Public Private Partnership

Pranjal Kapoor

Deloitte

Infrastructure
Road/Highways Sector
Public Private Partnership (PPP)
A public private partnership is defined as a cooperative venture
between the public and private sectors, built on the expertise of each
partner that best meets clearly defined public needs through the
appropriate allocation of resources, risk and rewards.
PPP is a way out to solve public deficit financing. It is done to give rise
to speedy infrastructure growth.
The Public Private Partnership has emerged as one of the most
important models government use to close the infrastructure gap.
For example, a city government might be heavily indebted, but a
private enterprise might be interested in funding the project's
construction in exchange for receiving the operating profits once the
project is complete.

Why PPP model?

There are usually two fundamental drivers for PPPs. Firstly, PPPs
enable the public sector to harness the expertise and efficiencies that
the private sector can bring to the delivery of certain facilities and
services traditionally procured and delivered by the public sector.
Secondly, a PPP is structured so that the public sector body seeking
to make a capital investment does not incur any borrowing. Rather,
the PPP borrowing is incurred by the private sector vehicle
implementing the project and therefore, from the public sector's

perspective, a PPP is an "off-balance sheet" method of financing the

delivery of new or refurbished public sector assets.
Characteristics of PPP model:

- Shared goals
- Shared resources (time, money, human resource).
- Shared risk
- Shared benefits

How PPP model works?

A PPP typically works as follows:
Bidding process. A public sector entity (usually a central government
body/local authority) will identify the need to deliver a particular
project, such as building a Highway or a hospital. The public entity will
advertise the need for such a project and then run a competitive
process under which private sector entities will "bid" in order to win the
right to deliver the project. The winning private sector bidder is then
awarded a "Concession" to implement its solution.
Project Company. A private sector entity will contract with the public
entity and raise funds from investors and lenders in order to deliver
the project (the "Project Company"). Usually, a new, separate, private
company will be set up to be the Project Company in order to insulate
the private sector sponsors of the project from the risk of insolvency if

the project fails. This new company is known as a "special purpose

vehicle" (an "SPV").

Sponsor. The activities of the Project Company will be managed by

one or more private sector companies (the "Sponsor"). Typically, the
Project Company is set up as a direct/indirect subsidiary of the
Sponsor. The Sponsors are usually the equity investment divisions of
large construction or facilities management companies who want their
construction or facilities management divisions to deliver the project.
This arrangement will be documented in a "Shareholders' Agreement".
Documentation. The Project Company will enter into a contract with
the public sector (the "Concession Agreement"). This is the key
document detailing the terms and conditions of the project.
Contractors. The Project Company will enter into contracts to enable
it to implement the project as it will typically have no employees. There
will usually be one entity who is made responsible for the delivery of
the facilities management services detailed in the Concession
Agreement (the "FM Contractor"), and another entity who is made
responsible for the provision of the construction works detailed in the
Concession Agreement (the "Construction Contractor"). Certain
responsibilities may be sub-contracted to other more specialist entities
(the Sub-Contractors).
Funding. The Project Company will obtain private funding in order to
finance the PPP. Usually, funds are made up of a mix of investments
by Sponsors (usually a small proportion of the overall debt) and loans

from outside lenders (the "Lenders"). The Lenders will enter into
"Financing Agreements" and "Security Agreements" with the Project
Company, under which they agree to lend in return for security over
the project. There will often also be "Direct Agreements". Project
finance is provided on the strength of the cash flows of the Project
Company, therefore the Concession Agreement is key. The payments
made by the public sector entity are the sole income stream into the
Project Company so if the Concession Agreement is terminated, the
Project Company will have no means of repaying its debts. If a project
starts to go wrong and the Project Company's right to deliver the
contract is in danger of being terminated by the public sector entity
then Lenders can rely on Direct Agreements to prevent the
Concession Agreement from being terminated until the Lenders have
had a chance to "step in" to the Project Company's shoes and attempt
to remedy the situation.
Lenders may include commercial banks with experience in project
finance, export credit agencies ("ECAs"), multi-lateral agencies
("MLAs") and development finance institutions ("DFIs"):
ECAs are governmental or quasi-governmental institutions. ECAs
provide finance to promote national exports. An ECA can act either as
a guarantor, an insurer or a lender. They have different models and
they can be government institutions (e.g. ECGD, K-EXIM) or private
companies operating on behalf of the government (e.g. Hermes,
COFACE).
MLAs are governmental institutions owned by a number of
governments. Whereas an ECA's prime aim is to support national
economic interests, an MLA's mandate is to further economic
development in developing countries. Major MLAs include the Asian
Development Bank and African Development Bank.

