The availability of government support, either direct or indirect, is among the most important elements in the financial structuring of a PPP project. The following paragraphs describe forms of government support authorized under the Philippine legal framework and discuss their potential implications.
The following are typical examples of direct and indirect LGU contingent support:
1. Equity participation. Equity participation may help achieve a more favorable ratio between equity and debt by supplementing the equity provided by the project sponsors, particularly where other sources of equity capital, such as an investment fund, cannot be tapped by the project company. Equity investment by the LGU may also be useful to satisfy legal requirements concerning the composition of locally established companies.
2. Output-based subsidies. The LGU may provide a project company with a defined cash subsidy in return for some targeted service output. When cash subsidies are tied in this way, they are referred to as output-based subsidies. Essentially, the project company would be required by formal agreement to provide service to a certain segment of the population, under a series of definable annual outputs, at a specified tariff. This type of subsidy is not to be confused with untargeted investment and operating subsidies. For example, a project company for a water supply project is asked to serve a rural barangay that has no capacity to fully pay for the service. The LGU signs an agreement to pay a rebate to the project company after it has installed connections to the agreed number of households.
3. Investment and operating subsidies. Such subsidies arise when government makes a contribution to a project's construction or operating costs without reasonably expecting to receive a return commensurate with the size of the contribution and risk taken. Investment subsidies are used to increase the project's financial internal rate of return and usually take the form of upfront grants. Operating subsidies, in contrast, could be year-on-year support designed to create revenue for a particular project, augment its revenue, or ensure a revenue stream:
a. Revenue deficiency guarantees ensure that the project has a minimum level of revenue, comprised of the revenues generated by the project and the operating subsidies made available through government. The total of these two revenue streams is usually enough to cover debt service and a negotiated profit element. Although this is beneficial for the project, revenue deficiency guarantees create problems for government as the level of subsidies required each year over the project life is not predictable;
b. Design-build-lease (DBL) arrangements, as referred to in some countries, have a different structure. In this case government designs and builds the project at its own expense. Upon commissioning, the project is tendered and concession is given to the private sector company willing to make the highest lease payments to government in return for the rights to operate and maintain the project. This structure is used for projects that have high levels of market risk.
c. Annuities constitute another method of tendering out projects. The LGU declares it is willing to award a concession to build and operate, for example, a solid waste landfill project to the bidder asking for the lowest annuity payments, measured on a discounted cash flow basis. This structure is also used for projects that have high levels of market risk.
4. Guarantees of performance by the LGU. The most common situations in which such guarantees are used are for take or pay agreements, where the LGU may be the sole buyer of the service.
5. Protection from competition. An additional form of support may consist of assurances that no competing infrastructure project will be developed for a certain period by the LGU or by another concessionaire. Assurances of this sort serve as a guarantee that the exclusivity rights that may be granted to the concessionaire will not be nullified during the life of the project.
6. Ancillary revenue sources. One additional form of support to the execution of PPP projects may be to allow the project company to diversify its investment through additional concessions for the provision of ancillary services or the exploitation of other activities. In some cases, alternative sources of revenue may also be used as a subsidy to the project company for the purpose of pursuing a policy of low or controlled prices for the main service. Provided that the ancillary activities are sufficiently profitable, they may enhance the financial viability of a project.