The viability of PPP projects is a key question in the minds of top policy makers. Access to additional resources for the implementation of much needed infrastructure projects remains to be the chief reason behind going for PPPs. As mentioned earlier, the public sector’s other advantages lie in the relief from bearing the costs of design and construction, the transfer of certain risks to the private sector and the promise of better project design, construction and operation.
| However, lack of funding from the traditional sources and relief of the public sector from bearing certain costs, or interest of the private sector should not be the sole criteria in considering implementation of an infrastructure project through the PPP mechanism. There are additional costs of having recourse to the private sector - usually the cost of borrowing money is higher for the private sector than for the public sector and there are administrative costs for the management of PPP contractual regimes. Transaction costs23 of PPP projects can also be substantial. It may take a long time to make a PPP project deal which has consequences on overall project costs. | Lack of funding or interest of the private sector should not be the sole criteria |
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In view of these, the business case for a project needs to be established before a decision is taken to implement it as a PPP project. Costs under different implementation arrangements, from direct public procurement to alternative PPP models, should be explored. A project should be examined to see if its implementation as PPP project may offer any better value for money compared with a traditional public sector project. The merits of alternative PPP models should also be considered to establish the best possible implementation arrangement.
| Any PPP project should be subject to full social cost- benefit analysis through a proper feasibility study to ensure its public as well as private benefits. Such an analysis can also provide an essential input to the political decision making process which can then become more transparent. The traditional evaluation criteria such as internal rate of return (IRR) and net present value (NPV) may be used to assess the economic justification of a project. | The need for the project should be established |
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A financial assessment with due consideration of the appropriate costs of capital 24 should also be undertaken to ensure commercial viability of a project.25 Such economic and financial analyses are undertaken to establish the need (of the project), and to provide the basis for public sector’s participation in financing (through equity participation, loans or incentives with fiscal or financial implications for the government). It is also desirable to consider a social goals achievement matrix to consider separately the likely social and political concerns of a PPP project.
Another important merit of assessing the viability of a project through a proper feasibility study is that it helps to make proper allocation of risks between the public and private sectors, which is an important element in establishing the business case for a PPP project. Sometimes, there may be a tendency to avoid any rigorous feasibility study when liberal government support may be available. As in such a situation it is convenient to structure the project debt around the guarantee, which basically turns the project risks into government risks.
All cost calculations for a project should be based on life cycle costs. Consideration of life cycle costs is also necessary to establish the business case for a project. Such costs may include:
• Capital expenditure directly by the implementing agency and all other parties
• Operational costs
• Life cycle maintenance and refurbishment costs
• Cost of any necessary associated infrastructure (for example, access or physical integration infrastructure for an urban transport project and new utility lines)
| Theoretically, a PPP project is favoured only when its generated benefits exceed the total cost including the additional costs discussed above. To ensure this, government regulations guiding PPP schemes may establish some value for money or public sector comparator criterion. For example, in the United Kingdom and in the State of Victoria in Australia (see box 5) the net present value of the project as a PPP scheme is compared with its value if implemented by the public sector. A project is implemented through the PPP modality only when it proves to give a superior value for money as a private project compared with its value as a public sector project. | How to judge the merit of private involvement |
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There are, however, many problems in applying the PSC concept ranging from methodological issues to various practical limitations involving the concept. Some of the major problems include lack of consensus on discount rate, high costs of financial modelling, omitted risks, lack of realistic data for meaningful comparison of implementation by the public sector, and non-existence of a public sector alternative. In view of these serious limitations of PSC, it may not be always a feasible proposition to apply the concept in developing countries.
| Box 5. Public sector comparator (PSC)
The PSC is based on the most efficient public sector method of providing the defined output; takes full account of the costs and risks which would be encountered in that style of procurement; and is expressed in terms of the net present cost to Government of providing the output under a public procurement, using a discounted cash flow analysis which adjusts the future value of expected cash flows to a common reference date. This enables comparison with bids and makes allowances for the imputed cost to Government of obtaining capital for a public procurement. The primary purpose of the PSC is to provide a quantitative benchmark against which to judge value for money of PPP bids, not to establish what level of service charges may be affordable to Government under a contract for services. The PSC has four core components: • Raw PSC. This is the base cost of delivering the services specified in the Project Brief under the public procurement method where the underlying asset or service is owned by the public sector; • Competitive Neutrality. This removes any net advantages (or disadvantages) that accrue to a government business by virtue of its public ownership; • Transferable Risk. The value of those risks which Government would bear under a public procurement but is likely to allocate to the private sector is added to the PSC to reflect the full costs of public procurement; and • Retained Risk. The value of those risks that are likely to be retained by Government is added to each private sector bid, to provide a true basis for comparison. Source: <http://rru.worldbank.org/Documents/PapersLinks/PVGuidanceMaterial_Overview.pdf> |
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23 See footnote 7 for explanation.
24 See chapter IV for discussion on cost of capital.
25 Both the economic and financial analyses use an identical format to account for all relevant costs and benefits of a project (or revenues) year by year. One of the major differences between these analyses is in the identification and valuation of the cost and benefit items. While the economic analysis considers all costs and benefits (including externals costs and benefits) to the economy as a whole and valued at their economic prices, the financial analysis considers only those costs and benefits that are internal to the project and are valued at their market prices. Both the analyses apply the discounting technique to find the present values of all future costs and benefits. This is done to reflect the time value of money or resources.
The IRR is the discount rate, which, when applied to the yearly stream of costs and benefits of a project, produces a zero net present value. A project is considered economically viable when its IRR is greater than a pre-determined cut-off rate (which is the opportunity cost of capital for that country).