 DFIs provide long-term development finance for private sector

enterprises in developing countries. Examples include DEG
(Germany) and FMO (Netherlands).

Benefits of PPP:

- Public private partnerships allow the costs of the investment to be

spread over the lifetime of the asset and thus can allow
infrastructure projects to be brought forward by years compared
with the pay-as-you-go financing typical of many infrastructure
growth.

- PPPs transfer certain risks to the private sector and provides

incentives for assets to be properly maintained.

- PPP can lower the cost of infrastructure by reducing both

construction cost and overall life cycle costs.

- Private sector involvement could be a good means of having

technology enhancement and operational efficiency.
Disadvantages of PPP:
- The number of parties involved and the long-term nature of their
relationships often result in complicated contracts and complex
negotiations, and therefore high transaction and legal costs. PPP
projects can take years to complete.
- There is a risk that the private sector party will become insolvent or
make large profits during the course of the project this can cause
political problems for the public entity.
PPP models:

- Design Build - The government contracts with a private partner to

design and build a facility. After completing the facility, the
government assumes the responsibility of operating and
maintaining.

- Design Build Maintain - This model is similar to Design-Build except

that the private sector also maintains the facility.

- Design Build Operate - Private sector designs and builds a facility.

Once the facility is completed, the title for the new facility is

transferred to the public sector, while the private sector operates the
facility for a specified period.

- Design Build Operate Maintain/ Build operate transfer (BOT) - It

combines the responsibilities of design-build procurements with the
operations and maintenance of a facility for a specified period by a
private sector partner. At the end of that period, the operation of the
facility is transferred back to the public sector.

- Build Own Operate Transfer - The government grants a franchise to

a private partner to finance, design, build and operate a facility for a
specified period of time. Ownership of the facility is transferred back
to the private sector at the end of that period.

- Build Own Operate - The government grants the right to finance,

design, build, operate and maintain a project to a private entity,
which retains ownership of the project. The private entity is not
required to transfer the facility back to the government.
PPP maturity model One offshoot of the rapid growth of infrastructure PPPs is that
countries remain at vastly different stages of understanding and
sophistication in using innovative partnership models.
There are three distinct stages of PPP maturity
Stage one

- Establish policy & legislative framework.

- Develop deal structures.
- Begin to build market place.
- Initiate central PPP policy unit to guide implementation.

Stage two

- Establish dedicated PPP units in agencies.

- Begin developing new hybrid delivery models.
- Leverage new sources of funds from capital markets.
- Use PPPs to drive service innovation.
Stage three

- Refine new innovative models.

- Use of more sophisticated models.
- Greater focus on total lifecycle of project.
- More creative, flexible approaches applied to roles of public &
private sector.

PPP maturity curve country wise:-

Challenges of PPP in India:

- Regulatory environment: There is no independent PPP regulator as

of now. In order to attract more domestic and international private
funding of the infrastructure, a more robust regulatory environment,
with an independent regulator is essential.

- Lack of information: The PPP program lacks a comprehensive

database regarding the projects to be awarded under PPP. An
online data base, consisting of all the project documents including

feasibility reports, concession agreements and status of various

clearances and land acquisition will be helpful to all the bidders.

- Financing availability: The private sector is dependent upon

commercial banks to raise debt for the PPP projects. With
commercial banks reaching the sectoral exposure limits, and large
Indian Infrastructure companies being highly leveraged, funding the
PPP projects is getting difficult.

- Project development: The project development activities such as

detailed feasibility study, land acquisition; environmental/forest
clearances etc. are not given adequate importance by the
concessioning authorities. The absence of adequate project
development by authorities leads to reduced interest by the private
sector, misplacing and many times delays at the time of execution.

Benefits government can achieve by using PPPs -

- Bringing construction forward:

- On time and On-budget delivery: Public Private Partnerships also
have a solid track record of completing construction on time or even
ahead if schedule.

- Shifting Construction and Maintenance Risk to the Private Sector:

Politics and Budget pressures play havoc with proper maintenance
of existing infrastructure. There are various risk involved that could
hamper the progress of the construction and could also defer the
maintenance ultimately imposing huge cost. Well-designed PPPs
can ameliorate these problems by transferring certain construction
and maintenance risk to the private partner.

