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So what is a Public Private Partnership (PPP)? And why have industry insiders declared it as broken even though India has 1200 such projects in operation (the largest number internationally for any economy) with a total investment of over Rs 7 lakh crores (US $ 100 billion)? And does it matter?
We really do not have a peg to hang the definition of PPP on. This is where the report of the Vijay Kelkar Committee on Revisiting and Revitalising PPP Model, submitted in November but made public last week, does salutary service. It presents a simple definition which can be paraphrased as follow
A PPP is a large project in which the government, or a subordinate authority of the government, has not more than a minority share; which provides a public good or service; which is operated for a defined time period – usually medium term – by a private firm, under a “concession”, which defines contractual, mutually binding obligations and provides to the concessionaire a market-determined revenue stream to ensure commercially viability.
By proposing a definition, the report makes four important distinctions from what the practice is today.
First, it highlights the need for a PPP policy duly presented to Parliament, so that an appropriate regulatory regime could be specifically designed, possibly under a new legislation. The report is mindful of the current political economy, which has created an impasse in Parliament. This is why it recommends against an immediate resort to legislation to solve implementation problems, as has been the trend in recent times, albeit ineffectually.
Second, it recognizes that for a PPP to work majority ownership must be with the private party. This is how PPPs are designed. This design advantage is completely subverted when government uses a notional PPP route to set up a special purpose vehicle with a state owned enterprise (SOE), even if the latter is incorporated under the Companies Act. The report warns against this fudge. It thereby implicitly acknowledges, what is internationally accepted, that SOEs are just not as efficient or nimble as a private firm. Nor would they be able to pull-in the additionality of managerial experience and private investment, which is one of the main objectives of a PPP.
Third, not all instances of public-private joint investment are PPPs. A firm producing steel and set up with an assured buy-back arrangement from government would not be a PPP because steel is a private, and not a public, good. This is how Tata Steel’s Jamshedpur plant was set up way back in 1907. But what of units proposed to be set up for defence equipment, under the “make in India” route, on a similar basis? This remains unclear and hence the need for a policy.
PM Modi seals the Rafale “buy and make in India ” deal in France. Photo credit: www. timesofindia.com
Lastly, by specifying the need for a “market-determined” revenue stream and commercial viability, the report deftly strikes a three-in-one blow for transparency, competition and efficiency. All three are hallmarks of a successful PPP. Related body blows are struck against crony capitalism and gold-plating through the emphasis on long term, high quality service as a monitored output linked to the revenue stream, rather than just one-time payment for construction of an asset.
What needs to be fixed?
So what ails PPPs today? Industry pundits ascribe deep problems with the manner in which PPP projects are designed, bid-out, financed and implemented as key reasons for the logjam in private investment, along with an unfavorable international economic environment after the 2008 financial crisis.
Happily the report also acknowledges that the PPP ecosystem has come a long way from when it all began in the mid-1990s.
—There are now standardised documents for every stage of the procurement and contractual cycle, introducing transparency and predictability for investors. Development finance is also available under the India Infrastructure Project Development Fund to meet the significant transactions costs of doing a “good” PPP.
—An Appraisal Committee weeds out early flaws in PPP proposals.
—Financing of projects is supported by the India Infrastructure Finance Company.
—The Reserve Bank of India (RBI) has been continually adapting banking norms to facilitate PPP lending.
A great deal of capacity building has been done through training programmes, tool kits, outreach, pilot projects and structured exchange of learning along with real time support from PPP cells in state governments and at the centre.
So with all this under our belt, why is the PPP model broken?
First, the domination of public sector banks often results in less-than-sensible due diligence and risky lending for large, politically important PPP projects. The report has studied this aspect in some detail. Here, mere words are unlikely to help, till the governance structures of the public sector banks are made autonomous of government, something the RBI is trying to do. Banks must strictly not finance, and government must not bid out, projects till all clearances and authorisations have been received. Ministry of Surface Transport data shows that 40 per cent of highway projects overshoot time and cost targets resulting in commercial disputes due to regulatory delays.
Second, 85 per cent of the PPPs have been in the highway sector. Not surprisingly, the concessionaires are realty and construction firms. The downturn in the realty market since 2012 has hit them hard. This has significantly reduced their financial capacity to invest in new ventures and they are selling, not creating, assets.
