PPP & Unsustainable Liabilities in Infrastructure

Understanding Liability Transfer in Long-Gestation PPPs

PPPs typically involve a concessionaire (private entity) designing, building, financing, operating, and maintaining an infrastructure asset for a specified period. Revenue is generated through user fees or government payments. The core issue arises when projects fail to meet projected revenue targets or experience cost overruns. This can lead to:

• Demand Risk Transfer: If actual demand is lower than projected, the government may be obligated to compensate the concessionaire through revenue guarantees or availability payments, effectively transferring the risk to taxpayers.
• Construction & Operational Risk Transfer: Delays and cost escalations during construction or operation can lead to increased project costs, often borne by the government through extended concession periods or increased payments.
• Financial Risk Transfer: High debt levels taken by the concessionaire, coupled with revenue shortfalls, can lead to financial distress and potential government bailouts.

Long gestation periods amplify these risks. The further into the future revenue generation is, the greater the uncertainty and the higher the probability of unforeseen circumstances impacting project viability. For example, changes in technology, environmental regulations, or economic conditions can render a project obsolete or financially unviable.

Mechanisms to Ensure Intergenerational Equity

To prevent the transfer of unsustainable liabilities, the following arrangements are crucial:

1. Robust Contract Design & Risk Allocation

• Realistic Demand Forecasting: Employing independent, rigorous demand forecasting methodologies, incorporating sensitivity analysis and stress testing. The 2018 report by the NITI Aayog emphasized the need for realistic traffic projections in highway PPPs.
• Clear Risk Allocation Matrix: Precisely defining which party bears which risk, with a focus on allocating risks to the party best equipped to manage them. For instance, political risks should largely remain with the government.
• Flexibility Clauses: Incorporating clauses allowing for renegotiation under unforeseen circumstances, with pre-defined mechanisms for dispute resolution.

2. Transparent Financial Modeling & Due Diligence

• Independent Financial Advisors: Engaging independent financial advisors to scrutinize project financial models and assess their robustness.
• Stress Testing: Conducting thorough stress tests to evaluate the project's resilience to adverse economic conditions and unforeseen events.
• Disclosure Requirements: Mandating full disclosure of project financial details, including debt levels and revenue projections, to enhance transparency and accountability.

3. Effective Regulatory Oversight & Monitoring

• Independent Regulatory Authority: Establishing an independent regulatory authority with the power to monitor project performance, enforce contract terms, and prevent opportunistic behavior.
• Regular Audits: Conducting regular audits of project finances and operations to identify potential risks and ensure compliance with contract terms.
• Contingency Funds: Establishing contingency funds to address unforeseen cost overruns or revenue shortfalls.

4. Lifecycle Cost Analysis

Moving beyond initial construction costs to consider the entire lifecycle cost of the infrastructure, including maintenance, rehabilitation, and eventual decommissioning. This provides a more accurate picture of the long-term financial implications.

International Best Practices

Countries like Australia and Canada have adopted sophisticated PPP frameworks that prioritize risk allocation and transparency. Australia’s use of ‘market sounding’ – seeking input from potential bidders early in the process – helps refine project design and risk allocation. Canada’s Public Sector Comparator (PSC) provides a robust benchmark for evaluating the value for money of PPP projects.