PPIAF

October 22, 2009

Effective management of contingent liabilities is at the heart of any successful infrastructure public-private partnership. What is the best way to apportion risks between governments and the private sector and how are these risks valued, disclosed and monitored? How can governments manage the risks they take on? These critical questions were the topic of discussion at a recent PPIAF-sponsored event to present the study “Managing Contingent Liabilities in Public-Private Partnerships: Practice in Australia, Chile, and South Africa.”

Contingent liabilities often take the form of government debt or revenue guarantees offered to a service provider to make a project seem less risky and more attractive to private investors. These contingent liabilities create fiscal risks and uncertainties for governments and could ultimately increase their debt burdens.

Much has been written about the principles for managing contingent liabilities in infrastructure public-private partnerships (PPP), but relatively little has been written on actual government practices. The goal of this study was to focus on how governments in Australia, Chile and South Africa actually manage contingent liabilities, and what other countries could learn from their experiences. This includes looking at who approves PPPs, what is done to gauge potential liabilities, and what monitoring systems exist to give warning before liabilities are incurred.

How Are PPP Projects Approved?

Following the presentation by Tim Irwin, the study’s author, on the PPP approval processes used by the three countries, several participants at the event expressed some doubt that the models discussed in the study could apply to other smaller countries with limited administrative capacity given that Australia, Chile and South Africa are large countries with an efficient and well-trained public sector.

In response, Irwin pointed out several practices that should apply to every country. Any country could benefit from a codified, multi-stage review process for PPPs that incorporates the ministry of finance and seeks to identify potential liabilities as early as possible.  In addition, he advised against having the government body approving PPPs also promoting them, as this would result in a conflict of interest and a bias toward PPPs. 

How Are the Contingent Liabilities Valued?

 The study revealed that the three countries investigated, as well as a number of other ones, used fairly sophisticated techniques for valuing risks. In Chile, for instance, guarantees are monitored using a cash flow at risk spreadsheet model, and extensive information on contingent liabilities is published in the government’s annual reports. Irwin stated that limited administrative capacity is a poor reason for not estimating the cost of risk of a guarantee. He stated that the analysis could be simple but still useful. Irwin further suggested that governments in this situation are better off seeking advice of external advisors or not offering the guarantee.  He also emphasized the importance of good qualitative analysis in addition to the quantitative analysis.

Getting the Incentives Right

The study revealed that one of the reasons governments turn to public-private partnerships is to get around debt constraints and accounting rules.  This point also came up during the discussion as participants voiced their concern about governments often selecting PPPs for the wrong reasons and not for the expected efficiency gains. Irwin advocated an approach that allows a fair comparison between public-private partnerships and traditional methods of financing infrastructure. He emphasized the importance of getting the incentives right to avoid biasing the decision toward, or away from, PPPs. 

One approach is that used by Victoria, Australia where the departments receive budget funding for a publicly financed project before a decision is made to undertake the project as a PPP. This clearly removes the illusion that PPPs appear free. This also has helped the state avoid taking on risks they could not control. However, for some countries, this entails governments going to the capital market to raise funds that they might end up not needing if the PPP option is selected.

The study will be finalized and disseminated soon. Please contact us -- ppiaf@ppiaf.org -- if you want a copy.