Use of safeguards to boost efficiency in road PPPs by reducing costs

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Public-private partnerships (PPPs) in transport infrastructure can provide significant gains in efficiency compared to public procurement options — under the right circumstances. The gains come from allocating to the private sector the risks that they can manage better than the public sector, such as those related to construction costs. The construction risk in the EDHEC project financing infrastructure shows that for a large number of transport infrastructures, PPP projects (including roads), construction overruns are significantly lower at 3.3% of the average for public procurement projects, an average exceedance of 26.7%.

Figure 1: Cost overruns in transport infrastructure projects (%)

Source: Project Finance Infrastructure Construction Risk; EDHEC, Blanc-Brude & Makovsek, 2013.

This means that, on average, the efficiency gains from overruns between PPPs and PPPs are around 23.3% (see Figure 1). However, to assess whether PPPs make sense in a given situation, these earnings must be traded against the incremental costs of the PPP approach. In addition to some key premises for institutions and the ability to prepare and manage PPPs, the country’s risk rating is a critical parameter. Unless the country has a minimum risk rating of at least BBB, funding costs may be higher than potential earnings. Even a glance at global risk ratings clearly indicates that funding costs limit the usefulness of traditional PPPs in many of our customer countries

Indeed, there is often a problem with chickens and eggs — the assessment of country risks depends partly on the institutional environment and the political commitment needed to create a market-friendly institutional environment requires a «good» private experience. Over the past two decades, many developing countries have begun implementing and financing performance-based rehabilitation and maintenance contracts (PBC or CREMA), often a 5-10 year contract, where publicly-funded payments and loans multilateral transactions are made on the basis of the quality of the asset provided (an example would be to have a road within a specific roughness limit). The contractor assumes the risk of resources, quality and quantity of work.

PBC contracts have built up important experience and skills in low-income countries. For countries with this experience, a variant of PBC — the 12 to 15 year extension, reinforced by innovative funding tools, offers the potential to explore PPPs in a cost-effective way

PBC presents the private sector and governance of a well-understood contract and environment, as well as a clear set of rules and practices.

It is important that the World Bank Group provides project-based guarantees that can guarantee part of the debt to reduce the financing risk and its costs. This means that creditors may be more willing to provide long-term funding, and the value of debt service may be lower. An example of a collateral impact on 50% of the total debt of an investment of $ 383 million, with a four-year construction period and a equity ratio of 30:70 in a Latin American country, assessed at BB without long-term financing, shows that a 1% interest rate cut and an extension of the five-year mandate will have a significant impact on the debt service and the cost of the project (see Figures 2a and 2b). This financial instrument will help governments gain efficiency gains from PPPs and bring private sector funding to infrastructure and service delivery

Impact of guarantee on interest and tenor

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