance, that the investors in a concession expect to be repaid just like the investors in a government bond expect to be repaid. Moreover, they both draw from the same sources of repayment, same basic sources, which is either taxpayer receipts or the charges levied on the users of the infrastructure.
Moreover, government debt when incurred through direct borrowing, is often cheaper than when done through a concessionaire. In the United States, for example, states can borrow at 5‐6% interest rates, whereas, investors in private infrastructure typically want a return of more than the 10‐12% range. Now, this difference in borrowing rates is a little bit of an illusion, because the taxpayer doesn’t have any default risk if the borrowing is through the concessionaire, whereas, he does have default risk if the borrowing is through the government.
The second motive which involves transferring resources for the immediate relief of government budget problems is also problematic. In Emerging Market and Developing Economies, this usually takes the form of the lease or sale of a state‐owned enterprise that is losing money because it has excess labor or its tariffs are unrealistically low or its services are more extensive than is really needed. And the basic idea is that the private concessionaire will shed labor, raise prices, prune the network of services, so as to restore profitability and alleviate the budget support that the government had to provide to the enterprise. In this case, the project essentially involves transfers from users, who now have to pay more, or labor which has to find a job, to taxpayers who no longer have to support the money‐losing enterprise.
In developed countries, it has taken the form of a sale or lease of a profitable enterprise or facility in return for an upfront payment from the concessionaire that can be used to meet immediate budget needs. In the United States, this is called asset monetization, and in Australia, it is called asset recycling. But either way, the essential is that it is a transfer of resources from future taxpayers who no longer have the available profits from the enterprise to current taxpayers who enjoy the upfront payment and can use it for other purposes. But if partnerships are all about transfers or only about transfers, then privatization becomes a zero sum game, in which one party gains and some other party loses. And zero sum games are politically controversial.
It is hard to build support for them. Real efficiency gains, on the other hand, are the only way that a project can become win‐win and not zero sum. So real efficiency gains are politically very important in a P3 project. Real efficiency gains come from several sources. The first of these, and often the most important, is that there’s a single person or enterprise that is responsible for both the building and the maintenance and the operation of the facility. And that means that there’s less finger pointing when something goes wrong. There is one person or one group that is held responsible.
In particular, this often takes the form of life cycle perspective so that the builder of the road or facility keeps in mind the problems of maintaining it. One dramatic example that I learned about recently was roads in the rainy area of Colombia, which typically wash out every rainy season. But when their grant is a concession to build and operate them, the concessionaire has an incentive to build them in such a way that they don’t have to be rebuilt every time the rain falls. A second source of efficiency gains is that you provide the concessionaire with more scope to decide how to produce the services themselves. In essence, you can think of it as they’re contracting for a stream of services rather than a specific asset. And giving that flexibility gives them an opportunity to be more efficient.
My favorite example is the Port of Miami Tunnel, which the public sector had estimated would cost at a billion USD to build. But when it was performed as a P3, the design was altered to cost only USD 600 million to build. This was done by altering the orientation of the tunnel slightly thus avoiding some difficulties. What was helpful was that the Port of Miami was buying not a specific asset, but a tunnel crossing. That flexibility allowed the concessionaire to search for more efficient methodology and designs.
In this light, greenfield concessions are more attractive than brownfield concessions, because in greenfield concessions, there’s more scope for efficiency gain in as much as the concessionaire does the construction as well as the maintenance. But the real reason to use expensive private capital in concessions or in PPPs is to motivate and incentivize these real efficiency gains. If the concessionaire has some skin in the game, then it’s going to try hard to build a road that doesn’t wash out in the rainy season; to build a tunnel that is cheaper and just as good. We may pay a little extra for that private capital, but without it, you would not get the efficiency gains that are important and would not get the value that you hope for out of the private sector.
The financial rationale for the Government in considering PPPs is underpinned in the aspects of budgetary constraints where public demands are exceeding public resources, need to accelerate the creation and provision of infrastructure projects and need to leverage Government resources. The benefits the Government will accrue from concentration of PPPs are improved quality of public services and technology anchored on output based performance, regular maintenance that focuses on life cycle costing, value for money incentives project selection and opportunity for technology knowledge transfer to Government staff.
Furthermore, increased operational efficiency and innovation is very key since it results into accelerated project development, on-time and on-budget delivery, risk borne by party best equipped to handle it, access to best practices, private expertise, innovation and technology.
To mitigate fiscal constraints , PPPs support the Government to mobilize finance , create better fund-raising capabilities, reduce budget inefficiencies, reduce subsidies , focus on commercial efficiency and encourage off- balance sheet financing.
In conclusion PPP Projects in Kenya should aim for projects where there are real efficiency gains, where there are good reasons to believe that the private sector can do it cheaper or better or more reliably than traditional public procurement. Furthermore, the Government should shy away from projects which involve mainly transfers, because they are going to be politically controversial and difficult to manage.
The writer is a Financial Management Specialist with the National Treasury (firstname.lastname@example.org)