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PPP – The Pros & The Cons

Public Private Partnership (P3) Benefits & Risks

February 20, 2018 © Copyright Glomacs

Many developing countries are experiencing large growth in their populations coupled with an inadequacy and rapid deterioration of their infrastructure. Also, many developing countries are suffering from a heavy debt load and are in dire need to improve their infrastructure. This is needed to serve their people, for attracting foreign capital and investment, and to prevent the flight of capital.

BOT is the terminology used for a system that uses private investment to finance projects that were formerly financed by the public sector. In this system, investors recoup their investment from the project’s revenue rather than relying on the government’s assets. BOT stands for Build-Operate-Transfer or Build-Own-Transfer. Variants of BOT include several acronyms as listed below:

BOO Build-Own-Operate

BOOT: Build-Own-Operate-Transfer

BRT: Build-Rent-Transfer

BLT: Build-Lease-Transfer

BT: Build-Transfer

BTO: Build-Transfer-Operate

DBFO: Design-Build-Finance-Operate

DCMF: Design-Construct-Manage-Finance

MOT: Modernize-Own/Operate-Transfer

ROO: Rehabilitate-Own-Operate

ROT: Rehabilitate-Own-Transfer

In this type of project financing, a private company or group is given permission to both build and operate a facility; that would otherwise be built and operated by the government or public body. Example projects may be power plants, airports, highways, tunnels, and waste treatment plants. At the end of a stipulated period of time when debts are recouped, and the investors have an acceptable return on their capital, the private company returns ownership of the project to the public body.

The contemporary term for BOT is PPP which stands for Public Private Partnership. The PPP approach has seen a large increase all over the world. Even developed countries are now suffering from an increased debt load making government financing through traditional bond sales expensive because investors are demanding higher interest rates due to high government debt levels. Even in countries with budget surpluses, PPP has been viewed as an ideal vehicle to efficient project and operational management as a direct result of private involvement.

The PPP approach offers an excellent vehicle for technology transfer, and enhancement of the local skills and knowledge of the individuals in the host country, in addition to the development of regional capital markets and new financing techniques. These positive results can be attained while limiting the exposure of the investors through offering a reasonable rate of return and serving the host country’s national and other interests.

Technology is defined here as the collective knowledge, experience, and skill needed to plan, construct, manage, operate, and market an infrastructure project. In traditional construction projects, the facility is delivered, and the foreign group supplying the know-how, and technology leaves the host country shortly after fulfilling its obligations. This short period of time does not allow for the full transfer of capability which leads to a high rate of breakdowns, interruptions, and large maintenance bills. In the PPP system, since contractors and equipment suppliers have a stake in the efficient operation of infrastructure projects, they are more likely to strive for the adoption of efficient and tested methods in the operation and management of the facility. In this case, host countries have a better opportunity to promote efficient and effective technology transfer procedures in the relatively longer period of time that the foreign group is in charge of the operation and management of the facility. If a PPP project is planned correctly, it can provide for the transfer of technology thereby reducing the foreign government’s dependence on foreign technology and enhancing their reliance on their own know-how, technology, and skill.

The appeal of PPP is in that the system provides a revenue vehicle for the host government that allows it to develop a project that otherwise would not be done due to a lack of funding. Also, Because PPP funds are from private sources, expenditures for such projects are not in the form of loans thereby not impacting the host government’s credit rating. PPP for host governments is also useful in that the system places a large incentive on the sponsoring group to fully study the project, its merits, and its expected revenue streams, since their payback is dependent on the expected revenue of the project.

Even though PPP projects normally cost the host government a higher initial cost relative to traditional financing methods, there is a great reduction of risk when a private entity undertakes the various phases of the project in an efficient and cost responsive attitude. Higher returns are the major incentive for private parties to engage in PPP projects. Another benefit of the PPP approach is that because financing bodies have an intrinsic interest in revenues, the operation of these facilities after completion can serve as a competitive benchmark model for the local industry in the host country.

With the benefits of the PPP system listed above, it is worthwhile to mention some of the problems of this method that may lead to additional costs and headaches for the host country. As the financing and legal arrangements for PPP projects are a lot more complex as compared to traditional financing methods, the host government needs to assemble its own consultation team. This expert advice may be expensive and may not be available. Also, infrastructure projects financed by PPP will have to generate enough income to satisfy the project sponsors and offer them a reasonable return on their capital. This means that costs of some services that may have been subsidized by the host country will now need to be increased and the subsidies reduced or eliminated. This has the potential of causing political unrest, however, research in this area has shown that the overall benefits to the economy exceed the potential impact on one or more sectors.

As project sponsors of PPP facilities may have a conflict of interest in supplying the host government with goods and services to be used in the project, the host governments need to ensure that they are getting the goods and services at the best and most competitive price.

There have also been numerous abuses reported on some PPP projects. In some instances, at the completion of the concession period, the governments received projects that are in dire need of repair. Some installations have either been using outdated technologies or ultra-advanced technologies that cannot be operated and maintained by the host government due to lack of expertise.

Corruption also plays a role in the demise of some PPP projects as bribes, kickbacks and exculpatory clauses inserted during contract negotiations can lead to extremely negative outcomes for governments. Also, obtaining government-backed loans by private entities for the financing of PPP projects can leave the governments and their citizens to shoulder the burden of project default, whose avoidance is the very reason the governments went to a PPP-form in the first place.

These risks need to be handled, however, it has been demonstrated from experience from several PPP projects that such arrangements can be both beneficial to project financiers and host governments as long as the issues above are considered.

This article is written by our senior consultants Dr. A. Oloufa and Dr. A. G. Hassanein.

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