Depending on the sector, the country and the risks specific to the project, a project may not be feasible or acceptable to the sponsors and the lenders without some financial commitment to the project from the government.
A government may decide to provide financial support to a project where the project "passes" a social cost-benefit analysis, but the private sector is not in a position to capture sufficient benefits to make the project financially viable.
The government's financial contribution to the project may take several forms:
• Direct equity investment. The government may be a shareholder in the project company. This allows the government to be in a better position to control and monitor the project through its equity in the project company (though the shareholders agreement and the constitutional documents of the project company will need to ensure this). In addition, the project company may benefit from the government's support and assistance in the implementation of the project, for example obtaining necessary regulatory clearances. A properly drafted concession agreement, however, could achieve the objectives of giving the government some control of the project and of ensuring that the project receives the necessary government assistance. An equity investment in the project company does not necessarily signal to private investors the government's commitment in the project. A direct equity investment can make a project vulnerable to "political interference" that tends to discourages private sector involvement.
• Direct loan. The government may provide a loan to the project company, although this is relatively unusual. An example of this is the Sydney Harbour Tunnel project where the government provided an interest free loan of AUD$223 million over a 30 year period.16
• Stand-by loan. The government may provide "stand-by" loans, which will be provided if certain events occur.
• Guarantee. The government may provide different forms of financial guarantees to the lenders or sponsors of the project as a pre-condition to the lender or sponsor providing the finance. A common form is a guarantee of operating revenue arising from the project. This usually occurs in the context of the electricity sector, where the government will enter into contracts with the private producer of electricity to purchase electricity on a "take or pay" basis.
• Subsidies. Where tariffs are regulated, the government may offer subsidies to cover the difference to the project company of the full commercial price and the actual user charges.
Except for direct equity investment, the government's financial commitment does not require an up front financial contribution and is sometimes contingent upon certain specified events occurring (for example, failure of toll road demand to meet the forecast). This means that the lenders and the sponsors will look at the credit rating of a particular government in to assess what reliance can be placed on such financial commitment.
__________________________________________________________________________
16 Ibid 67; Ralph Harris (Auditor General's report), Private Participation in the Provision of Public Infrastructure: The Roads and Traffic Industry, 17 October 1994.