CHAPTER 4 Fiscal and Other Measures in Support For PPPs

Box 3. Contingent Liabilities. Ensuring Fiscal Stability of Local Budgets.

Although PPP procurement has many benefits over traditional public investment, it certainly has its risks. Arguably, the most noticeable of them are risks of contingent liabilities. While conventional public procurement allows for clear reflection of obligations in budget accounts, PPP procurement creates both explicit and implicit contingent liabilities. The latter stems from guarantees on particular risk variables, compensation clauses, termination payment commitments, debt guarantees and other credit enhancements, litigation, as well as general obligations of governments reflecting the public interest.

Occurrence, timing, and magnitude of such commitments depend on some uncertain future event. That is why they are called contingent. Originating from the very nature of PPP contracts and if not appropriately managed, such liabilities may grow up to enormous amounts and pose a real threat to the fiscal stability of a state. Given the popularity of various state guarantees as a means to attract private investments, it is no wonder that countries have started to pay increased attention to contingent liabilities in PPPs.

To date, global experience hints to four essential elements of managing contingent liabilities.

First, it is necessary to assess the affordability of financial commitments to PPPs either by forecasting budget limits or by introducing budget rules. For example, In Brazil, project studies must include a fiscal analysis for the next ten years. In the UK, procuring authorities must demonstrate the affordability of a PPP project based on agreed departmental spending figures for the years available, and on cautious assumptions of spending envelopes after that. As regards budget rules, Colombia's law on contingent liabilities (CO 1998, Article 6) requires implementing agencies to make a cash transfer to a contingency fund when a PPP project is signed. The cash transfer is set equal to the expected cost of programs, including any guarantees provided. The payments may be spaced out over several years, meaning that the decision to accept a liability has an immediate budget impact to be considered.

Second, controlling aggregate exposure to PPPs may prove worthwhile. In this respect, Brazil's Federal PPP Law (BR 2004a, Law 11079) limits the total financial commitments of all PPP contracts to a maximum of five per cent of annual net current revenue. In Peru, Legislative Decree No. 410-2015-EF (PE 2015) states that the present value of the total public commitments to PPPs, excluding governmental finance entities, shall not exceed 12 per cent of GDP. However, every three years, the President may issue a decree to revise this limit, depending on the infrastructure needs of the country.

Furthermore, budgeting for government commitments to PPPs is critical for success and involves making sure money is appropriated and available to pay for whatever cost the government has agreed to bear under its PPP projects. In Indonesia, the Infrastructure Guarantee Fund (IIGF) fulfils such a task. IIGF is a state-owned enterprise established by government regulation and a 2009 Ministry of Finance decree. As one of the fiscal tools of the government, IIGF is under the direct supervision of the Ministry of Finance and has the mandate to provide guarantees for infrastructure projects under PPP schemes. IIGF operates as a single window for appraising, structuring, and providing guarantees for PPP infrastructure projects. Such a configuration ensures a consistent policy for evaluating commitments and a singular process for claims. It introduces transparency and consistency in the process, which is critical for market confidence. IIGF provides guarantees against specific risks based on private-sector demand in a variety of sectors-including power, water, toll roads, railways, bridges, ports, and others.

Finally, governments need to account for and report on their financial commitments, including those under PPP contracts, which calls for consistent fiscal monitoring and evaluation of PPP projects. In China, both the Ministry of Finance (MOF) and the National Development and Reform Commission (NDRC) of China have recently demanded tighter scrutiny over PPPs as the government seeks to boost infrastructure funding while containing fiscal risks. The MOF has recently issued several guidelines to standardize PPP development and forestall new off-budget debt risks of local governments. Till now, Chinese authorities have vastly explored funding infrastructure and public works through PpP models since late 2013. A total of 8,654 PPP projects had been registered in a national data bank by the end of 2018, according to official data. Now, all PPPs are required to go through a thorough feasibility study, including the project cycle and cost, operation efficiency as well as risk management. Projects that will increase local governments' off- budget debt might then be stopped or transferred in other legal ways for continued construction.

