Making PPPs work again
4 min read . Updated: 21 Jul 2014, 01:59 PM IST
PremiumIf PPPs are to work, the division of risks between private contractors and the government has to be transparent
The Mumbai monsoon in its full fury, a taxi driver from Varanasi, and the budget day steered the conversation towards the Ganga. “ ₹ 2,000 crore theek hai, magar implement kaise hoga?", I earnestly enquired of the man behind the wheel. How would the mammoth task of cleaning the river materialize despite the funds allocated to it by the first budget of the National Democratic Alliance (NDA) government? The driver, clearly smitten by Narendra Modi and his promise of achhe din (good days) nonchalantly exclaimed, “Sir, PPP."
The treasury benches have often thrown in public-private partnerships (PPPs) in budget speeches over the last two decades; so much so that its shorthand, PPP, is bordering on becoming colloquial. In a country high on hope and aspiration, but starved for capital and technical expertise, privatization of big infrastructure and services is inevitable and desirable. But privatization is a bad word. Its more kosher version, PPP is, however, digestible. In subcontinental spirit, like all else that came to our shores, we are Hinduising capitalism—gleefully taking from it, and teaching it a thing or two of our own.
So, what is a PPP? Though widely practised, there is no clear internationally accepted definition. Broadly speaking, it is contractual arrangement between the public sector and a private party where the latter infuses capital, and constructs, operates, or provide some other service that is either a public good or in larger public interest. While hiring private firms to clean the Ganga could very loosely be termed a PPP, infrastructure projects such as in mining, power, transport, etc. fit the more routine definition.
Three key principles characterize a successful PPP. First, the mechanism employed to select the private party should be transparent and driven by some semblance of a market price. Second, it should have a clear contractual structure of capital investment and revenue sharing between the public and private parties. And, third, a substantial portion of the risk associated with the project must be borne by the private party. These principles have been repeatedly flouted in many infrastructure projects over the last few years. The coal and 2G scandals made a mockery of the first. Reliance Industries Ltd’s handling of the KG basin gas reserves has bulldozed two and three.
On the first principle, the government has the option of holding an auction or assignment through bilateral negotiations. There is nothing sacred about an auction. However, in a scenario where negotiations can turn into personal discretion, it is a fair and efficient method of allocation. Beyond the usual and non-ignorable rants of collusion, the problem with infrastructure projects is that the bidders face extremely high levels of uncertainty regarding their valuations—costs of production and revenue stream can be fairly unpredictable. Thus, the instruments of the auction need to be carefully chosen. Should we bid on large upfront payments, or fraction of revenue sharing, or number of years of private operation, or a combination? Moreover, renegotiations are often unavoidable, which can render the original auction impotent.
This leads us to the principles of ownership and risk. Who claims the revenues from the Gurgaon-Delhi highway and till when? What happens to the price of gas in the event of a macroeconomic shock? While renegotiation of these terms can in many cases be socially desirable, outright dependence on it by the bidders can completely handicap the mechanism—bid to give the government a very large share of the pie, lock in the upfront capital and then renegotiate later for more favourable rent-seeking terms.
Often the holdup has large social costs. For example the refusal of the big firms to show up for the spectrum auction last year to renew their licences is a collusive tactic to force government’s hand. The government cannot possibly shut down mobile technology for three-fourths of the country. Airwaves, which are a public good, need a better mechanism of private ownership.
The economic purpose of a PPP is beaten if the government is made to bear a large portion of the risk. If the price of coal has gone up because of a Supreme Court judgment and forced imports, should the new private power plants be subsidized? Successful private enterprises successfully allocate risk. Thus, a well specified and flexible contractual structure is a prerequisite of efficient implementation. In a large body of research on PPPs, economists Eduardo Engel, Ronald Fischer and Alexander Galetovic have repeatedly emphasize poor design as a common pitfall.
Moreover, in India, government commitment has been found lacking. Should the government commit to a certain mechanism by holding up to its terms and send a clear signal to future participants? Unfortunately, a large number of PPPs are directly financed to the end by nationalized banks. With non-performing assets on the rise and financial stability in question, a hold-up of these projects bears a direct cost for the taxpayer. Better financial management and impetus to the corporate bond market are key steps to improve upon principles two and three.
In the second chapter of the Economic Survey for 2014-15 titled Issue and Priorities, which lays out the new government’s economic plan, the word “mechanism" appears 11 times. To implement macro plans, an approach that resembles engineering is required towards design. Hinduising the mechanism design of PPPs is the need of the hour.
Rohit Lamba is a post-doctoral fellow at the Institute for New Economic Thinking at the University of Cambridge.
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