Public-Private-Partnerships and
Finance
Patrick Legros*
ECARES, ULB
* Part of work in progress (Dewatripont-Estache-Grout-Legros)
Background
• 80-90s:
– Lack of investment in public infrastructures
– Declining service quality
– Widespread popular support for reforms, including
privatization and creation of independent regulators
• After 1997:
– Decline in private investments
– Not as much as expected (20% of investments, 10% of
the needs)
– Urban better off than rural
– WB estimates: India might need to invest 8% or more of
GDP over the period 2006–10 to sustain annual GDP
growth at near 8% and replace old capital stocks.
A Map
• Debt as a financing scheme may generate a
virtuous cycle at the micro level
– Capital flows to PPPs if high expected returns
– However, infrastructure projects: LT, demand
uncertainty, political risk, endogenous risk in the
provision of quality
– Debt facilitates the creation of incentives
– Less endogenous risk => higher returns
• Private financing
– Role of decentralization of loans
PPPs
• Literature: costs-benefits of bundling different
phases of infrastructure development (buildingoperation).
• Little attention to the issue of financial
contracting (!)
• Important because
– Form of finance creates distortions that may undo
potential benefits of PPP contracting (micro level)
– Some forms of finance lead to more growth than
others (macro level)
On Some Benefits of PPP
• Consider a road project:
– building and operation phases, investment I.
• The quality of the road:
– high (little need for repairs) or low (many repairs).
• Depends on effort of the builder
– e = 0 (low effort) or e = 0.5 (high effort).
– Probability of low quality is 1 if low effort and 0.5 if
high effort.
– The builder’s cost of effort is C.
• Revenues at the operation stage
– V1 if high quality
– V0 if low quality
Investment Made by the State
• Conventional contracting:
– builder’s contract separated from operator’s contract:
builder does not internalize the externality of his effort
on future revenues: e = 0.
• PPP (bundling) contracting is good:
– builder cares about effect on revenues and will do high
effort when its marginal benefit outweighs its marginal
cost, or when:
0.5 (V1 - V0) ≥ C
Risk Borne by the Private Parties?
• Why shift the risk to private parties?
• Reasons:
– political economy (public accounting rules; “Enronic”
tricks)
– Cost of servicing foreign debt
– Poor fiscal performance
• In terms of efficiency: same total risk has to be
borne?
– Not if differences in access to capital market.
– Not if endogenous risk is present.
PPP Financing
• Consortium consisting of the builder and the
operator (bundling)
• Finance investment of I by equity: keep a share
1 – d of operating revenues, the private investor
gets a share d
• Finance by debt of D : if V1>D >V0, repays
min(D,V0)=V0 if low quality, repays min(D,V1)=D
if high quality.
Debt vs. Equity
Equity
Debt
Incentive:
do e = 1
1  d   0.5 V1  V0   C
0.5(V1  D)  C
Repay
investment
d  0.5 V1  V0   I
0.5( D  V0 )  I
Same repayment if d (V1  V0 )  D  V0 ,
but then,
V1  D  (1  d )(V1  V0 )
 (1  d )(V1  V0 )
The Form of Financing Matters
• Equity (paying dividends to investors) is not
optimal: a debt contract is better.
• Debt is better for effort incentives: Can give less
to the builder when V0 and therefore more when
V1, for a given expected repayment to the
investors.
• Still, when I is high enough, effort will also be low.
Summing Up
• Private financing of projects generates
additional agency costs, which
undermines the incentive benefits of ‘PPP
bundling’.
• These costs depend on the form of
financial contracting (e.g., equity vs. debt)
– Debt contracting often provides better
incentives to the PPP
Caveat
• Renegotiation
– Renegotiation of payment may be more
difficult with a financial intermediary than the
state
– Renegotiation matters for all forms of
financing
– (soft budget constraint) renegotiation with
state may be discouraged with debt
Some other Possibilities
• Foreign borrowing
– Exposure to exchange risk
– Difficult to service debt since infrastructure is locally
consumed
• Consumer financing (and preferential access)
• State
– Taxation-subsidies (tax holidays: most valuable to
profitable projects!)
– Direct investment (where are PPPs?)
– Guaranteed interest rate
What is Needed for Growth?
• Theories
– Legal system (La Porta et al.)
– Political institutions (Acemoglu-Johnson)
– Financial system (King-Levine, RajanZingales)
A Detour by China (2)
• Poor legal and financial system
• Corrupt and autocratic government
• Large but undeveloped banking system
dominated by four state owned banks.
• Stock market growing fast but still small
w.r.t. banking sector
China, India : counterexamples
• Growth fuelled by private firms
•
(Allen et al. 2005, 2006)
• Main source of financing is “self fundraising”
(even for listed and state firms in China)
• Alternative mechanisms to formal governance
(reputation and trust. Confucius beliefs?)
• A difference in China: Decentralization of loans
to local markets (right to incur debt at local level)
– Local governments supportive and participating
Decentralization
• Facilitate cooperation at the local level to
avoid fragmentation
• Help the bond market liquidity
– reduce transaction costs for secondary
market
– Facilitate transparency
Infrastructure stocks, China and India
World Bank data (Priya Basu presentation oct. 2006)
300
India
China
200
100
0
1998
2003
electricity generation,
watts per person
1998
2003
km of paved roads per
100,000 hab
1998
2003
Number of fixed lines
per 1000 people
India: Sources of Funds for Firms
Non-state sectors
Sources of Funds
All
Firms
State
Sector
Overal
l
Listed
Unlisted
SSI
SSSBE
Internal
36,3
42,0
33,1
35,0
28,8
6,4
12,5
Capital markets
17,8
12,6
20,9
20,0
22,4
31,2
28,6
Equity
13,3
8,5
16,1
15,7
16,6
29,2
27,7
Debt
4,5
4,1
4,8
4,3
5,8
2
0,9
Banks/Fin.Inst.
15,9
11,5
19,0
19,7
17,3
9,4
-8,7
Others (current
liabilities,
provisions)
30,0
33,9
26,9
25,3
31,6
53,0
67,0
Years 1991-2004.
F. Allen et al. (2006), “Financing Firms in India,” W.B., WP 3975, August 2006