Enhancing Financial Viability Through Government Support Mechanism In Public Private Partnership (PPP) Contractual Framework

The development of infrastructure such as roads, water, communications, power, and other infrastructure as a means of answering the growing demand associated with economic growth and sustain such growth is extremely crucial. It speeds up the nation's production and distribution of private economic output as well as to its citizens' overall quality of life. A research by Cain (1997) has noted that public infrastructure has potentially strong effects on private economy activity. Easy access to infrastructure such as modern telecommunications services, reliable electricity supply, and efficient transport will lead to more investments, and the investments are more productive. Thus, those public facilities, resources, and services will mobilize the rising in GDP and reduce the poverty in the country. Kessides and Ingram (1995) stated that infrastructure links to economic development work through its contributions to economic growth, poverty alleviation, and environmental sustainability.

Zhang (2005a) reported that improving deliveries of many major public works and services would not have been possible without private finance. The necessity of creating financial return in the infrastructure projects generates an innovative focus to shift the roles of the government to the private participation through infrastructure investment (World Bank, 2005). Government failure - in terms of slow and ineffective decision making, derived externalities, unworkable organizational and institutional frameworks, lack of competition, monopoly, allocative inefficiency, and dysfunction between output and payment—provides a rationale for private involvement (Walsh, 1995; Mustafa, 1999). The involvement of private sector is established with an idea of raising the level of funding available, generating more revenues and reducing deficits/debts, faster market development, increase improving project efficiency synergy, and enhancing better services over project lifetime since the risks are allocated to the best party to manage them. As the operational process is getting more efficient and the profit of the project output is being considered, the project turns to be attractive to the investors and thus, economically feasible.

An autonomous organization within the body of Public-Private Partnership (PPP) project is essential to posit as “the heart” of the project. Many activities in project/ construction management are often confined within national or cultural boundaries due to lack of knowledge, reluctance (inertia) to change, resource constraints, high pressure on growing project. They require immediate results, and the complex nature of issues in this field such as sensitive and confidential data (Loosemore, 1999). Furthermore, the evolving knowledge and expertise in infrastructure PPPs are widely dispersed, inadequately documented, and rarely analyzed or compared (Zhang, 2004). The concessionaire company functions as an independent legal entity, named Special Purpose Vehicle (SPV), must be set up not only to secure the risk allocation and sharing, but also the interest of all parties involved. In addition, PPP project also engages many different stakeholders with different roles such as lenders, financial institutions, public sector, guarantors, suppliers and off-takers. In PPP project, the concession company deals with different participants in the project in terms of legal and financial aspects. The sponsors of the SPV are usually a consortium of shareholders who may be investors or have other interest in the project.

The financing structures, risk sharing arrangement and host government participation have a significant impact on the success or failure of a project. At the same time, the financial evaluation of privatized infrastructure project is complex and challenging because of the complexity of the non-recourse financing techniques and a variety of risks and uncertainties related to project finance, which make the forecasting of cash flows very difficult (Zhang, 2005a). Then, it is necessary to facilitate the aims of public-private win-win principle, considering interests, concerns and requirements between the contracting parties within the PPP project, in order to bind them, defining their relationships and obligations. It is also critical to ensure that PPP delivery achieves maximum Value for Money in the terms of service over the project’s life.

Continuous project funding through numerous project development phases and prediction of revenue stream is required to be ensured in order to achieve the maximum project VFM and to fulfill each stakeholder’s interest and goals as well. The guarantee from project financiers to raise funds throughout the development process is the life-blood of the project. However, the profits are usually gained after the operation phase is initiated, while in the meantime the SPV has the obligation for full financing the development process. Developing and managing funding in PPP project is extremely complex process due to long-term timeframe (± 20-30 years) and various different participants involved with different functions and interests from investing to the project. Instead of all project difficulties, an excellent and careful arrangement and consideration of all the possible related aspects is required to ensure that the project will generate adequate revenue to reimburse the initial funding with the interest. The involvement of government support plays critical role in order to mobilize private loans and equity in developing countries which typically considered having high country risk. It creates favorable political, legal and economic investment environment for the project funders.

Government support and guarantees in long-term PPP scheme is an essential approach in enhancing the financial viability of PPP projects within uncertain environments and involving various kinds of stakeholders. However, many issues can be considered in utilizing such kind of approaches. Ms. Yessie Agustina made a study intended to: (1) identify the essential performance parameters of PPP contract and variables to those parameters concerning PPP risk factors; (2) identify the needs of government support and determine option range level of government support concerning power plant projects in Asian developing countries with emphasize on risk allocation; and (3) assess the effectiveness and deficiencies of government support mechanisms in various project cases and develop guidelines for similar project condition

Conclusion
To facilitate the creating of favorable investment among those many inherent uncertainties and risk of PPP schemes, necessary host government support is needed to optimize the investment security and maintain a balanced risk-return structure. The support and guarantees should then be laid beneath each contract with consideration to the severity of negative consequences emerge from the absence of those support and guarantees to the ability of the project to service its debt on time and in full. Then those support mechanism will provide a sufficient confidence to project investors so that the project becomes financially viable.