PPPs Require Special Policy Approach

To date, a wide range of supportive measures exists to facilitate launching and implementation of infrastructure and other investment projects, including PPPs. The latter substantially differ from traditional public investment in the areas of procurement and tenders, defining the form of project financing, as well as the distribution of risks between the public and the private partner.i

In this chapter, we describe commonly used measures in support for PPPs such as fiscal incentives, state guarantees, grant payments, subsidised loans and support for property transactions. At the same time, we do not distinguish between who provides such measures for it can be either governmental bodies or dedicated PPP units, as well as various development institutions, including banks and national funds.

Designing a Policy Mix Takes Evidence-Based Approach

As seen from the G20 Survey responses, there are a few types of supportive measures that countries apply. All of them pursue the same goal - to attract private investments in infrastructure. The risk, therefore, is in possible duplication and lack of coherence in a chosen policy mix. It is even more important if we take into account the fact that every measure has its pros and cons. Obviously, 'one size fits all' does not work here.

Country experience shows that successful choice in policy tools is often based on the regulatory impact analysis. The latter, among other things, implies taking into account both current and prospective conjuncture, local governance institutions and a broader economy and political context. By elimination of duplicative or incoherent measures, it is possible to improve the policy mix.

Fiscal Incentives

The G20 countries use various fiscal incentives, including those referring to VAT, tax on credits and debits in bank accounts and other financial operations, as well as corporate acquisition, income, registration and property taxes. The majority of countries offer investors fiscal incentives at the stage of construction.

The Survey identified at least 6 out of 22 countries covered that use fiscal measures to incentivise investments via PPP. For example, Argentina allows for creating individual PPP Trusts.ii All transactions made via a PPP Trust are exempt from all national taxes, fees and contributions, both existing and to be introduced in the future. A wide range of fiscal incentives is also available in the Republic of Korea. In Italy, special tax relief measures are widely used to spur the implementation of PPPs in the motorway sector.

State Guarantees

As reflected in country responses to the Survey, state guarantees are a widely used measure, and half of the countries rely on it. There are at least three kinds of warranties that protect PPP contracts.

The first group refer to overall force majeure conditions when a private party is unable to stay in the project. The government then may compensate for some proportion of private investments and even take on the project to ensure the delivery of a particular public service.

The second group of guarantees deal with banking. The state ensures that if private partner defaults on its credit obligations, the budget will step in.

Also, foreign exchange and other risks may be approached by the state.

By de-risking PPP projects, public guarantees may significantly contribute to their bankability and attract additional financing. On the other hand, contingent liabilities is a comprehensive instrument that is not always easy to manage and evaluate in terms of risk. As a separate issue, we discuss contingent liabilities in Box 4 further.

Grant Payments

Grant payments are the second most frequently reported measure that is used in ten G20 countries. Public funding directly supports the project to cover the capital expenditures of a private party. In India, for example, capital grants are provided to PPPs in the amount of up to 20% of the total project cost.iii Furthermore, the state body that runs the project may provide an additional grant of 20% of the total project cost. In France, public subsidies provided to some projects account for 18% of total CAPEX amount. Grant payments may also come through the issue of public bonds, which is the case of Korea.

Subsidised Loans

Just 4 countries reported to use subsidised loans. The essence of loan subsidy is to lower the interest rate by (partially) paying it from the budget. In some rare cases the state may be ready to provide completely interest-free repayable loans, as was reported for example by Switzerland. The attractiveness of the measure lies in the opportunity not only to support a project but also to stimulate debt markets.

Support for Transactions

Supporting an investor in concluding critical deals is often used in such PPP initiatives that are highly dependent on the cost of property transactions implied. The public authority might wish to assist the investor in acquiring the needed property so that the user's tariff remains reasonable. A few countries provide such option in respect to land transactions including Korea, South Africa and Turkey.

Supporting investor's transactions may as well include deals with various types of immovable and intangible assets such as buildings, related infrastructure and intellectual property. Such options are in place in Chinaiv and Indiav.

