Governments may have to provide guarantees for a wide range of reasons as suggested in the recent book by Irwin (2006). When unexpected events arise and a renegotiation of a contract arises, government need to come up with a mix of government actions that ensures that an acceptable financial return can be generated. This means that the rate of return of the PPP has to cover its cost of capital.15 These actions may include some redesign of the financing schemes to include guarantees but also of the project design, including its duration as suggested by Engel et al (2001).
A variety of mechanisms can be used to support private financing ex ante by facilitating the closure of the financing aspects of the PPP. These range from revenue enhancements to equity guarantees. Equity guarantees gives the private operator the option to be bought out by the government at a price that guarantees a minimum return on equity. Although the liability is contingent, the government in effect assumes project risk and corresponding private sector incentives are reduced. A debt guarantee is an equivalent instrument to protect the lenders. It ensures that the government will pay any shortfall related to principal and interest payments. The government may also guarantee any refinancing that is scheduled. It creates significant government exposure and reduces private sector incentives, although it may decrease the cost or increase the amount of debt available to the project. Governments can also provide subordinated loans which can fill a gap in the financing structure between senior debt and equity. From the government's perspective, they also have the attractive feature that they can be repaid with a return if the PPP is successful. There are also a number of interventions which reduce the risks associated with demand. A minimum traffic or revenue guarantee, in which the government compensates the concessionaire if traffic or revenue falls below a minimum threshold, is a relatively common form of support for toll roads and more rarely so in railways, airport or ports. 16 This guarantee can often help facilitate the access of the operator to the financial market. 17 The main alternative to this guarantee to protect against demand risk is to allow the contract to have a variable duration. The contract ends when the demand has reached the level built in the bidding documents. Ex-post, this can also be achieved through contract extensions. These types of financial support involve limited public sector risk, but also do little to support or enhance private financing. First, a government can extend the concession term if revenues fall below a certain amount. Second, a government can restrict competition or allow the development of ancillary services by the concessionaire.
For developing countries, the main risk may be the exchange rate risk. With an exchange rate guarantee, the government agrees to compensate the concessionaire for increases in financing costs due to exchange rate effects on foreign financing. Exchange rate guarantees expose the government to significant risk, as well as increasing the incentive to utilize foreign capital. This can be an important challenge of highly leveraged transactions in foreign currency.
In addition to these instruments which are typically discussed an assessed and negotiated before the contracts are signed, there is a series of instruments government often use as part of the renegotiation of contracts. These include grants or subsidies which ideally should be identified ex-ante but which are more common as part of contract restructuring, at least in the transport sector. In Argentina, this subsidy took the form of a forgiveness of accumulated payments due to the government for the right to operate the concession. In general, these grants or subsidies have no provision for repayment. A common approach to commit to subsidies ex ante in some OECD countries is the provision of subsidies through shadow tolls. Under a shadow toll, the government contributes a specific payment per vehicle to the concessionaire. Because they are paid over time, they may be less of a burden on the public budget. The drawback of shadow tolls, though, is that they may not provide investors with much protection from revenue risks. In addition, the payment of shadow tolls over time creates a credit risk for concessionaires. These inefficiencies can be reduced in a number of ways, such as a declining payment schedule as volumes increase or a maximum traffic level beyond which shadow tolls are not paid. Output-based aid (OBA) is another example of subsidy driven PPP. In this case, it is a mechanism for providing explicit performance-based subsidies to support the delivery of basic services where policy concerns-such as limited affordability for some consumers, a desire to capture positive externalities, or the infeasibility of imposing direct user fees-justify public funding to complement or replace user fees.
_________________________________________________________________________________________________
15 See Alexander et al (2001) for a discussion of the cost of capital in the transport sector.
16 Note that in some countries such as Chile for instance, minimum income guarantee to protect the operator are introduced jointly with revenue sharing scheme which allow the government to share-30-50 percent- into extra profits (i.e. revenue generating a return in excess of 15 percent) when traffic is consistently above forecast.
17 If government's share "downside risk" with the private sector through guarantees, they should also consider seeking instruments that allow profit on the "upside". One way to do this is by a revenue-sharing arrangement in which the government receives a portion of revenues above a maximum traffic threshold.