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
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.
• 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
• 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.
• 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
government’s expected capital and noninterest current expenditure,
– while a portion of such future expenditure
streams is allocated to such a traditionally
procured project.
• 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
government’s expected capital and noninterest current expenditure,
– while a portion of such future expenditure
streams is allocated to such a PPP.
• 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
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?
• 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.
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
• 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
• 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
• 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.
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.
• 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.
• 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
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.
• 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-usercharge burden of those individuals benefiting
from the good or services acceptable?
• 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.
• 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
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