Public private partnerships in India

Leadership Development Program for Public Utility Managers

Public-Private Partnerships I

Presented by the Asian Institute of Technology

William P. Kittredge, Ph.D.

Visiting Scholar in Residence

Definitions

Market failure is the term applied when the allocation of goods and services by a free market is not efficient. Market failures are often associated with information asymmetries, non-competitive markets, principalagent problems, externalities, or public goods and services. The existence of a market failure is often used as a justification for government intervention in a particular market.

Public good or service is a good or service desired by the public which the private market lacks the incentives to produce or produces in below demand quantities.

Externalities

A cost or benefit which results from an activity or transaction and which affects an otherwise uninvolved party who did not choose to incur that cost or receive that benefit.

Negative externalities e.g. water pollution, call for government intervention at the appropriate level to match the authority with the scope of the externality.

Usually thought of as negative, that is a 'cost' justifying government intervention, there are also positive externalities, e.g. the bee keeper who wants only honey providing pollination for an apple orchard and the flowers around your house.

Equity

Issues of equity result from a subjective assessment of what is, and what is not, a fair distribution of resources. A political consensus is generally the standard. Hence, access to public education (a merit good) regardless of ability to pay might be an equity issue.

Social efficiency is an allied concept. Social efficiency is achieved at the point where the marginal benefits to society for either production or consumption are equal to the marginal costs of either production or consumption, which is a fancy way of saying that if we expend money on public education, the economic benefit to the society should justify the expense.

Efficiency in the Public Sector

Allocative efficiency = whether goods and services are allocated to the people who value them most

Productive efficiency = whether goods and services are produced using best practices

You can improve public welfare by boosting either type of efficiency!

Public Private Partnerships (PPP)
Provision and Production

Production

A government agency responds to public demand for a service by hiring government workers, purchasing equipment, making capital investment, and establishing a program

Provision

A government agency may provide the same service by partnering and/or contracting with a private entityIndividual (technical expert e.g. attorney)

For-profit corporation

Social business

Non-profit organisation

(c) William P. Kittredge 2013


Source: KPMG


Definitions

PPP involves a contract between a public sector authority and a private party in which the private party provides & or produces a public service, or project, and may assume substantial financial, technical or operational risks.

The variations on this theme are almost endless and are constantly being expanded around the world India is arguably the world's leading PPP implementer.


Definitions

PPP refers to an arrangement between the public and private sectors with clear agreement on shared objectives for the delivery of public goods (e.g. infrastructure) and/or public services (e.g. ambulance services).

Not the same as privatisation.

It is an approach that public authorities adopt to increase private

sector involvement in the delivery of public services to:Increase total investment in public goods & services

Reduce costs

Access expertise.


Definitions

The Government of India defines a PPP as "a partnership between a public sector entity (sponsoring authority) and a private sector entity (a legal entity in which 51% or more of equity is with the private partner/s) for the creation and/or management of infrastructure for public purpose for a specified period of time (concession period) on commercial terms and in which the private partner has been procured through a transparent and open procurement system." Source: Department of Economic Affairs, Ministry of Finance, Government of India. 2007.


Main Features

Long-term (10-60 years) contractual relationships enduring relationships create opportunities & may create problems

Shared responsibilities relative roles depend on situation

A method of procurement - emphasis on the desired outcome

Risk transfer somewhat problematic

Flexible ownership myriad of options to suit individual situations


Elements

Design and Build these are usually integrated with at least one of the other elements;

Operation and Maintenance in some projects, these two elements are kept separate from each other. For each PPP arrangement, the public sector must decide whether the private sector company should have responsibility for both operation and maintenance of the asset or service, or whether it would be preferable for it to be operated by the public sector and maintained by the private;


Elements

Finance typically, in pursuit of the optimum means of financing the costs of public infrastructure projects, PPP make use of a combination of public and private sector funds. The private sector raises capital funding for a project through equity and debt finance, to be recovered either from members of the public through user charges, or from the sale of the service to the public sector, or from a combination of the two where the public sector subsidises the service to make it affordable to the end user;


Elements

Ownership when entering into a PPP, the public authority must decide whether the government or the private company should own the facility that is developed. In some arrangements, the land and facility will be owned by the private sector, whereas in others the asset will revert to public ownership after construction.




