Public-Private Partnerships: Pathway to sustainable infrastructure development in Sri Lanka

Given the fiscal constraints faced by the Government of Sri Lanka, PPPs should be a key implementation mechanism for large-scale infrastructure projects

Introduction

Public Private Partnerships (PPP) are long-term agreements between the public and private sectors to create or operate public assets. The advantages of PPPs extend far beyond mere financial considerations. They bring with them the efficiencies of the private sector in construction and operations, enhancing the speed of development and the quality of infrastructure. One of the key benefits is the ability of PPPs to generate additional resources outside government budgets. 

The recent economic and social disruptions caused by the COVID-19 pandemic have forced policymakers to revise their budgetary allocations, focusing more on social programs and reducing the headroom available for infrastructure investments. There is a general pressure on governments worldwide to increase spending on social programs and consequently the governments may have to rely more heavily on PPPs and asset monetisation to meet the funding requirements of economic and infrastructure development programs.

Shifting focus in the SAARC region

Governments in the SAARC region are increasingly shifting focus away from profit-making ventures, recognising that the private sector typically operates with greater efficiency and expertise. A notable trend in the region is the transfer of existing assets to the private sector, with proceeds being reinvested into priority areas for the government – a process commonly known as asset recycling. For example, in India, the federal government has embarked upon a program for monetising National Highways wherein existing highways are handed over to the private sector for operations, maintenance and user fee collection in lieu of upfront payments. Such upfront payments are then reinvested for the furtherance of the National Highways development and in the process has opened the sector to investors who would typically not take on the construction risk. 

Identification and selection process

While a specific PPP law is advantageous, experts believe it is not essential to explore PPPs, particularly in countries like ours where the existing legislative framework does not restrict such ventures. Crucial elements for successful PPP implementation include: (1) a robust and transparent process for project identification, project preparation, development and execution; (2) effective project structuring with well-balanced risk-reward allocation to both the public and private sectors and (3) clear guidelines for post award contract management. 

Projects suitable for PPPs can be identified through two main approaches: 

(1) Top-Down Approach: Establish a national policy for infrastructure and direct the respective line ministries to identify suitable projects in line with this policy 

(2) Bottom-Up Approach: Line ministries identify projects based on need, and seek national level buy-in 

Once identified, projects must be ranked and prioritised based on parameters such as economic and social need, financial viability, cost-benefit analysis, government financial assistance requirements, risk allocation frameworks, and user and investor appetite. It is important that a healthy pipeline of well-prepared projects is maintained by the government to avoid ill-prepared projects being floated in the market.

Optimal risk allocation through effective project structuring

For PPPs to be successful, the incentive structures must be attractive to the private sector, with due attention given to risk allocation. The government should ideally retain control of the PPP project, through regulations and contracts. A primary reason for the failure of PPPs is weaknesses in project structuring, particularly suboptimal risk allocation. 

The evolution of the road sector PPPs in India serves as a case study. Since the 1990s, India has explored various PPP models, including the toll-based design-build-operate-transfer (DBOT-Toll) and the annuity-based design-build-operate-transfer (DBOT-Annuity). In the DBOT-Toll model, the private sector is expected to carry the traffic/revenue forecast risk, while in the DBOT-Annuity model, the Government takes the traffic risk and the private sector is paid an annuity during the operation and maintenance period. The number and type of road sector PPPs peaked in 2012 but declined from 2013 onwards due to an increase in stalled projects and non-performing assets stemming from poor risk-allocation. Projects under construction faced challenges in achieving completion on schedule and completed projects could not generate the expected revenue, which discouraged private sector investment and bank financing.1 

Because the private sector was entirely responsible for collection of tolls and ensuring revenue projections were achieved, the DBOT-Toll model became less attractive to the private sector. This was due to difficulty in recovering their investments due to realisation of lower-than-expected toll revenue as the entire investment decision was based on projected traffic with no history of user fee collection on those highways. Meanwhile, the DBOT-Annuity model also had its own challenges as the private sector had to bear the inflation risk on the fixed annuity payments from the government, which also eroded expected returns.

To revive the sector, the government of India introduced the Hybrid Annuity Model (HAM) in 2016, which aimed to reduce the financing burden on the private sector by sharing risks more equitably. While the revenue forecasting and toll collection risk and cost escalation risk remains with the government in HAM, both the government and private sector share the financing risk. 

Improving access to infrastructure financing

Large infrastructure projects require both equity and debt funding, and given their long-term nature, long-term financing – or “patient capital” is essential. While bank financing is widely sought after, commercial banks often hesitate to offer long-term financing due to asset-liability mismatches (i.e. lending tenure could extend to 15-20 years in infrastructure projects, while the commercial banks’ asset profiles are typically only 5-7 years). To address this, the Reserve Bank of India released a Circular on “Flexible Structuring of Long-Term Project Loans to Infrastructure and Core Industries” (more commonly known as the 5:25 refinance scheme) which allowed the refinancing of a loan for 5 times, effectively extending the tenure to 25 years. Once the commercial lending market achieved certain maturity, this scheme was rolled back.

Alternative financing instruments such as Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs) [infrastructure-investment units are listed on the stock exchange to attract individual and institutional investor interest and are similar to a mutual fund] and Infrastructure Bonds [debt instrument to finance long-term infrastructure projects] can also be explored but may need a more mature infrastructure market as they are more suited for brownfield investments. Ideally, pension and insurance funds and other investors looking for more stable returns may prefer the profiles of such instruments backed by infrastructure projects that experience less volatility.

With the increasing importance of sustainability, financing sources such as Green bonds or Sustainability-linked bonds are becoming more attractive. Development banks and multilateral institutions are pivotal in supporting these initiatives, offering various forms of concessional financing and guarantees to attract private capital to sustainable infrastructure projects.

What next for Sri Lanka? 

Given the fiscal constraints faced by the Government of Sri Lanka, PPPs should be a key implementation mechanism for large-scale infrastructure projects. The Government should focus its limited financial resources on improving essential social infrastructure like healthcare and education, gradually shifting away from “business engagements”. The private sector should be encouraged to participate in large-scale infrastructure projects with the support of development finance institutions and foreign investors. The World Bank has identified three key pillars that drive PPPs: (1) the political commitment to support the national PPP agenda; (2) a standardised and transparent PPP process; and (3) a strong, technical team with key skill sets for efficient execution of projects2. Given the current limitations in mobilising affordable funding, the government should focus on strengthening these three key pillars to attract private sector financing for large-scale infrastructure projects. 

Footnotes:

1ADB. August 2022. Dinesh Shiwakoti and Devayan Dey. The Hybrid Annuity Model for Public-Private Partnerships in India’s Road Sector

2World Bank Blogs. August 2018. Lincoln Flor. Three ways governments can create the conditions for successful PPPs

(Ruvini Fernando is Financial Advisory Services Lead at Deloitte Sri Lanka and Maldives, and Kushal Singh is Partner – Financial Advisory Services at Deloitte India. These are views of the authors and do not represent the views of the organisation.)