Governments' contributions to the "partnership" of PPPs always create different types of fiscal commitments. PPP contracts have financial implications and always pose fiscal risks for governments that need to be monitored and managed effectively.3 In the case of direct liabilities, the need for payment commitments is known, even though there may be some uncertainty about the exact value of the payments. Examples of direct liabilities include upfront "viability gap" payments, in which the government makes a capital contribution to ensure a project that is economically desirable but not commercially viable can proceed; availability payments in which a regular payment over the life of the project is conditional on the availability of the service or asset; and output-based payments or payments made per unit of service. For contingent liabilities, payment depends on some uncertain future event outside the control of the government-so the occurrence, value, and timing of a payment may all be unknown. Contingent liabilities include guarantees on particular risk variables such as exchange rate, inflation, prices, and traffic, force majeure, termination payments, and credit guarantees, among others.
The nature and extent of fiscal commitments that governments bear depend on the actual PPP projects they are supporting, as well as broader market conditions. In the 2008 global financial crisis, governments found that new forms of support may be needed-under which the government bears more risk-to enable PPP deals to close. A recent note on the European Union's PPP market outlines two main avenues being explored by several countries after the crisis: sovereign guarantees applied to project debt or project bonds, and co-lending by the government. Examples of recent developments include: sharing interest rate risk in the Republic of Korea; loan guarantee facilities in France and Portugal; facilities for direct loans to PPPs in France and the United Kingdom; and re-financing risk in Australia.4 Providing government guarantees as PPP support instruments is not a new phenomenon and has been used since the 1980s in Latin America and East Asia.
In addition to the explicit fiscal commitments that governments bear under PPPs and that are defined in contracts, these projects also give rise to implicit liabilities. Non-contractual obligations that arise from moral obligations or public expectations are considered implicit liabilities. For example, governments may take on a payment obligation despite the absence of a legal commitment to do so when a project is considered too politically and socially sensitive to fail (and lead to service interruptions). A "Comfort Letter" from a minister or other high-level public official to support a PPP project proposal is often seen by some creditors and investors as equivalent to a sovereign or sub-sovereign guarantee (even if it is in reality an implicit contingent liability of the central government). Another form of implicit liability arises from the long duration of PPP contracts (20 to 30 years or more): over this period unexpected issues almost always arise that can lead to contract adjustments or even renegotiations, which can create additional fiscal costs. Contract termination (normal or early termination) usually creates implicit liabilities-besides compensating the project company (or lenders) according to contractual rules, public authorities will need to safeguard the continuous provision of public service, or to decommission facilities (that is, terminating public service and using the facilities for other purposes, or demolishing them). Governments should recognize that PPP contracts always embed implicit fiscal commitments; even when government decides not to rescue the project company, public authorities are expected to rescue the project. The extent of implicit risks embedded in a PPP structure, the incentives they generate on the operational behavior of the PPP project, and the government's ability to manage these risks, are criteria that should be taken into account when deciding to develop a project as a PPP and design its contractual arrangements accordingly. As a long term project, a PPP will be (positively and negatively) impacted by exogenous change-technological, demographic, and commercial - but also by government action or inaction, for example, by changes in public policy and poor execution of government obligations. The government needs to manage the risks that it imposes on PPP projects.
The "upstream" due diligence on PPP selection and design are some of the most important determinants of a PPP's fiscal implications. If the underlying project does not make sense in terms of national policy, socioeconomic cost-benefit analysis, or the improved public service delivery it aims to achieve on the basis of minimum acceptable service standards, or if the PPP is not structured in a way that will achieve value-for-money, then a PPP cannot be fiscally responsible even if its cost is well understood and managed. The primary consideration for embarking on a PPP should be improved public service delivery rather than financial cost minimization. It has been suggested that the post-Asian crisis realization of PPP-related contingent liabilities largely resulted from inadequate project design and poor investment decisions.5
Lack of proper economic analysis of PPP projects may create fiscal shocks. PPP projects should be subjected to a sound evaluation of costs and benefits incurred by all agents in the society, including risks. Even after considering risk, the benefits should outweigh the costs. Without such evaluation, the sustainability and credibility of a PPP program risks being affected by fiscal surprises, particularly by ones that should have been identified ex-ante as relevant project risks.
These decisions-choosing a particular project, deciding to do that project as a PPP, and deciding how that PPP is structured (including allocating risks and responsibilities and defining payment mechanisms)-are also central elements of the PPP development process. For the purposes of this note, the structure of a proposed PPP is assumed to have been developed following these upstream analyses. This note focuses primarily on the "downstream" assessment and management of the fiscal implications of a PPP, once these key decisions have been made.
_________________________________________________________________________
3 For instance, Chile's financial obligations to concessionaires in future years have an estimated present value of $3.4 billion. Most of the future payment obligations relate to subsidies and agreements to purchase services in concessions with no user fees. The estimated present value of revenue guarantees is lower, at $0.3 billion; see World Bank (2007), "Improving the Management of Concessions: Better Reporting and a New Process for Decision When to Use a Concession."
4 Philippe Burger, Justin Tyson, Izabela Karpowicz, and Maria Delgado Coelho (2009), "The Effect of the Financial Crisis on PPPs," IMF Working Paper, WP/09/144; European PPP Expertise Centre-EPEC (2011), "Risk Distribution and Balance Sheet Treatment: Practical Guide"; EPEC (2011), "State Guarantees in PPPs: A Guide to Better Evaluation, Design, Implementation and Management"; and Richard Foster (2010), "Preserving the Integrity of the PPP Model in Victoria, Australia, during the Global Financial Crisis," World Bank Institute PPP Solutions Note.
5 Hana Polackova Brixi (1998), "Government Contingent Liabilities: A Hidden Risk to Fiscal Stability," Policy Research Working Paper, World Bank; Hana Polackova Brixi and Allen Schick (2002), Government at Risk: Contingent Liabilities and Fiscal Risk, World Bank and Oxford University Press, Washington, DC and New York.