Budgetary risks in public-private partnerships: Q&A with 3 senior PPP specialists
With hundreds of PPP projects under their belt, senior PPP consultants Albane Deau, Elan Cusiac-Barr and Jan Grabowiecki answer 5 key questions on budgetary risks in PPPs in the infrastructure sector.
How the public sector manages budgetary risks in PPP contracts can be crucial in determining whether it successfully delivers infrastructure or is saddled with financial loss for the foreseeable future.
1. Why should we care about budgetary risks in PPP contracts?
Elan: Assessing budgetary risks is an effective way of knowing if a public-private partnership (PPP) for an infrastructure project is “fit for purpose.” PPPs or P3s shouldn’t necessarily be the default arrangement for delivering infrastructure. Even as they’ve become increasingly popular in recent years, they’re far from a panacea to meet the infrastructure gap challenge.
Albane: A country can be in a bad spot if budgetary risks aren’t accounted beforehand.
Think of a power purchase agreement where the State is entitled to supply gas to the private partner. In this case, one risk could be increasing gas prices. Given that the State has contractually committed to be the gas supplier, it would be forced to buy gas at a higher price than expected. Such setback usually happens when risks have not been evaluated and provisioned. That’s why the numbers need to match before committing to a project.
Jan: PPPs are long-term investments that span many years. This means that the consequences of poor project preparation or oversight last for an equally long time.
2. Why are PPPs financially risky?
Elan: PPPs are inherently risky because additional partners are added to the equation. The more players, the more complications that lead to interface risks.
Jan: That’s not a reason to avoid PPPs altogether, though. Bringing in a private partner allows the government to transfer risks to a more suitable party. For the right projects, well-managed PPPs can deliver infrastructure more efficiently and at a lower cost.
3. What are some of the drivers affecting budgetary risks?
Jan: Budgetary risks in PPP infrastructure projects have all sorts of potential drivers.
The market is a major one. Take a toll road under a PPP arrangement, for example. Here, the market affects whether this toll road will attract enough users. If the market is poor, the road’s revenue could be lower than expected. Assuming the government is responsible for the revenue risk, it would have to spend its own money to cover this shortfall.
Albane: We saw the market’s influence in full effect with COVID-19.
When countries started imposing restrictions, the number of infrastructure users sharply decreased. Roads and bridges that rely on tolls to pay off their construction were suddenly empty. Revenues from infrastructure users were reduced across the board, and governments had to honour their guarantees on many occasions.
Elan: By nature, no market offers complete certainty, but the government can mitigate unpredictable impacts on PPP projects.
The contracting parties can implement mechanisms to prevent termination clauses being triggered when an infrastructure is losing too much money. Concession contracts can include periodic review provisions to redress imbalances in risk allocation. The concept of Material Adverse Government Action (MAGA), for example, allows certain types of “political” risk to be allocated to the Contracting Authority.
But the bigger question is: do governments in developing countries have the capacity to manage these market-driven events adequately?
4. Do budgetary risks in PPP projects vary by infrastructure sector?
Elan: It’s not necessarily the sector that determines the risks.
My experience suggests that project type and business model are more important. Infrastructure projects that can pay for themselves over time are less risky than those that can’t. Telecom projects are usually a safe bet thanks to robust demand for mobile or broadband infrastructure and services, as well as their relatively low-risk revenue model that attracts financing.
Jan: Agreed with Elan.
Another factor that influences budgetary risks is the initial investment required to develop an infrastructure project. As a general rule, the higher this investment, the higher the risk that the project’s subsequent revenues will prove insufficient to compensate for the initial infrastructure costs.
This reinforces the importance of the due diligence process before signing the PPP contract. The government needs to ask itself how these projects would fit in its budget framework.
Albane: The length of the PPP contract is important as well. A longer contract means that it takes more time before the contracting parties get a return on their investment. Long contracts also mean more room for budgetary problems to crop up. One should be especially careful of contracts that last beyond 20 years.
5. We covered why budgetary risks are important and the drivers affecting them. Now, how do we mitigate these risks?
Jan: Preparation is the best mitigation. Carefully assessing the risks before the infrastructure project is launched—during the due diligence process—allows parties to best allocate these risks. It also allows the government to set aside fiscal room to combat these risks if and when they occur.
Albane: The severity of these risks can be estimated by multiplying the probability that they will happen by the costs incurred if they do happen. By quantifying risks, the government can know which major risks to prioritize and prepare for.
In addition, it’s good practice to designate a public official to proactively monitor the budgetary risks of a given project. This person would maintain a strong dialogue with the private partner as well as having access to the latest data on project performance.
Any last words?
Jan: PPPs are not suitable for every infrastructure project. Because they rely on private finance, PPPs often involve higher financing costs than projects funded by the government. PPPs should only be used when the participation of a private partner is expected to generate value that more than offsets their higher funding costs.
As such, minimizing budgetary risks in a PPP project is critical for protecting the government’s finances.
Elan: PPP projects are fundamentally about choice. Risky, difficult projects can become a financial burden, especially when it comes to overlooked contingent liabilities.
Therefore, choosing the right project goes a long way in minimizing budgetary risks. Due diligence should not be underestimated, and a robust process for project selection that clearly identifies the budgetary risks should be put in place so the right investment is made.
About Albane, Elan and Jan
Albane, Elan and Jan have in the past 5 years worked on PPP projects and government capacity building in more than 20 African countries.
CPCS’s PPP consultants are involved in preparing and developing some of the largest infrastructure projects in Africa:
- The Terminal Industriel Polyvalent de San Pedro in Côte d’Ivoire
- The Transgabonaise Highway in Gabon
- The Train Express Régional in Senegal
- The Kafue Gorges hydropower dam in Zambia
- The Volobe and Sahofika hydropower dam projects in Madagascar