Traditional Procurement

PPP Model

Variations

Private Finance Initiative - capital investment is made by the private sector on the basis of a contract with government to provide agreed services and the cost of providing the service is borne wholly or in part by the government.

Government contributions to a PPP may be in kind (e.g. transfer of existing assets, including land).


Variations

Public Goods Projects - In projects that are aimed at creating public goods (e.g. major infrastructure investments) the government may provide a capital subsidy in the form of:

One-time grants

Revenue subsidies

Tax abatements (sometimes tradeable)

Guaranteed minimum annual revenues

In most cases, the last three are for some stipulated period of time and may contain 'claw-back' provisions.

The intent is to make the investment more attractive to the private investors.


Variations

Typically, a private sector consortium [e.g. a construction or maintenance company, consultants, and lender(s)] is formed to develop, build, maintain and/or operate the asset for the contracted period.

These special purpose companies are named special purpose vehicle (SPV).

In cases where the government has invested in the project (including in-kind investments), it is typically (but not always) allotted an equity share.


Variations

It is the SPV that signs the contracts with the government and the subcontractors to build the facility and/or maintain it.

In the infrastructure sector, complex arrangements and contracts that guarantee and secure the cash flows make PPP projects prime candidates for project financing.

For example, a hospital building financed and constructed by a private developer is leased to the hospital authority. The private developer then acts as landlord, providing housekeeping and other non-medical services while the hospital itself provides medical services. (Barlow, 2013)


Variations

Product development partnerships (PDP) are a class of publicprivate partnerships that focus on scientific research and commercialization. For example, pharmaceutical product development for diseases of the developing world. These include preventive medicines such as vaccines and microbicides, as well as treatments for otherwise neglected diseases. PDPs were first created in the 1990s to unite the public sector's commitment to international public goods for health with industry's intellectual property, expertise in product development, and marketing.


Critiques

A common problem with PPP projects is that investors obtain a rate of return that was higher than the governments bond rate, even though most or all of the income risk associated with the project was borne by the public sector. (Barlow, 2010)

From an economic perspective, this means that investors got a risk premium for project risk that the government assumed. As a result, the cost to the government was above the cost if the government borrowed the money itself by selling bonds.


Critiques

A number of Australian studies of early infrastructure PPP concluded that, in most cases, the schemes being proposed were inferior to the standard model of public procurement based on competitively tendered construction of publicly owned assets (EPAC 1995; House of Representatives Standing Committee, 1997; Harris 1996; Industry Commission 1996; Quiggin 1996).


Critiques

In 2009, the New Zealand Treasury, released a report on PPP schemes that concluded that "there is little reliable empirical evidence about the costs and benefits of PPP" and that there "are other ways of obtaining private sector finance", as well as that "the advantages of PPP must be weighed against the contractual complexities and rigidities they entail". (The New Zealand Herald)


New Model

The PublicPrivate Community Partnership (PPCP) model, wherein both the government and private players work together for social welfare, eliminating the prime focus of private players on profit dovetailing nicely with the movement for Corporate Social Responsibility (CSR) & social business concepts.

This model is being applied more in developing nations such as India.


PPP in India

History of PPP in India can be traced back to 1853 and The Great Indian Peninsular Railway Company (source: PPP in India website)

Roads and urban development comprise the vast majority of the projects ~ 73% (source PPP India database as of July 31, 2011)

Growing since 1998 and significant acceleration since 2006, both as a result of legislative & regulatory changes, & increased political will.


PPP in India

Prime Minister Manmohan Singh today set an investment target of Rs 1.15 lakh crore in PPP (public private partnership) projects across infrastructure sectors in rail, port and power in the next six months. (Firstpost online Jun 29, 2013)

"Increasingly, in India, PPPs are emerging preferred mode of investment for publicly managed construction. (The Times of India website accessed: Jun 23, 2013, 07.43PM IST)

Driving Forces in India

Rapidly growing economy's demand for infrastructure

Public deficit constrains government's ability to fund infrastructure and government borrowing is capped through the Fiscal Responsibility and Budgetary Management Act.

