## _wp09144

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---

### I. Introduction — crisis context and fiscal framing
- The global economic and financial crisis generated challenges at all levels of economic policy decisions, requiring actions including bailouts of systemically or politically sensitive sectors, counteracting downturns in economic activity, and protecting vulnerable populations.
- Actions occurred amid falling government revenues and shrinking domestic and foreign financing, with medium to long-term consequences for budgets and debt.
- Anti-crisis packages in a number of countries included higher public investment, at times implemented through public-private partnerships (PPPs).
- PPPs can serve as counter-cyclical fiscal policy tools by supporting private sector recovery and generating employment, but growing PPP programs and their contractual structures may entail fiscal risks exacerbated by the financial crisis.
- Both existing and planned (pipeline) PPP programs could be affected through channels such as the availability and cost of credit, lower growth, and unforeseen exchange rate movements.
- Government interventions to maintain value-for-money (VfM) of existing projects should be:
  - aligned with broader fiscal policy objectives,
  - temporary,
  - transparent,
  - costed and budgeted.
- Empirical notes (national PPP program sizes):
  - Korea: total capital value of PPP equaled 6.7 percent of GDP at the end of 2008.
  - Portugal: 5.6 percent of GDP at the end of 2007.
  - South Africa: 1.7 percent of GDP for 2008.
  - Peru: 2.6 percent of GDP for 2008.
  - Canada: 1.4 percent of GDP for 2008.

### II. Public-Private Partnerships — rationale, definition, and phases
- Rationale:
  - PPPs are chosen over traditional procurement to improve VfM—maximizing the net present value of social benefits (benefits less costs) over the project life cycle.
  - VfM tests typically involve a risk-adjusted comparison of the PPP and public procurement alternatives.
  - Caution: PPPs have been used to move borrowing off public sector balance sheets under the misconception this creates fiscal space; a PPP replaces debt incurred through traditional procurement with the present value of future service charges, which usually include a component to service PPP debt.
- Definition (characteristics used in this paper):
  1) Agreement between government and private partner(s) whereby private partner(s) undertakes to deliver an agreed upon quantity and quality of service.
  2) Private partner(s) receives either a unitary charge paid by government or a user charge levied by the private partner.
  3) Emphasis on a whole-of-life approach: private partner(s) usually responsible for construction and operational phases.
  4) Some degree of risk sharing determined by which party is best able to manage each risk to optimize VfM.
- Project phases and relative vulnerability to crisis:
  - Operational phase: negotiated, construction complete (if applicable), services provided by private partner(s).
  - Construction phase: negotiated, construction underway, services not yet commenced.
  - Pipeline phase: planned or tendered, but no financial closure and no physical works started.
- VfM note: the optimal option on a VfM basis is not necessarily the least expensive once quality and risk adjustments are made.