The report suggests that “monetizing” the existing public assets can help by leasing out the operation and maintenance functions. O&M concessions are less capital intensive and also less risky since the project is operational. Alternatively, the government could front load the proportion of public financing in a PPP – an evolution of the existing viability gap funding – with the concessionaire repaying the government for the enhanced support, over time from the revenue stream earned by it or by resort to “take out” financing from risk averse finance companies. This is a good suggestion.
But a new ecosystem of O&M service suppliers would need to be evolved and supporting documentation standardised. Also the inefficiency, gold-plating and poor quality associated with public asset creation would continue to present serious problems. The revealed cost of privately maintaining poorly-built public assets to ensure high service quality will always be higher than what the government spends to provide poor quality service. This leads to the myth of private management being more expensive, as the report has noted.
Third, improved and time-bound dispute resolution systems can reduce regulatory delays. According to Assocham, Rs 12 lakh crores (US$182billion) of investment in infrastructure is stuck because of regulatory delays. The report recommends that independent regulators could also help solve some disputes and oversee contract management. According to Crisil, more than one-third of highway PPPs get stuck because actual revenue earnings from traffic are less those assumed in the bid documents. The expectation that independent regulation can solve commercial problems is not justified by the experience over the last two decades. With honourable exceptions (mostly at the central level) independent regulators tend to be handmaidens of the government of the day. Worse, they adopt a narrow bureaucratic, defensive approach to recognizing and working with private developers to resolve unforeseen business risks, which inevitably crop up.
Why do PPP’s matter?
Lastly, why does a robust PPP eco-system matter? Rewind to the dwindling years of the UPA government, specifically to 2012 when the 12th Five Year Plan (2012-17) was prepared. The government had adopted a twin target for infrastructure – a significant scaling up of investment in infrastructure and a never-before-achieved share of 48 per cent in investment for private investors. This was significantly more than the 37 per cent share achieved in the 11th Five Year Plan (2008-12) also under the UPA government and 25 per cent in the 10th Five Year Plan (2002-07) under the NDA-1. But achievement has been tardy over the first two years of the 12th Plan – 2013 to 2015. Public investment is 20 per cent lower than target and private investment is 40 per cent below target. Low investment adversely affects economic growth which, in turn, squeezes new job creation.
Here, then, is the conundrum. India needs to invest 8 per cent of GDP in infrastructure. We invest one half of this proportion. The only way out is to shrink the scope of direct ownership and management of public assets by letting the private sector have a larger share. The trick is to keep a close eye on the heightened macroeconomic and project risk the government would incur, should a more aggressive fiscal policy be followed.
This is why the report suggests first picking the low hanging fruit. Speeding up statutory clearances, improving dispute resolution mechanisms by rationalizing the risk incurred by government negotiators and decision makers of being unfairly fingered as being corrupt and, simultaneously, increasing accountability along the governance chain to also reduce petty corruption (which usually has a disproportionately higher fiscal impact).
This report makes 49 key recommendations across the three pillars of institutional development, transparency and financing, all of which deserve careful consideration.
Two recommendations herald bold new beginnings in governance. First, removing the hanging sword of Damocles of government audit of a concessionaire’s accounts, post the award of contract, subject, of course, to the highest standards of corporate governance being followed and the quality of service being maintained. This can substantially reduce risk for the private partner. Second, making concessions majority owned by government and SOEs ineligible for PPP benefits can contain “gaming” and avoid unfair capture of centrally-provided viability gap funding.
But four others reek of defensiveness and could be abandoned. First, banning the Swiss challenge option is unnecessarily conservative. Second, a 3PI (a PPP institute of excellence) is a public waste. Instead, facilitating a virtual network of academic and consulting talent in IIMs, National Law Schools and IITs could provide competitive, high quality learning and evidence based research at lower cost.
Third, the recommendation of avoiding small PPPs is regressive. At the heart of decentralization and local government are small infrastructure and social sector PPPs which provide local jobs and build local entrepreneurs. Simpler regulations for these projects work well without diluting accountability since the community oversees implementation closely.
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Fourth, there are good reasons why PPPs need to be fast forwarded. But scaremongering that India could “grow old – lose the demographic dividend – before it becomes wealthy” is not one of them. If we remain poor, we will not grow old. Wealth creates the impetus to constrain population. Poverty has no disincentives for population growth. In the modern world, all cultures think of babies as “wealth”. But only poor countries keep producing them.
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Adapted from the authors article in Swarajyamag January 6, 2016 http://swarajyamag.com/economy/kelkar-ppp-report-saving-government-from-itself/