PPPs%20and%20Affordability

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PPPs and Affordability

• Philippe Burger
• University of the Free State

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• Affordability in principle terms
• Affordability in practical terms
• Affordability and VFM
• Affordability, limited budget allocations and
  legally imposed budgetary limits
• Conclusion

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Affordability in principle terms

• Affordability and VFM are the benchmarks for PPP
  viability.
• Because of the off-balance sheet nature of PPPs,
  their use has led to some misconceptions
  regarding their impact on the affordability of
  projects.
• Though PPPs may enable some projects to become
  affordable, this does not stem from their
  off-balance sheet nature.
• The point is Affordability not only relates to
  PPPs, but to gov expenditure items in general.

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• Confusion about affordability created by the
  off-budget nature of PPPs
• Impression that because government not
  responsible for the acquisition of the asset,
  that PPPs are cheaper than traditional
  procurement this is a fallacy

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• In principle affordability is about whether or
  not a project falls within the long-term
  (intertemporal) budget constraint of government.
• If it does not, then the project is unaffordable.
  
• However, because the cash flows and balance sheet
  treatment of PPPs differ significantly from that
  of traditional procurement, some confusion exists
  about the effect of PPPs on affordability.

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• In principle terms, a traditionally procured
  project is affordable if the present value of the
  future revenue stream of government
• equals or exceeds the sum of expected future
  interest payments and the present value of
  governments expected capital and non-interest
  current expenditure,
• while a portion of such future expenditure
  streams is allocated to such a traditionally
  procured project.

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• In principle terms, a PPP is affordable if the
  present value of the future revenue stream of
  government
• equals or exceeds the sum of expected future
  interest payments and the present value of
  governments expected capital and non-interest
  current expenditure,
• while a portion of such future expenditure
  streams is allocated to such a PPP.

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• In both cases the positive net worth of
  government depends on whether or not the present
  value of expected future primary surpluses (i.e.
  surpluses that exclude interest payments) equal
  or exceed the value of existing public debt.
• The only essential difference between the two
  cases is between the timing of the flows

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Affordability in practical terms

• Even though the above is technically correct, it
  has one shortcoming
• Although PPPs and the PSC used in PPPs involve
  detailed present value calculations over the
  whole life of a PPP contract, governments rarely
  use present value calculations for the rest of
  their activities.
• Governments also rarely budget for a longer
  horizon than the upcoming year (although some use
  medium term fiscal forecast).
• This raises the question how should
  affordability of a PPP be assessed within an
  environment where the planning horizon is not
  very long?

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• As with other government activities in such an
  environment a PPP project is affordable if
• the expenditure it implies for government can be
  accommodated within current levels of government
  expenditure and revenue
• and if it can also be assumed that such levels
  will be and can be sustained into the future.
• This working definition of affordability allows
  for the use of present value calculations when
  estimating cost of a PPP vs that of traditional
  procurement (using a PSC), but to do so in an
  environment with a short planning horizon.

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Affordability and VFM

• Relative affordability affordability of PPP
  compared to that of traditional procurement
• Interest rate and efficiency differentials main
  determinants (of relative affordability and VFM)
• Absolute affordability Can the project
  (delivered either trough a PPP or traditional
  procurement) be accommodated within the budget
  without violating the budget constraint

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• UK
• Procuring authorities must complete affordability
  model for any planned PFI (it includes
  sensitivity analysis)
• The models based on agreed upon departmental
  figures for the years available and cautious
  assumptions about future dept spending envelopes

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• Victoria
• Decision about how a project is funded is
  separate from the decision about how it is to be
  delivered.
• Potential PPP compete with other capital projects
  for limited budget funding to ensure that they
  fall within what is considered affordable
• Funding is approved on the preliminary PSC

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• Brazil
• Project studies must include a fiscal analysis
  for the next ten years. In addition, the
  commitment of the federal budget to PPP projects
  is limited by law to 1 of the net current
  revenue of the government.
• Hungary
• From 2007 a limit on the amount of expenditure on
  PPPs within the budget, so that each program has
  to fit within this limit.

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Affordability, limited budget allocations and
legally imposed budgetary limits

• Distinction between affordability, limited budget
  allocations and legally imposed budgetary limits
• In many countries there are
• Limits on second- and third-tier government
  borrowing.
• Fiscal rules that limit government expenditure,
  deficits or debt.
• Thus, project might be affordable, but legally
  imposed budgetary limit prohibits borrowing.

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• Further example budgetary allocations of
  government departments and authorities that are
  done from a central budget and within which
  expenditure plans must be fitted.
• Even if a traditionally procured project would
  not violate the long-term budget constraint of
  government, a project may still exceed the future
  expected budgetary allocations of a specific
  government department.

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• Danger less of a focus on VFM and create an
  incentive to get project off the books of
  government
• Three specific cases when there is an incentive
  to get project of the books of government
• The first case is one where a project cannot be
  delivered through either traditional procurement
  or a PPP within budgetary limits.
• Has 3 features, but a short-run focus on the 1st
  and a disregard for the 2nd and 3rd by government
  creates the incentive to go the PPP route

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1. Should government use traditional procurement,
   the large initial capital outlay will cause a
   government entity to exceed its allocated budget.
   
2. Should entity then decide to go the PPP route, it
   may not be able to make future fee payments to
   private partners without exceeding its expected
   future allocated budgets.
3. In addition, the private partner also cannot
   impose a user charge on the direct consumers of
   the service.

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• Second case shares the same features with the
  first with the exception that instead of
  receiving a fee from gov, the priv partner can
  impose a user charge directly on the consumers of
  the service
• As a result, the project might fit within the
  budget allocation of the government entity.
• Additional question Is the higher
  tax-plus-user-charge burden of those individuals
  benefiting from the good or services acceptable?

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• Third case occurs when gov operates under a
  fiscal rule that sets a limit on the overall
  fiscal balance of government (or a department
  operates under a budget allocation).
• Traditional procurement Capital outlays may
  contribute to breaking the budgetary limit in the
  year in which government undertakes outlays.
• PPP Private sector responsible for initial
  capital outlay and government might be able to
  fit future payment of fees to private partner
  into its budget without exceeding the budget
  limit.

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• In all three cases the budgetary limit may be
  main reason why government might want to get
  projects of its books.
• However, main reason should be higher VFM.
• This is not an argument against budgetary limits
  and rules rather it is an argument in favour of
  emphasising VFM as the main rationale for going
  the PPP route

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Conclusion

• Because of the off-balance sheet nature of PPPs,
  there has been some misconceptions regarding
  their impact on the affordability of projects
• On the whole, these misconceptions may lead to a
  shift of focus away from VFM as the main
  rationale for doing PPPs
• The analysis, though, indicates that
  affordability has little, if not nothing, to do
  with the set of books on which the project
  appears