|Project Rationale and Linkage to Country/Regional Strategy
The infrastructure needs of Punjab and Sindh outpace the provincial fiscal space available for new investments. To address significant infrastructure requirements the two provinces have been exploring means of engaging the private sector more actively in infrastructure and public service provision through PPPs. A PPP structure involves a contractual arrangement between public and private entities through which the skills, assets, and/or financial resources of each of the public and private sectors are allocated in a complementary manner. A suitable PPP structure would be one in which the two parties would share the risks and rewards and seek to provide optimal service delivery and good value to service users and taxpayers. The PPP structuring process should create transparency in all of the specifications, costs, support, and procedures required to yield a sustainable project matters that are sometimes obscured from view within public sector transactions. Private sector participation has the potential to increase operating efficiency in infrastructure and public service provision through new technologies, innovative solutions and improved corporate governance structures. To the extent that these efficiency gains are passed through to users and taxpayers, the PPP solution adds value when compared with traditional infrastructure procurement. But this is not the automatic outcome of every PPP contract. The reason why it is very important to build the capacity of PPP units and risk management functions is to properly assess PPP proposals and safeguard taxpayers against unnecessary risks.
During the last 5 years, GoPb and GoS have been actively exploring PPP opportunities. GoS has achieved financial closure of two infrastructure PPP transactions. One of the PPP transactions, the Hyderabad-Mirpurkhas Dual Carriageway, has been constructed and is already generating revenue to the private partner. The positive demonstration effects and the relatively straight forward nature of this project has generated further interest from private sector investors and financiers in subsequent projects. GoPb is working on the financial closure of two transactions, one in food storage and one in the urban transport sector the Southern Lahore Ring Road. Both governments also have a pipeline of projects that are at various stages of conceptualization.
During this process, it has become evident that the private sector investors' and financiers' perception of risk associated with PPPs is high. This perception is due to (i) provincial governments' generally limited fiscal space to meet financial commitments (for which the accumulation of circular debt in the energy sector has been a proxy at the federal level), (ii) the concern that public financial management mechanisms may not be in place to enable provincial government's timely payment of financial obligations triggered by contingent liabilities on which PPP transactions are commonly based, and (iii) the private sector partner perception that they are in a weak position to enforce contractual commitments. As a consequence of these largely unquantifiable risk perceptions, investors and financiers are reluctant to participate in PPP projects. If they do participate, expectations of returns and cost financing are disproportionately inflated. In these cases, the private sector has the bargaining leverage of having more information about the underlying expected profitability and risks of the project than has the public sector party which is under pressure to reach financial closure. These expectations eventually increase the cost of project finance, and governments' contingent liabilities and project-related annual outlays, and result in sub-optimal and incomplete transfer of risks to the private sector.
The potential provincial PPP pipeline continues to grow and is increasingly more diversified from road to food sectors. The need for the governments to develop risk assessment and management mechanisms is urgent, to ensure that PPPs are fiscally affordable and economically sustainable. Risk assessment entails the determination of the probability that a risk will occur and then the potential cost associated with that risk. Through the terms of a PPP contract, different types of risk can result in additional costs and contingent liabilities to the public sector. These fiscal risks need to be properly appraised. By valuing the potential cost of these risks, the public manager is then in a better position to discuss and negotiate risk-sharing with the private entity and agree on which risks should be managed with greater priority.
The most important principle of risk allocation arrangements in PPPs is that risks are unbundled, quantified, and allocated to the parties that are best able to manage each risk. Ineffective risk allocation in a PPP results in an additional cost premium. The challenge is thus to negotiate a clear risk allocation between the public and private sectors that can maximize value for money to society and be implemented. These are required for sustained private sector investments and service provision to beneficiaries. Credit enhancement products, such as a guarantee facility, ADB's partial credit guarantee or partial risk guarantee products, can also be utilized effectively to attract private sector investment to infrastructure projects and improve the risk allocation arrangements in PPP transactions. For efficient risk management, the capacity of GoPb and GoS risk management units needs to be strengthened and operational linkages with PPP units and cells in the different departments clarified.