As a result, one-third of the finance needed for infrastructural development over the next five years [i.e. 2009-13] will be funded by the private sector (Research Republic LLP. 2008)


Driving Forces in India

Government of India is actively promoting the expansion ofPublic Private Partnership (PPP) activities across all key infrastructure sectors including highways, ports, power and telecoms.

To date, various PPP models have been tried in India, including public contracting; passive public investment (equity, debt, guarantee, grants); joint ventures; and long-term contractual agreements of various types.



Design-Build (DB)

Build-Transfer (BT)

Build-Transfer-Operate (BTO)

Design-Build-Operate (DBO)

Build-Operate-Transfer (BOT)

Build-Own-Operate-Transfer (BOOT)

The private sector designs and builds an asset, and then transfers it to the government. The private sector may also operate it, and then transfers it to thegovernment when the operating contract ends. The private partner may subsequently rent or lease the asset from the government for a specified period.(Taxonomy by IMF 2004)



Wrap Around Addition (WAA)

Lease-Develop-Operate (LDO)

Buy-Develop-Operate (BDO)(Taxonomy by IMF 2004)

The private sector buys or leases an existing asset from the government, renovates, modernizes, and/or expands it, and then operates the asset, with no obligation to transfer ownership back to the government.



Design-Build-Finance-Operate (DBFO)

Design-Build-Finance-Maintain (DBFM)

Build-Own-Operate (BOO)

Build-Develop-Operate (BDO)

Design-Construct-Manage-Finance (DCMF)

These are variants of Design-Build-Finance- Operate (DBFO)

The private sector designs, builds, finances, owns, develops, operates and manages an asset with no obligation to transfer ownership to the government.

(Taxonomy by IMF 2004)


PPP in India

The BOT form, including its variants, is the most common form of PPP model used in India accounting for almost two-thirds of PPP projects in the country. (PPP in India website)

The two major forms of BOT models are:

User-fee based BOT model: Commonly used in medium- to large-scale PPP for the energy and transport sub-sectors (road, ports and airports).

Annuity-based BOT model: Commonly used in sectors/projects not meant for cost recovery through user charges such as rural, urban, health and education sectors


PPP in India

Modified design-build (turnkey) contracts

The design-build contracts yield benefits in the form of time and cost savings, efficient risk-sharing and improved quality.

The turnkey approach with milestone-linked payments and penalties or incentives can be linked to such kind of contracts.


PPP in India

Performance based management/maintenance contracts

The PPP models that lead to improved efficiency are encouraged in an environment that is constrained by the availability of economic resources.

The sectors most commonly employing this form of PPP include water supply, sanitation, solid waste management, and road maintenance.


PPP in India

While there do exist build-own-operate (BOO) models, they are not supported by the GoI due to its finite resourcesand the complexities in imposing penalties in case of non-performance and estimation of value of underlying assetsin case of early termination.

The GoI does not recognize the engineering-procurement-construction (EPC) contracts and asset divestitures as PPPs.


(Ernst & Young 2012)

Caveats

It is important to understand that PPP are not catch-all solutions to the persistent difficulties of under-investment and lack of resources for development. As the World Bank (2006) pointed out, in regard to Indian infrastructural development,

PPPs represent a claim on public resources that need to be understood and assessed in each case.

They often involve complex transactions, needing a clear specification of the services to be provided and an understanding of the way risks allocation between the public and private sector.


Caveats

Moreover, the long-term nature of many PPP means that government has to develop and manage a relationship with private providers

Address the unexpected events that can disrupt even the best contracts.

Ultimately,PPPs always involve projects for which, in the eyes of citizens, government ultimately bears responsibility even if the task of delivery has been contracted out.


