Can we afford this?

At first glance, public-private partnerships (PPPs) seem to be a government’s best friend in times of crisis.

After all, PPPs allow governments to provide a shot in the arm to ailing national economies by stimulating private investment and creating jobs. Crucially, upfront infrastructure costs are shouldered by the private sector, with public repayments to the private parties spread over many years.

But in the wake of Europe’s unfolding sovereign debt crisis, new questions are being raised on whether indebted European governments with sluggish growth estimates can continue to rely on PPPs’ off-balance sheet magic as a path to economic growth.

There is a case to be answered about whether any government can expect to get away with ‘off the books’ liabilities nowadays – regardless of their legality or otherwise – following the devastating impact of Greece’s Goldman Sachs-sponsored currency trade deals. These deals allowed Greece to effectively receive loans using derivatives that could be kept under the budget radar.

Critics will make the argument that PPPs are just another expression of this malaise, allowing governments to spend more on infrastructure than they can really afford by shifting liabilities off the books.

This argument conveniently ignores some of the disadvantages of public procurement, such as delays to project delivery, cost overruns and the private sector’s arguably superior ability to manage infrastructure assets.

However, it would be disingenuous to ignore how PPPs can tempt governments into using them as a sort of infrastructure-related credit card, allowing states to bite off more than they can responsibly chew.

On the back-burner

Recently, Portuguese Prime Minister Jose Socrates, under pressure from both the international money markets and vociferous domestic political opposition, announced that he would postpone many of his government’s intended flagship PPPs, including Lisbon’s new €5 billion airport and several tranches of what was once projected to be an €8.5 billion high-speed rail network.

PPPs are not a panacea that can be used to procure all types of public works under every circumstance

Mariana Abrantes

These projects were central to the government’s economic programme, which also included a €5 billion PPP roads programme, successfully procured in the midst of the financial crisis. However, many in Portugal started raising serious concerns about the current government’s use of PPPs and how they could constrain the country’s budgetary capacity down the line.

Eduardo Catroga, an ex-finance minister and well-known Portuguese economist, warned in an opinion article that the PPP commitments “assumed or projected by the state (directly or indirectly) for the next few years (especially starting in 2013) represent about 12 percent of 2008’s gross domestic product (GDP), or about €20 billion…an enormous figure,” he stated in May 2009. By the end of the year, new estimates revised that figure to €28 billion.

In contrast, the capital value of UK projects procured through its project finance initiative (PFI) – the country’s standardised PPP procurement process – was close to five percent of the UK’s GDP in 2009, or about £64 billion (€78 billion; $93 billion), The Economist recently reported. This difference is significant considering that the PFI initiative started in 1992, the exact same year Portugal signed its first PPP contract.

More worryingly, Catroga pointed out at a recent economic forum that if the current government were to go through with all of its projected PPPs, then the accumulated capital value of Portuguese PPPs would represent about 30 percent of the country’s 2008 GDP, or some €55 billion.

The main problem, Catroga argues, is that it is doubtful whether many of these investments will help solve the Portuguese economy’s structural weaknesses and significantly contribute to the country’s long-term GDP growth, which has been declining over the last decade from an annual growth of three percent to just one percent in 2010.

As European governments struggle with sluggish growth prospects and burgeoning deficits, the question of what they can afford is more pertinent than ever, with new PPP investments coming under the microscope regarding their affordability and potential to stimulate growth.

Move to transparency

The UK’s new coalition government has taken the notable step of waiving the right to record PPP/PFI projects off balance sheet as part of a stated ambition to record liabilities more transparently in the face of a record debt burden.

Shortly after coming to power, new UK chancellor George Osborne took steps to bring some £217 billion of PFI liabilities back onto the balance sheet in a move that also includes accounting for pension liabilities in the new budget. The PFI liabilities are the result of 630 signed contracts and will have to be paid between now and 2033, law firm Norton Rose wrote in a pre-election briefing.

On the campaign trail, Osborne pledged to stop using PFI as the default procurement method for public works, with future projects having to clearly demonstrate value for money and a thorough risk transferral to the private sector. As many as seven ongoing PFI projects are said to have already been put on hold as the new government conducts a spending review.

Signalling that the “value for money” theme is here to stay, the UK’s National Audit Office (NAO), an independent body that scrutinises public spending, has recently opened an inquiry into the £6 billion M25 road PFI contract to determine whether the procuring authority “selected a cost-effective option to deliver its objectives and value for money” considering that the contract was signed at the height of the credit crunch.

The NAO’s conclusions are unlikely to derail the contract but could push the M25’s bank loans – priced at between 250 basis points and 350 basis points – to be refinanced earlier than expected in a bid to lower the availability payments being made by procuring authority the Highways Agency, an industry source suggested.

Robert Bain, an independent consultant (see interview, p.XX), is on record as saying that the M25 scheme was likely to increase the “Highways Agency’s PFI-related obligations up to nearly 40 percent of its budget”. However, the road agency’s PFI schemes, while taking up almost half its budget, only account for 17 percent of the UK’s road network, Bain added.

But if Europe’s sovereign debt crisis is highlighting how PPPs can compromise central government budgets over the long term, their impact can be equally severe at a regional level.

Towards the latter part of 2009, Standard & Poor’s (S&P) assigned a negative outlook to the AA+ credit rating of the Autonomous Community of Madrid, “because servicing PPP debt now accounts for 60 percent to 75 percent of its spending – severely constraining future expenditure flexibility,” Bain stated. Shortly after, S&P downgraded Madrid’s credit rating to AA, saying the crisis had significantly reduced its available cash flows.

Mariana Abrantes, a Portuguese economist who advised on the country’s first PPP contract, argues there is nothing wrong with the PPP model. But she warned in a recent interview that PPPs “are not a panacea that can be used to procure all types of public works under every circumstance,” without severe consequences.

As Bain wrote, regarding Madrid’s debt woes: “That’s what happens when you buy infrastructure on the government credit card, rather than exploring what consumers might actually be willing to pay for premium facilities like user-paid toll roads.”