- Cost Savings: Cost savings in several different forms, maintenance

cost and lower cost of associated risk.

- Strong Customer Service Orientation: Private sector, often relying

on user fees from customers for revenue, have a strong incentive to
focus on providing superior customer service.

- Enabling public sector to focus on outcomes and core business:

PPPs enable governments to focus on outcomes instead of inputs.
Government can focus leadership attention on the outcome based
public value they are trying to create.
Overview of Indian Roads:
Indias road network of over 4.1 million km is second largest in the
world consisting of expressways, national highways, state highways,
major district roads and other roads. These roads carry about 65 per
cent of freight and 80 per cent of passenger traffic. National highways
constitute only 1.7 per cent of the road network, but carry about 40 per
cent of the total road traffic. Road Transport has emerged as the
dominant segment in Indias transportation sector with a share of 4.7%
in Indias GDP in 2009-10. The number of vehicles on Indian roads
has been growing at an average pace of 10.16% per annum over the
last five years. Hence, development of road network assumes
paramount importance in the context of a rapidly growing economy.

Investment in Road Sector:

Investment in the roads sector during the Tenth Five Year Plan (200712) and the Eleventh Five Year Plan (2007-12) are shown below:

National Highways Authority of India (NHAI):

The National Highways Authority of India (NHAI) was established as a
statutory entity under the National Highways Authority Act 1988 for
development, maintenance and management of National Highways.
Its initial mandate was restricted to a few projects undertaken with
external assistance. From 1998 onwards, the Government has been
implementing the National Highways Development Programme
(NHDP) comprising:
Phase I: Augmenting the Golden Quadrilateral connecting the four
largest metropolis.
Phase II: Augmenting the North-South and East-West corridors.
Phase III: Four-laning of high-density national highways connecting
state capitals and places of economic, commercial and tourist
importance.
Phase IV: Up gradation of single-lane roads to two-lane standards.
Phase V: Six-laning of four-laned highways.

Phase VI: Construction of 1,000 km of expressways.

Phase VII: Construction of ring roads, by-passes, underpasses,
flyovers, etc.

Public Private Partnership in National Highways:

Owing to constraints of public funding, Public Private Partnership
(PPP) has come to play a major role in the development of national
highways. The National Highways Act, 1956 was amended in 1995
with a view to enabling private investment in development,
maintenance and operation of highways. The Government initiated

several other measures in this direction such as declaration of road

sector as industry to facilitate borrowing on easy terms and reduction
in the custom duties on construction equipment.
Several government initiatives have been taken to enhance
private sector participation (PPP) in road sector:

- Viability Gap funding in the form if capital grants subsidy of up to

-

40% of project cost.

100% tax exemption in any consecutive 10 years out of 20 years.
Duty-free import of certain identified high quality construction plants
and equipment.
Allowing FDI up to 100% in the sector.
Long concession period of up to 30 years.
Right to collect and retain toll.
Model concession agreements for state highways.
Standardizing of model bidding documents.

Public Private Partnership downfall in India:

Lately it has been noticed that PPP projects in India are not taking off.
The main reasons:

- Lack of clarity about project objectives: Sponsors sometimes lack

-

consensus about the purpose of and expected outcomes for the

project.
Too much focus on the transaction: The government may view
PPPs merely as financing instruments when in fact they represent a
very different way of working. This has led to poor operational
focus.
Conflicting interest of multiple shareholders.

- Inflated traffic projections made in the beginning.

- Renegotiating contracts: It is the duty of the private company to
-

continue to meet the commitments originally made in the

concession agreement without asking for contract renegotiation.
There are delays in handling over the entire land in time, inefficient
project planning.
Use of inappropriate business models.
Slowdown in the economy and lack of funding available.
Delayed legal clearances and aggressive bidding have emerged as
two major factors causing problem.

Some recommendations:
Understanding of proposed assets.
Integration between all parties involved for smooth information flow.
Prudent sharing of risk and rewards among all the parties involved.
Better preparations before the process of bidding for a PPP project.
Ill equipped consultants, selected through lowest bid could also be
the root cause of failure, so choosing the right consultants also
plays an important role.
- Government should assist the private partner throughout the project
and ensure that the capital invested sees fair rate of return.
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