PPP in India
Cautions & Concerns

UN warns India against disaster risks in major PPP projects(The Times of India website accessed: June 23, 2013, 07.43PM IST)

These partnerships do not necessarily lead to improved disaster risk assessment and management, and may underplay disaster risks or lead to their transfer as shared costs to the public sector or to city residents." (UN GAR 2013 quoted in The Times of India website accessed: Jun 23, 2013, 07.43PM IST)

It has been much debated as to whether water should be privatized since it is a public good and a utility essential for life. (Lanjekar, 2010)


Common Reasons for Failure (Source: Ministry of Finance, Singapore 2004)

Poorly drafted contracts;

Contract managers assigned insufficient resources;

Lack of experience in either public sector or provider teams;

A failure to adopt a partnership attitude;

Personality clashes between project team personnel;


Common Reasons for Failure (Source: Ministry of Finance, Singapore 2004)

Lack of understanding of complexity, context and dependencies of contract;

Unclear identification of authority and responsibility in relation to commercial decisions;

Lack of measurement of performance;

Focus on existing arrangements rather than emphasis on potential improvements;

Inadequate monitoring and management of statutory, political and commercial risk.


Signs of Inadequate Management

The provider may assume control, leading to unbalanced decisions that do not reflect the interest of the public sector;

Decisions are made at inappropriate times;

New business processes are unsuccessfully integrated with existing ones, and fail;

People within either sector may fail to understand their roles and responsibilities;


Signs of Inadequate Management

Disputes and misunderstandings may arise, some of which might be inappropriately escalated;

Progress may be slow or there might be an inability to move forward;

The desired benefits may not be achieved;

Possibilities for improved performance or value for money might be lost.


Contract Renegotiation

Recently, the realisation that the long contract lives imply changing conditions.

This is especially true in a rapidly developing economy in which rural residence and agricultural employment is expected to decline; urbanisation increase; and GDP increase significantly.

While financing contracts are impacted, the main concern being raised is in operating contracts.



In a recent Business Standard article, the issue was discussed in some detail and makes an interest topic for discussion.

The author sites several recent incidents in which changing circumstances have caused what may become major disruptions.

GMR and GVK have walked out of recently-won mega-highway projects. The Gurgaon Expressway is in trouble. Delhi Airport Metro Express is under arbitration. (Chatterjee, 2013)



An overview of more than 1,000 PPP studied by the World Bank Institute in Latin America (1985-2000) reveals:

41.5 per cent have undergone renegotiation;

Out of the total concessions in the transport infrastructure sector, 55 per cent of the concessions underwent renegotiation;

85 per cent of renegotiation occurred within four years of concession awards, and 60 per cent occurred within three years;

Renegotiation occurred mostly in concessions awarded through competitive bidding;

In 61 per cent of cases, the concessionaire requested renegotiation.(Ibid)



Taking the last two into special consideration, let's discuss the questions the author poses:

Can bidders who lost in the competitive process take government bodies to court claiming that the renegotiation creates material changes to the tender that were not extended to them during the bidding stage?

If the material conditions of a PPP contract awarded through the bid process are changed by renegotiation, does this encourage many more project developers to anticipate post-award renegotiations?



A moral hazard exists if PPP SPV bidders know, or believe, that losses will be reimbursed by post facto government action, whilst profits do not have to be shared. How could the incentives be structured to avoid the moral hazard?

Distinguishing between services or projects that become unviable because of genuine unforeseen developments and projects that are unviable in the first instance, perhaps as a result of predatory bid pricing or commercial judgement errors, a normal business risk, will be difficult. In your environment, how would you distinguish?


PPP in India

PPP is, and for the foreseeable future, a dominant model for infrastructure investments and may become more common in the service delivery arena as time goes on.

India has entered into long-term agreements that will continue to have fiscal, social, environmental, and political effects for at least the next three decades.

We will not turn to examine some cases of Indian PPP and discuss them in light of the information above.


PPP Process Case Examples
Comprehensive Due Diligence Studies

Vadodara Halol Toll Road Case

Traffic estimates, and therefore toll revenue forecasts, werebased on the assumption that the industrial incentiveswould continue indefinately.

When the incentives were withdrawn, traffic volume, and therefore toll revenue, was almost 50% lower than forecast.

Delhi Gurgaon Expressway experience just the opposite problem.

Due Diligence, including Life Cycle Cost Sensitivity Analysis, was not faithfully conducted.


Dealing with Speculative Bids

Hyderabad Metro Case

Winning bid was wildly better than the SPV other submissions.

Due to investor reluctance, the project was not able to achieve financial closure.

The government finally had to withdraw its award and re-launch the bid process, causing delays in entire schedule and loss of social welfare.

