Debt and deficit treatment of PPPs by Eurostat

In challenging times for public finances, the national debt and deficit treatment of a PPP is always likely to be a critical issue from the perspectives of the public contracting authority and government. The reason for this is that, given the economic convergence criteria in the Stability and Growth Pact 8 and the mandatory requirements of the Excessive Deficit Procedure, EU governments are concerned that they may be prevented from going ahead with an economically worthwhile PPP because of its 'debt and deficit' treatment.

Eurostat requires that the debt and deficit treatment follows the requirements of the European System of Accounts (ESA95), which is mandated by a Council Regulation. <13>

Eurostat has issued several interpretations of ESA95, including a Manual on Government Deficit and Debt (MGDD). <14>

For the purposes of recording PPPs, ESA 95 requires national statisticians to look at the balance of risk and reward in the underlying PPP arrangement. Such balance is judged by analysing the allocation of two key risk categories: construction risks and market risks (i.e. availability and demand) between government and the private sector (the PPP company):

□  Construction risk covers events related to the construction and completion of the PPP asset(s). In practice, it is related to events such as late delivery, non-compliance with specified standards, significant additional costs, technical deficiency, and external negative effects (including environmental risk) which trigger compensation payments to third parties;

□  Availability risk covers situations where, during the PPP operational phase, underperformance resulting from the state of asset results in services being partial or wholly unavailable, or where these services fail to meet the quality standards specified in the PPP contract;

□   Demand risk relates to the variability of demand (higher or lower than expected when the PPP contract was signed) irrespective of the performance of the PPP company. Such a change in demand should be the consequence of factors such as the business cycle, new market trends, a change in final users' preferences, or technological obsolescence. This is part of the usual "economic risk" borne by private businesses in a market economy (see Box 3 Traffic revenue risk allocation).

Table 2 illustrates the combinations of risk allocation between government and private sector (the PPP company) which result in the PPP being classified "on" or "off" the government's balance sheet.

Table 2. Accounting treatment of a PPP according to ESA95 rules

Thus, the conclusions from Table 2 are:

□  If the government bears the construction risk, the PPP will always be on the government's balance sheet irrespective of the allocation of the demand and availability risks.

□  If the private partner bears the construction risk, the PPP will be classified off the government's balance sheet unless the government bears both demand and availability risk.

Thus, it is important for the public contracting authority and its advisers to be aware that the risk allocation which they agree to in the PPP contract can have a direct influence on the treatment of the PPP arrangement for the purpose of its impact on the national debt and deficit.

In addition to the key risks in Table 2, Eurostat also takes into consideration other ways through which governments get involved in PPP arrangements. Again, where such ways influence risk allocation, they may affect the debt and deficit treatment of PPPs. Ways in which a government may become involved in PPP arrangements include: government financing, government guarantees, and contract termination clauses which involve financial compensation by the government.  The impact on the treatment of PPPs of such government financial involvement depends on a careful interpretation of several features including the transfer of risks and rewards that takes place and the degree of government control over the underlying PPP asset. <15>

In case of doubts regarding the appropriate statistical treatment for a PPP arrangement, a Member State statistical authority can request advice from Eurostat on a past (ex post) or future (ex ante) PPP project. Eurostat has established specific administrative rules for the provision of ex-ante advice. <16>



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8 A criterion is that the ratio of government deficit to gross domestic product must not exceed 3% and the ratio of government debt to gross domestic product must not exceed 60%. See http://europa.eu/scadplus/glossary/convergence criteria en.htm .