Managing fiscal commitments under PPPs poses several challenges. Fiscal commitments which are long term-extending over the lifetime of the PPP contract-often do not start until several years after contract signing. Payments for contingent liabilities are by definition uncertain, and they can arise suddenly and unexpectedly when a trigger event transpires. By contrast, most government budgets are cash based, with a relatively short planning horizon (for example, a -three- or four-year Medium Term Expenditure Framework) and follow a process designed to be relatively inflexible to "in-year" changes.6
Because of these challenges, governments can be tempted to undertake PPPs for the "wrong" reasons. If fiscal commitments are not clearly acknowledged and managed, PPPs may be pursued simply to postpone the budget impact of public investment, and to move the associated debt off the government balance sheet in a way that does not take into account the longer-term implications for public finances. This approach can undermine the possible advantages of PPPs and increase the risk of accumulating significant fiscal exposure in the future.
PPPs may help identify but also may hide true costs of infrastructure projects. Assessing PPP fiscal commitments is critical for good project selection and prioritization. Contrary to traditional procurement-in which a government agency can start implementing a project based on an undervalued budget, creating significant sunk costs before the real cost of the project emerges-PPP procurement requires bidders to do a whole-life costing of the project before committing to the project's implementation. Thus, governments can use PPP procurement to help uncover real project costs before contract close. But PPPs may also be used as a convenient way to hide costs, presenting them as contingent liabilities (explicit or implicit). Such hidden costs can bias project selection and project prioritization, and they can also jeopardize long-term fiscal sustainability. PPPs should instead be undertaken in cases that can be expected to lead to better value-for-money compared to the public project.
Proper assessment of PPP fiscal risks is also relevant to ensure effective competitive procurement practices. When fiscal risks are not clearly identified and addressed by the government, bidders may expect to obtain rents from the government during the construction or operational phases through anticipated renegotiation after being awarded the contract (with no competitive pressure by then). Therefore, bidding behavior may be influenced, with some firms betting on their ability to influence future government decisions-bidders with poor ethical standards will benefit from formal competitive procedures, not necessarily the most efficient firms. In that case, the utmost competitive and transparent procurement process will not solve the issue; formal competitive rules will not translate into effective competition (in the sense of survival of the best), but rather into gaming behavior.
Budgeting appropriately for PPP fiscal commitments is important for the reputation of a PPP program. Providing a clear budgeting mechanism to ensure timely payment of both direct and contingent commitments to PPPs improves the credibility of the government's commitments in the eyes of its private partners. If this is not the case and the private party perceives a risk that payments will not be made when due, the cost of this risk will be priced into the PPP contract accordingly and the advantages of a well-designed risk allocation undermined. Systematic budgeting and payment are best done as part of the overall framework in government for managing all PPPs rather than only on a project-by-project basis.
In the absence of a proper assessment of traditional (non-PPP) procurement projects, several anti-PPP biases may dominate. Adequate assessment of and reporting on PPP fiscal commitments help eliminate a few pro-PPP biases, reducing the incentive for shifting costs to future generations and mitigating the potential threat to fiscal sustainability. However, a poor assessment of traditionally procured projects can create a bias against choosing the PPP route, reducing the effectiveness and efficiency of projects. Indeed, traditional procurement is a major source of cost overruns. In traditional procurement, the absence of concerns with long-term maintenance and operational costs can result in non-optimization of the cost of the project over its life and allows for easier strategic misrepresentation of projects through underevaluation of costs and overestimation of revenue. Therefore, a framework for proper assessment of PPP projects should not disregard the assessment of traditional procurement projects. Ideally, the assessment of traditional procurement should be part of a public investment management framework that establishes a level-playing field for the decision on using PPP or traditional procurement. (As previously noted, this note will only address the specific case of PPPs fiscal commitments and their management.)
Historic and recent experiences have demonstrated the importance of managing government fiscal support to PPPs and avoiding biased decision making between PPP and public procurement routes. In the midst of the 1997 Asian crisis, several Asian countries suffered exacerbated impacts due to PPP contingent liabilities that transformed into immediate obligations. While the banking sector was the major source of fiscal liabilities in Korea, infrastructure projects added to the fiscal stress. In Indonesia, concerns have been raised regarding the role of the Ministry of Finance, which had the chance to intervene in the development of a concession only when it was too late to propose major changes without serious disruption to the investment program. Such problems may have been more effectively addressed if the Ministry of Finance had assessed the fiscal obligations of these deals at approval.7 More recently and under the current financial and economic crisis, a number of European countries have faced the reality of the fiscal implications of their PPP projects. Portugal and Hungary have placed a moratorium on new PPPs and are reviewing existing ones. Portugal's recent crisis has been exacerbated by the fact that the government had to make large payments to PPP companies as a result of PPP contracts developed in the years before the crisis without adequate consideration of their fiscal implications. Spain is facing a sequence of PPP toll road operators going bankrupt.8
The above examples reflect instances of macroeconomic crisis which are closely correlated to the performances of PPP projects. For instance, all PPP road projects in countries affected by macroeconomic crisis (Greece, Portugal, and Spain recently, and previously Malaysia and Mexico) simultaneously suffered demand challenges (and faced bankruptcy risk) creating a systemic risk. The predictability of these events and the extent to which their impact could be mitigated through a fiscal commitment framework can be significantly different from project specific and idiosyncratic risks. A careful examination of these examples shows that several projects already suffered from microeconomic issues-low demand (including projects for which effective demand, after the ramp-up phase, stabilized at 10 percent of expected demand) or high cost (for example, cost overruns arising out of ex-ante cost under-evaluation due to strategic misrepresentation of projects in order to maximize the chances of approval). In some cases, those issues induced governments to cancel PPP projects and even PPP programs.
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6 For more on medium-term fiscal frameworks, see Jim Brumby et al (2013 forthcoming), "Medium-term Budgeting in the Public Sector," World Bank.
7 Tim Irwin and Tanya Mokdad (2009), "Managing Contingent Liabilities in PPPs: Practice in Australia, Chile, and South Africa," World Bank and PPIAF Publication; Louis Wells and Rafiq Ahmed (2006), Making Foreign Investment Safe: Property Rights and National Sovereignty, Oxford: Oxford University Press.
8 http://bankwatch.org/public-private-partnerships/background-on-ppps/build-now-pay-heavily-later; Mariana Abrantes de Sousa (2011), "Managing PPPs for budget sustainability: The case of PPPs in Portugal, from problems to solutions," PPP Lusofonia network; and http://www.claretconsult.com/spaintollroads.html