Kittredge's Rule: If something seems to good to be true, it probably is...


Robust & Simple Bid Criteria

Gangavaram Port Case

Initial tender evaluation criteria were internally inconsistent, creating speculative bid incentives.

The criteria scoring favored larger commitments, even if unrealistic.

While the government eventually decided to terminate the process, BUT the situation could have resulted in an unsustainable project.

KISS


Robust & Simple Bid Criteria

Nhave Sheva Integrated Container Terminal Case

A single bid evaluation criterion of the highest royalty payment NPV was simple but insufficient.

The lacking a method to assess royalty payouts to the licensor and

The problems arising from the interaction of the royalty withthe tariff level created a number of issues in the subsequent operations phase.

Cover all the necessary issues


Land Acquisition Risk

Mumbai Metro Case

The the PPP agreements included the government's land acquisition schedule commitment.

The land was under disputed private ownership exposing the government to land acquistion risk & construction delay costs.

The issue was eventually resolved, but it would have been more efficient to address it before signing the PPP agreement or addressing the issue in the documents.

Land acquisition is project critical. As a core issue, it should be comprehensively addressed during Due Diligence studies.


Co-Ordination of Approvals

Delhi Gurgaon Expressway Project Case

The project involved the States of Delhi and Haryana, requiring approvals from over fifteen agencies.

The complex caused significant, and expensive, delays during construction.

Similar problems were experienced during the Karnataka Urban Water Supply Improvement project.

In cases like this, my experience tells me that your best approach is to get them all in a single room & hammer out the problems in batches.


Well Defined Scope of Work

Delhi Gurgaon Expressway Project Case

The DGE experienced significant time and cost overruns due to changes in the concessionaires scope of work issued days before original project completion date.

NHAI initiated substantial changes in the original design to address future requirements.

These matters should have been incorporated into the bidprocess.

Very costly in time and money.


Tariff Determination Clarity

Nhava Sheva Integrated Container Terminal Case

The PPP agreement lacked clarity regarding the royalty payment calculation.

The port tariff calculation method did not clearly specify the characterisation of the royalty payment in the SPV's accounts.

Royalty payment could be classified as either a cost or a share in the SVP profit

Failure to examine the calculation methods is a common mistake, especially when one hurries.


References

Chatterjee, V; Renegotiating PPP contracts The Business Standard Online. June 22, 2013 accessed: May 20, 2013

Barlow, J., Roehrich, J.K. and Wright, S. (2013). Europe Sees Mixed Results From Public-Private Partnerships For Building And Managing Health Care Facilities And Services. Health Affairs. 32(1):146-154

Barlow, J. Roehrich, J.K. and Wright, S. (2010). De facto privatisation or a renewed role for the EU? Paying for Europes healthcare infrastructure in a recession. Journal of the Royal Society of Medicine. 103:51-55.

Economic Planning Advisory Commission (EPAC) (1995), Final Report of the Private Infrastructure Task Force, Australian Government Publishing Service, Canberra.

House of Representatives Standing Committee on Communications Transport and Microeconomic Reform 1997 Australian Government Publishing Service, Canberra.

References

Lanjekar, P. (2010). Public-Private Partnerships and Urban Water Security : Issues and Prospects in Mumbai , India. Ritsumeikan Asia Pacific University.

New Zealand Herald, The. "Brian Rudman: Promised electric trains derailed by misguided enthusiasm". 1 June 2009. Retrieved 21 February 2010

Quiggin, J. (1996), Private sector involvement in infrastructure projects, Australian Economic Review, 1st quarter, 5164

Research Republic LLP. (2008). Developing Indias Infrastructure through Public Private Partnerships. London England: City of London.

S.S. Raju (2011). "A Successful Indian Model". The Hindu Survey of Indian Industry 2011.

References

Venkat Raman, A. and JW Bjorkman (2009), 'Public Private Partnerships in Health Care in India: Lessons for Developing Countries'. London. Routledge.

World Bank. (2010). Public Private Partnership Projects in India: A Compendium of Case Studies. New Delhi: Ministry of Finance, Government of India. Retrieved from www.pppinindia.com

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Public private partnerships in India