Infrastructure projects have long gestation periods, and often are not financially viable on their own. A feasibility study may reveal that a project is not commercially viable or attractive to private investors but is economically and socially desirable from long-term considerations. In such a situation, various options can be considered for improving the project's commercial viability and attractiveness. These options may include government intervention of various types and provision of incentives or subsidies. Government support is also well justified when a project can generate substantial external benefits, which cannot be captured or priced by the project operator. Social welfare is improved by undertaking such projects with government support.
Government support may also be needed considering a fundamental problem in infrastructure financing that arises due to a mismatch between the shorter duration of market valuation time compared with the long life of many infrastructure assets.
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. Subject to provisions in the government's PPP policy framework or in legal and regulatory framework, the commonly available government support includes:
• Land acquisition
• Capital grant and other forms of financial support
• Revenue guarantee
• Foreign exchange risk
• Tax incentives
• Protection against reduction of tariffs or shortening of concession period
• Loan guarantee
• Relief in certain Force Majeure events
• Equity participation
• Performance guarantee
These are discussed below.
Land acquisition: Land acquisition is a typical problem in most developing countries. 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 ensure that minimum amount of land is required and also consider the use of public lands for infrastructure projects when such lands are available. If necessary, the government may also acquire 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 the financial close.
Capital grant and other forms of financial support: A capital grant, one-time or deferred, may be considered by the government. The government may also consider other forms of financial support. 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. The 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 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 by most 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 qualify for various tax incentives offered by the government. These incentives may include:
• Exemption from registration tax on the acquisition of real estate;
• Exemption from, or application of a lower rate of value added tax for infrastructure facilities or construction of those facilities;
• 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; and
• Exemption of capital equipment from import taxes and duties.
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.
Loan guarantee: A loan guarantee is an assurance to a lender providing credit to a project company. Such a guarantee provides an assurance that, if a borrower defaults, the government will repay the amount guaranteed, subject to the terms and conditions of the 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 available. However, it is important to mention here that full guarantee by government reduces the incentives for the private operator to manage the project risks.
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 for the government and may significantly affect its fiscal framework. Further discussion on this issue is provided in the next section.
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 or contract 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 is not available. Equity participation helps to achieve a more favourable debt-equity ratio necessary to keep the debt service obligations manageable, particularly in the initial years of project operation. It may give comfort to debt financiers and consequently the cost of lending could be lower. Equity participation by the government is also helpful in securing public support for politically sensitive projects and projects that are of strategic importance.
Performance guarantee: The main purpose of the types of support discussed so far is to make projects commercially viable. However, the government may also consider other forms of support 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 the governments such as acquisition without adequate compensation. The performance guarantees relate to the honouring of the commitments of the contracting authority, as provided for in the contract agreement, by the government.
The Implications for any government support, particularly liabilities on the government (direct and indirect) need to be carefully assessed before agreeing to any such support.