Involvement of the government in supporting those four power plant projects were examined based on eight important aspects in PPP contract, which are: (1) land acquisition and site suitability; (2) cost of finance; (3) financial gain; (4) assurance of performance; (5) political, legislative, and regulations; (6) public interest and environmental issue; (7) force majeure; and (8) contract termination and default situation. The conclusions which can be derived from each abovementioned aspects are explained below.

Land acquisition and site suitability: There are two crucial points to be considered in determining the level of government support in acquiring the site. The first issue is associated with the importance of the site to the government after contract termination in terms of ownership and public interest. Second, government should initiate the coordination of land acquisition process whenever it is considered to be time consuming and expensive. Meanwhile, government is only able to provide upfront assistance in choosing the right location of site and addressing existing site deficiencies.

Cost of finance: A reliable sponsor such as World Bank is necessary both in terms of enhancing project creditworthiness and minimizing contractual dispute as it is able to develop pressure to the central government. In PPP, the state government and other government agencies such as the electricity board are often not regarded as creditworthy. Thus, the central government guarantee and counter guarantee are needed. Furthermore, the project performance is assured as the project can utilize reliable project development standards developed by such institutions. Foreign investors are looking for such investment coverage especially in an uncertain political environment. Moreover, competitive bidding and guarantee for currency exchange, convertibility and transferability are believed to maximize the use of budget in an effective and efficient manner.

Financial gain: It is strictly important that the government should guarantee minimum purchase of electricity output. Either onshore or offshore escrow account can be employed to guarantee that the loan will be repaid. Considering the economic standard and political instability in developing countries, tariff must be maintained at par or lower than the project’s competitor. It avoids political influences in the future since the government does not have to subsidize and it reduces dissatisfaction from the public.

Assurance of Performance: Government is expected to furnish a clear, consistence and objective output performance standard. The requirements are higher to open and competitive bidding process. On the other hand, inadequate standard may still generate outstanding performance and low-cost plant on condition that a consortium of experienced and reliable developer is used. The consortium will then conduct all the design, procurement, construction, operating and maintenance at once. Moreover, power purchaser and fuel supplier performance are the most important matters in power project. Any circumstances which may reduce their performance would adversely affect the project company’s ability to pay its debt. Thus, government is obligated to provide guarantee for the continuous performance standard and counter guarantee in the event of default besides maintaining the adequate risk sharing mechanism.

Political, Legislative, and Regulations: Most of developing countries are lack of legal standard to develop such large and long-term project. While on the other hand, the political instability still becomes a major concern. Therefore, government is challenged to develop an adequate legal law and regulations for infrastructure development under PPP scheme. Clear and specific legal guidelines containing the required law, regulations and approval which needs to be taken are necessary. In addition, sovereign guarantee, transparency and commitment of non-corruption are in the primary line of investors’ requirement.

Public Interest and Environmental Issue: The public emphasizes on transparency in the project development process and commitment of non-corruption from the government. The effort to improve the local community’s life and policy for domestic equity investment are also essential to obtain public support for the project. In attempting environmental preservation, the utilization of environmental friendly fuel and worldwide accepted environmental standards and management system such as World Bank standard and ISO 14001 are considered to be important.

Force Majeure: Project lenders and sponsors require government risk sharing in the event of force majeure. However, it should be limited to either the event which has material delay on project completion or material damage. While delay and cost overrun risk caused by temporary inability to produce electricity and adverse geographical location are borne by the private.

Contract Termination and Default Situation: The level of government assistance to ensure ongoing service delivery following contract termination depends on the project strategic importance to the government. At the same time, the project investors require the government to ensure that the asset will meet certain performance standard at the end of concession period taking into account asset depreciation and lower process efficiency. It also has the need to obtain the first priority to seize the project asset and to provide remedy in the event of default.

Recommendations for Contract Competency Improvement through Adequate Government Support Mechanism

The propose guidelines is supposed to lead the optimization of the risk sharing arrangements under the contractual framework. Whenever the private investors are in favor of the supports and guarantees the host government provides, the private capital can be mobilized straightforwardly. It indicates a favorable investment environment, where the private investors are confident that the project is able to provide acceptable returns to equity holders and to service its debt on time and in full. Yet, the government must be able to select the appropriate alternatives of support mechanism at its adequate level regarding to the precise project circumstances.

Her thesis abstract is copied and posted.

ABSTRACT

An appropriate arrangement within the Public Private Partnership (PPP) contractual framework is essential to ensure the financial viability of the project. The project investors are only willing to invest whenever they are confident that their investment will be reimbursed in time and in full with the interest. Due to the complex nature and numerous risks, PPP project will not be able to success unless government gives necessary support. It creates favorable political and legal investment environment as well as maintains a balance risk allocation structure. This research identifies and evaluates government support mechanism in eight PPP contractual framework parameters: (1) land acquisition and site suitability; (2) cost of finance; (3) financial gain; (4) assurance of performance; (5) political, legislative, and regulations; (6) public interest and environmental issue; (7) force majeure; and (8) contract termination and default situation, for the project to work smoothly. Four power plant projects from Asian developing countries are discussed. The research outputs will facilitate both government and private sector in selecting appropriate alternatives of government support mechanism regarding to particular project circumstances.