Even where a PPP is expected to generate additional resources-for example, by charging users for services-governments typically bear or share certain project risks. For example, governments may provide guarantees on particular risk factors such as demand, exchange rates, or certain costs; while PPP contracts often contain compensation clauses in case of termination of the agreement for a range of reasons.
Accepting these risks could be consistent with good risk allocation, as described in Section 3.3. However, doing so creates contingent liabilities for government-the cost of which can be harder to assess than the direct liabilities and upfront capital costs created by a traditional government investment project. As a result, governments often take on significantly more fiscal risk under PPP projects than they had expected, or than would be consistent with prudent fiscal management.
In this context, the influence of optimism bias on project decision-making (see Section 1.3.2 Poor Planning and Project Selection) can be exacerbated-for example, a government may agree to provide a demand guarantee for a project, as optimistic forecasts mean it appears to have no cost. Contracting authorities can also have an incentive to over-estimate demand in order to 'hide' the need for subsidies and push through projects that are not really viable. The cumulative impact over several PPP projects can create substantial fiscal risk. Moreover, public resources may go into projects that do not really provide value for money, since costs are higher or benefits lower than initially expected.
Irwin's book on government guarantees [#161, Chapters 2 and 3] provides examples of how guarantees have been used, in some cases creating large exposure for the government, and describes some of the reasons governments make bad decisions regarding guarantees.
In addition to the government's explicit liabilities such as guarantees, PPPs can give rise to implicit liabilities-that is, non-contractual liabilities that arise from moral obligation or public expectations for government intervention-that create further fiscal risk (see [#206]). Weak contracts and ineffective enforcement can mean that governments fail to really achieve risk transfer to the private sector. Again, this means that governments end up bearing significantly more risk than they had expected when projects were initially implemented.
Box 1.3: Excessive Fiscal Risk-Examples from Colombia, Korea, Mexico, United Kingdom provides examples of PPPs for which the government ended up making large, unexpected payments, either as a result of called guarantees or realization of implicit liabilities
| Box 1.3: Excessive Fiscal Risk-Examples from Colombia, Korea, Mexico, United Kingdom Governments often provide guarantees to PPP projects, which often cost more than expected. For example: • In the 1990s, the Government of Colombia guaranteed revenue on toll roads and an airport, as well as payments by utilities that entered into long-term power-purchase agreements with independent power producers. Lower-than-expected demand and other problems required the government to make payments of US$2 billion by 2005.(1) • Also in the 1990s, the South Korean government guaranteed 90 percent of forecast revenue for 20 years on a privately financed road linking the capital, Seoul, to a new airport at Incheon. When the road opened, traffic revenue turned out to be less than half the forecast. The government has had to pay tens of millions of dollars every year.(2) PPP projects can also create substantial implicit liabilities for governments. When PPP projects are financially distressed, governments can be under significant pressure to bail them out, to avoid disruptions in service. For example: • In the five years between 1989 and 1994, Mexico embarked on an ambitious road building program, awarding more than 50 concessions for 5,500 km of toll roads. The concessions were highly leveraged, because equity contributions were made in the form of "sweat equity" for the construction instead of in cash. Debt financing for the projects was on a floating-rate basis and provided by local banks-many of them government owned-which might have faced government pressure to lend. By 1997, a combination of lower than forecasted traffic volumes and interest rate rises pushed the government to restructure the entire toll road program and bailout the concessions. In total, the government took over 25 concessions and assumed US$7.7billion in debt(3) • The United Kingdom National Air Traffic Services (NATS) was partially privatized, to separate the air traffic control functions from the Civil Aviation Authority. Under a PPP arrangement, NATS was to be paid a fee based on airline traffic volumes. The PPP company took on considerable debt for its investments and operations. After the September 11th attacks, airline traffic fell below forecasts and the company was in danger of not meeting its debt obligations. To reduce the perceived risk of a disruption in service, the United Kingdom Government injected GBP100 million of equity into the project company.(4) Sources: (1) Tim Irwin (2007) Government Guarantees: Allocating and Valuing Risk in Privately Financed Infrastructure Projects, World Bank, Washington, D.C.; (2) Kim, Jay-Hyung, Jungwook Kim, Sung Hwan Shin & Seung-yeon Lee (2011) PPP Infrastructure Projects: Case Studies from the Republic of Korea, Volume 1: Institutional Arrangements and Performance, Asian Development Bank, Manila, Philippines; (3) and (4) David Ehrhardt & Tim Irwin (2004) Avoiding Customer and Taxpayer Bailouts in Private Infrastructure Projects: Policy toward Leverage, Risk Allocation, and Bankruptcy |