Faculty Diaries: Public Private Partnerships for Infrastructure development
By Veronica Vecchi, professor of Buisness Governmnt Relations, SDA Bocconi
Director of Executive Education, MISB Bocconi – Bocconi India
The Indian Government has announced to build 100 motorways (21 projects for a capital value of INR 28,000 crore to be awarded this year) with the hybrid annuity PPP model, based on the sharing of costs between the private (60%) and the public sector (40%). The public sector will pay a further charge for the management and operations and the private concessionaire won’t bear the demand and the inflation risks.
Infrastructure development is actually one of the main priorities of Governments across the world, as they are undoubtedly a catalyst for economic growth. However, the gap between needs and actual provision is still wide and it may affect the competitiveness of countries. Public Private Partnerships (PPPs), mainly based on concession agreements funded via project finance schemes, are attractive for many Governments as a way to fill the infrastructure gap, both in developed markets, where they have to control the ‘headline’ measures of indebtedness and in emerging markets, where their ability to raise funds and implement projects is limited.
Infrastructure gap worldwide
PPP models based on a capital grant and availability charges (called in the domestic model annuity), have been used also abroad, especially after the financial crisis, to cope with the bankability issues and attract institutional investors (especially pension funds and insurance companies that are more – risk adverse), looking for higher yields.
Furthermore, the failure of many projects across the world, which forced the authorities to renegotiate the financial terms of the original contracts or to buy back the infrastructure, has determined a progressive shift towards availability – based concessions, under which the traffic/demand risk is fully retained by the contracting authorities.
However, when the public Authority retains partially or totally, directly or indirectly, the demand risk as a consequence of the guarantee issued (availability charge/annuity, capital grant, pure debt guarantee) bidders have strong incentives to bid with opportunism and not to manage and monitor efficiently the contract.
According to a study developed with some colleagues in Bocconi, we found that whenever the level of dishonesty in the system is far high ( for example in countries with a high level of corruption, like India or Italy), the probability that a dishonest bidders win the tender is very high and therefore it is very likely that the private contractor would ask for a contract renegotiation, thus increasing the costs for the public sector and reducing the value for money of the PPP.
PPP contract renegotiation is a already a plague here in India and the turn to PPP should be seen not only as a way to close the infrastructure gap but also as a stimulus to develop a more competitive and responsible private sector.
It is obvious that certain risks can’t be transferred to the private sector, especially those that the private operators can’t manage. Therefore, the annuity model can be a good solution but only if it is supported by a deep investment in the public sector competencies in order to have public officials able to structure feasible, value for money and affordable PPPs and to assess the real quality and reliability of bids received.
The figure below summarizes the main results of the study conducted by Bocconi and it shows the decrease in the probability of dishonest winners in case of an increase by 10% or 20% in the public sector competencies.
An investment in skills will be certainly profitable for the public sector, the society and the economic development of India.