COUNTRY

Fiscal Incentives

State Guarantees

Grant Payment

Subsidised Loans

Transactions Support

Argentina

Australia

Brazil

Canada

China

France

Germany

India

Indonesia

Italy

Japan

Rep. of Korea

Mexico

Netherlands

Russia

Saudi Arabia

Singapore

South Africa

Spain

Switzerland

Turkey

United Kingdom

In place

Not in place

As regards fiscal monitoring, central contingent liability management units may be established specifically for that purpose. For instance, the Ministry of Finance of Chile has a Contingent Liabilities and Concessions Unit established in 2006 as part of the Budget Department. Although it has considerable expertise in concessions, the unit is also responsible for monitoring a wide range of contingent liabilities, not just those associated with concession agreements. The government's primary source of expertise on concessions is the much larger Concessions Department in the Ministry of Public Works.

Source: PPPKnowledgeLab.org,ADB.org; countries' responses to the G20 questionnaire.

Brazil

To ensure government payments under PPP contracts, Brazil has created a special guarantee fund.vi The federal government, either directly or through independent agencies or public foundations, is authorised to contribute up to 6 billion Reais to the fund (USD 1.5 billion). The fund's assets are explicitly dedicated to the PPP program, and cannot go to general public spending. Although the fund is technically a "private" entity, the PPP statute mandates that a financial institution controlled by the federal government managed the fund and has the authority to represent it in legal proceedings.

In 2012, the law was enacted, authorising the Federal Government to participate as a shareholder to the limit of 11 billion Reais in the guarantee fund to cover risks related to infrastructure projects.vii Thus, the infrastructure guarantee fund was established under private law to guarantee projects resulting from public- private partnerships, including those organised by states, federal district and municipalities.

Also in 2012, the Brazilian Guarantees Agency was created to manage the infrastructure guarantee fund and represent it judicially and extrajudicially.

Italy

The Italian Government continues to support implementation of PPP operations, as underlined in the National Reform Programmeviii.

In Italy, special tax relief measures for the implementation of PPP infrastructure projects are operational in the motorway sector only.ix Implemented in line with the corresponding guidelines, they allow a public entity to substitute the immediate payment of a grant owned to an SPV with reductions of future tax payments. Only new strategic infrastructure projects may apply for the measure.

As regards organisational aspects, the maximum extent of public assistance, including tax relief measures expressed in present value terms, may not exceed 50% of the investment cost. Supportive measures are assigned by the Interministerial Committee for Economic Planning, after consulting the Public Infrastructure Regulation Unit that operates in the Department for the Planning and Coordination of Economic Policy.

Ideas for Policy-Making

• Conduct an evidence-based regulatory impact analysis before enacting any supportive measures

• Eliminate duplicative or incoherent measures that undermine policy efficiency

• Ensure that adequate management of contingent liabilities is in place including through fiscal monitoring and other respective provisions

Public grants are also provided to maintain the economic and financial balance in PPPs. Additional financial support is available for specific infrastructure projects, mainly from Cassa Depositi e Prestiti, which is the National Promotional Institution.x It includes corporate loans and project finance for long-term projects, as well as contributions to infrastructure equity funds that invest in innovative and responsible service sectors.

Turkey

In Turkey, state guarantees are commonly used in airport sector PPP projects.xi Also motorway PPPs and urban transportation projects such as Eurasia Tunnel rely on state guarantees. In case of airports, guarantees amounting to a certain number of passengers in a given contract year are key subsidies in the Turkish context. If the actual number of passengers using the airport falls below the guaranteed number within the relevant year, the government party provides specific incentives accordingly. For motorways and tunnels, traffic guarantees are provided. If the car equivalent of all the vehicles which used the motorway/tunnel falls below the guaranteed level, the government pays for the remaining gap. Most of these projects have revenue sharing mechanism which requires the private sector to share a certain proportion of the revenue exceeding the guaranteed level with the government.

Equally, direct revenue guarantees are also seen in the airport sector. The mechanism typically works both ways: if the actual revenues in the relevant year are below the guaranteed total revenue for the relevant year, the government party pays the difference. Conversely, if the private partner generates more than the guaranteed revenue amount, the surplus revenue is shared with the government party.