| The financial viability of PPP projects is of great concern to the government. If a project is not found commercially/financially viable, then its economic evaluation can be reviewed to determine whether the investment is justified from the standpoint of the economy. If a PPP project is not financially viable but found to have high economic internal rate of return (EIRR), various options can be considered for improving the project’s financial rate of return, which may include government intervention of various types and provision of incentives or subsidies. It may be noted here that any significant difference between financial and economic internal rate of returns of a project arises primarily due to existence of a large size of uncaptured external benefits of the project to third parties. Government intervention and provision of incentives for such projects are justified on the ground that they correct market failure in addressing this problem. Social welfare is improved by undertaking such projects with government support. | Why government support may be needed |
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Without government support, implementation of commercially unviable projects is not possible. Government support may also be crucial in the early years of PPP development in a country or in an untested PPP market. Without sufficient government support, the private sector may not take much interest in such situations.
Many Governments have established policies and formal mechanisms for providing support to such PPP projects under the provisions of their PPP laws (for example in the PPPI Act of the Republic of Korea). The main types of supports and incentives considered by governments may include:
| • Land acquisition • Capital grant and other forms of financial support | Forms of government support and incentives |
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| • Revenue guarantee • Foreign exchange risk • Tax incentives • Protection against reduction of tariffs or shortening of concession period • Loan guarantee (also discussed in a previous section of this chapter) • Force majeure • Equity participation • Performance guarantee |
Land acquisition. Any delay or problems in land acquisition could be a major source of risk to investors, particularly for road and rail projects and other projects that require large tracts of land. In order to remove the uncertainties in land acquisition, the government may consider the use of public lands for infrastructure projects when such lands are available. If necessary, the government may also acquire the private land for a project on behalf of the investor. In situations where the investor is required to negotiate with the owners for the purchase of land, the government can also assist the investor through its use of the right of eminent domain. The land acquisition issue should be settled before bids are invited.
Capital grant and other forms of financial support. A capital grant, one-time or deferred, may be considered by the government with the objective of making a project commercially viable. The government may also consider other forms of financial support to make projects commercially viable. These may include interest free or low interest loans, subordinated loans, operation and maintenance support grants, and interest subsidies. A mix of capital and revenue support may also be considered.
Revenue guarantee. For high-risk projects, the government may consider to provide revenue guarantees. The government can guarantee up to a certain specified percentage of the projected revenues. Where these guarantees are provided, governments normally also limit the maximum amount of revenues that the project developer can retain. Any amount in excess of this defined maximum limit is taken by the government. Revenue guarantee, however, has a major drawback. When such a guarantee is available debt can be structured around it and may practically mean transferring of commercial risks to the government. In such a case, the private operator may also lose interest in increasing its internal efficiency.
Foreign exchange risk. One of the serious concerns in the minds of investors relates to foreign exchange risk. The revenues generated from the services provided by infrastructure projects are primarily in local currency. But a large part of debt servicing and other payments are often made in a foreign currency. The government may undertake measures to limit the investor’s risk from foreign exchange fluctuations. Where foreign exchange fluctuations exceed a certain defined limit (say, 20 per cent), a part of losses due to such fluctuations may be offset through modifications of tariff rates, government subsidies, adjustment of the concession period or other provisions.
Tax incentives. PPP projects may also qualify for various tax incentives offered by the government. These include:
• Exemption from registration tax on the acquisition of real estate for BOT projects
• Exemption from, or application of a lower rate of value added tax for infrastructure facilities or construction of those facilities supplied to the State or local governments as BTO and BOT projects
• Reduction of or exemption from various appropriation charges
• Recognition of a certain percentage of the investment as a reserve to be treated as an expense for the purpose of computing corporate taxes
• Allowing the project company to issue infrastructure bonds at a concessional tax rate on interest earned
Protection against reduction of tariffs or shortening of concession period. Another incentive is protection from a reduction of tariffs or the concession period if the project developer is able to reduce construction costs below those estimated in the agreement. In fact, such a provision provides an incentive for early completion of a project. However, this implies that there would be no adjustment if construction costs exceed the original estimate. This would be a disincentive to delay completion of a project.
| Box 6. Incentives for private sector participation in the road sector in India The Government of India has taken a number of administrative, legal and fiscal measures to promote public-private partnerships in the road sector. The model concession agreement has been made investor friendly through more equitable allocation of risks and provision of incentives in the form of grants and other measures. The main incentives include: • Government bears expenses for land acquisition and pre-construction activities; • Foreign direct investment up to 100 per cent; • Capital subsidy up to 40 per cent to meet the viability of a project; • Government equity up to 30 per cent; • 100 per cent tax exemption in any consecutive 10 years; • Duty-free import of road construction equipment; • Bond exempted from capital gains tax; • Tax benefits for property development activities; • Transparent and well defined procurement procedure; • Equitable dispute resolution mechanism. | |
| Source: | A.P. Bahadur, “Financing national highways in India”, paper presented at the Expert Group Meeting on the Development of the Asian Highway Network: Regional Experiences and Lessons in Financing Highway |
Loan guarantee. A loan guarantee is a guarantee to a lender providing credit to a project company that, if a borrower defaults, the government will repay the amount guaranteed, subject to the terms and conditions of an agreement. As the guarantee reduces the lender’s risk, the borrower should be able to obtain funds at a lower interest rate or negotiate a loan that might not otherwise be obtainable.
As loan guarantees do not involve immediate cash spending by the government, they can be a more attractive tool to the government than direct loans or grants, particularly in periods of fiscal restraint. However, they can generate sizable financial obligations and significantly affect the government’s fiscal framework.
Force majeure. The government may consider buyout of a project in cases of prolonged force majeure. Government buyouts may also apply in certain extraordinary circumstances as may be provided for in the concession agreement.
| Equity participation. The government may also consider direct or indirect equity participation in a project to assure government support for its implementation and operation. Equity participation helps in many ways. It may be a vital source to supplement equity provided by project sponsors, particularly when equity capital from investment funds or other sources are not available. Equity participation helps to achieve a more favourable debt-equity ratio necessary to keep the debt service obligations manageable in the initial years of project operation (see discussions in the next chapter). It may give comfort to debt financiers and consequently the cost of lending could be lower. Equity participation by government is also helpful in securing public support for politically sensitive projects and projects that are of strategic importance. | How equity participation of government helps |
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| Performance guarantee. The main purpose of the supports discussed so far in this section is to make projects commercially viable. However, the government may also consider other forms of supports for PPP projects to attract private investment and enhance investors’ confidence. An important one among such supports is sovereign guarantees. These guarantees include performance guarantees, and guarantees against adverse acts of governments such as acquisition without adequate compensation. The performance guarantees relate to honour of the commitments of the contracting authority, as provided for in the contract agreement, by the government. | Performance guarantee |
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