PPP - The issue on risks and returns

 We look at Public-Private Partnership (PPP) as a scheme where the private sector gets involved in the delivery of public infrastructure projects and services.  But we have stated last Sunday that the private sector’s main reason for getting involved is mainly to generate a return.  Or simply said, they are in for the profit.

Investments are ways to make more money, measured as a percentage of your original money called capital.  That percentage is called the return on investment - the higher that is, the better and more attractive is the investment.  But the other side of the coin, as all investors know, is the degree of risks associated with such investments.  In general, the higher the risks, the higher the returns.  The safest investment even a child can have is a savings account in the bank where you get less that 1 or 2% interest per annum with relatively zero risk (unless there’s a bank run which is rare).  Time deposits will give you higher interest earnings but with some higher risks.  The even riskier options for the aggressive investor are stock, bonds, mutual funds, and the like which generates ample returns.  Of course, one can go into business itself with the possibility of getting 50% returns or even double your money in a short period of time but at a risk of losing everything you have!

This poses the first hurdle in PPP, because the government, or specifically the people in it, wouldn’t want to take risks.  With a private individual or company, you take risks because you are “gambling” with your own money.  In government, you are managing “people’s money” and you are generally graded as to how much you guard it and put it to best use, and without waste it either through inefficiency or corruption or both.  Start taking some risks and you face the possibility of the Commission on Audit (COA) running after you or the Ombudsman, or in the case of politicians, opponents making issues against you during elections.

That’s why government has such stringent laws on budgeting, accounting, auditing, and procurement, which oftentimes looks unreasonable especially for the project sector, since processes are very tedious and time consuming.

So when government solicits the involvement of private sector through PPP, it has to be through the offer of higher returns but with higher risks.  Government is generally conservative minimizing risks by setting lower returns in investment.  In fact many government undertakings do not make financial returns at all.  Projects like roads, schools, day-care centers, and other government buildings do not generate income at all.  Other government enterprises do make money but their rates of return vary considerably.  The ones which can generate income or revenues are the ones open for PPP.  Others like lighthouses could never be PPP’ed unless we find a way to collect fees for a service which everybody can see and use.

Thus, in the case of PPP’eable projects, the most important matters to discuss are the sharing of revenues (and costs) between government and the private sector partner, and the sharing of risks.  This is shown in the risk allocation matrix, and important instrument in any PPP agreement, and there has to be a balance of the financial agreements and the allocation of risks.  You give more returns to the private sector while keeping the risks with government and you face the risk of an Ombudsman investigation.  Giving the risks to the private sector while keeping much of the revenue will simply result in a scenario of “no takers” and a failure of the PPP.  The goal of getting a successful PPP is through the formulation of a balanced PPP structure or “Business Case” such that we download as much risks to the private sector while allowing them latitude of return on investment such that overall, over the entire duration of the PPP agreement, it would be considered positively beneficial for government.