### III. Transmission mechanisms: threats, vulnerabilities, and risk management
- Conceptual framework:
  - Risk realization = ƒ(threat, vulnerability).
  - Threat: probability that a negative event occurs.
  - Vulnerability: PPP-specific or country-specific factors capturing preparedness to prevent or cope (e.g., lack of capacity and/or desire to manage risk and project outcomes).
- Channels of transmission (threats) and primary effects
  - Upward pressure on interest rates:
    - Policy rates in many developed economies decreased, but emerging markets saw increases in corporate and sovereign bond rates.
    - Spreads between corporate and sovereign rates increased since mid 2008 to levels not seen since the Asian crisis, the dotcom bubble, or the Argentine crisis.
    - Effect: increase in cost of borrowing affects pipeline projects and existing projects with refinancing needs (most likely construction phase) and/or variable interest payments.
  - Decrease in availability of credit:
    - Liquidity constraints affect both price and quantity of credit; banks ration credit regardless of price.
    - Downgrading of monoline insurers shrunk the bond market for infrastructure projects.
    - Project finance syndicated loans declined sharply in 1Q 2009 after a late-2008 peak, most notably in Western Europe.
    - Most affected: PPPs in the pipeline phase; existing PPPs may have residual refinancing needs.
  - Real effects of economic slowdown on revenue cash flows:
    - Lower demand for services reduces revenue cash flows (e.g., landing fees in airports, toll-road revenues).
    - Mainly affects operational and pipeline phases; operational phase PPPs relying on user charges are particularly vulnerable.
  - Unforeseen exchange rate movements:
    - Private partners with sizeable, unhedged external debt can see balance sheet and debt servicing impacts.
    - In some emerging markets hedging is impossible due to absence of forward markets.
    - Increased cost of imported capital goods and operational inputs can affect projects under construction or operation.
    - Most affected: PPPs in operational or construction phase with unhedged external debt.
- Vulnerabilities (project-specific and institutional)
  - Project-specific: high unhedged external debt; overly optimistic revenue forecasts without guarantees.
  - Partnership/institutional: contract structure, institutional framework, explicit contingent liabilities (e.g., exchange rate, minimum traffic, revenue guarantees) and implicit contingent liabilities (e.g., contractor failure, contract renegotiation).
  - Key elements to reduce partnership vulnerability:
    - Robust public investment planning: systematic investment planning, project selection and prioritization, framework for future budget implications.
    - Adequate distribution of risks: party best able to manage a risk should bear it to realize better VfM.
    - A sound legal framework: detailed legal framework reduces risk premia by assuring contracts will be honored.
    - Regulations limiting aggregate government exposure: (i) flow limits on annual total PPP-related payments and contingent commitments, and (ii) stock limits on overall PPP program size or total project liabilities, consistent with wider fiscal framework.
    - Good institutions: capacity to manage and assess risks, allocate responsibilities, ensure Ministry of Finance can veto unaffordable/wasteful projects.
    - Transparency in PPP finances: comprehensive disclosure of PPP-related risks and liabilities mitigates understatement of fiscal risks and prevents PPPs from bypassing expenditure controls.
- Risk classification and management
  - Risk types: commercial, macroeconomic, political.
  - Macroeconomic risks include aggregate demand risk, interest rate risk, liquidity risk, exchange rate risk; these can trigger other risks (e.g., credit risk).
  - Distinction: endogenous risks (can be actively managed) vs. exogenous risks (cannot be prevented by parties).
  - VfM requires allocating risk to the party best suited to carry/manage it by answering:
    1) Which party is best able to prevent an adverse occurrence?
    2) If no party can prevent it (exogenous), which party is best able to manage the outcome?
  - Risk management methods:
    - Risk avoidance
    - Risk prevention
    - Risk transfer (contractual)
    - Risk retention
    - Risk insurance

### IV. Box 2 — Effect of a Crisis on PPP Partners (summary)
- Parties potentially affected:
  - The relevant government department or agency; private partner(s) responsible for construction, operation, and financing; the special purpose vehicle (SPV); direct recipients of the service (tax payers/users).
- Balance-sheet and leverage effects:
  - SPVs usually have rather high levels of debt—frequently in excess of 70 percent of capital—which means:
    - A drop in profit might negatively affect SPV equity value.
    - A drop in the profit of an SPV will also affect the balance sheet of its owners—more so if the owners also have a high degree of leverage.
  - Leverage of private operators and financial institutions influences their ability to obtain credit and extend loans.
  - Realization of downside risk on a PPP may run in several directions; transmission need not be only from the SPV outward.
- Endogenous vs exogenous risks and VfM implications:
  - Allocating exogenous risks to private partner(s) cannot increase VfM when the private partner cannot manage the risk responsibly.
  - Private partner normally expected to carry some macroeconomic risk such as weathering normal business cycle movements.
  - Risks that are endogenous under normal circumstances might become exogenous in a global crisis (examples: credit crunch, global recession).
  - Transmission of risk to the partnership is most likely to entail fiscal costs.
- Typology of risks affecting PPPs:
  - Commercial: Supply, Demand, Project risks (Design and construction risk; Operation; Maintenance risk; Input and output quality and quantity risks; Residual value risk; Contractor failure risk; Renegotiation risk; Early termination risk; Security risk; Technology risk)
  - Political: Different investment preferences of alternating governments; Risk of expropriation
  - Macroeconomic: Aggregate demand risk; Interest rate risk; Liquidity risk; Exchange rate risk; Idiosyncratic interest rate and liquidity risks; Expansionary anti-crisis policies raising the cost of financing; Force majeure
  - Credit risks: of the SPV; of the construction and operating company; of the financial institution; sovereign risks
  - Revenue structure: private partner receives a fee from government and/or a user charge; amount may be fixed or variable
- Empirical evidence during the 2008/9 crisis:
  - PwC survey: shift away from long-term loans toward loans with much shorter term to maturity in UK PPP market.
  - World Bank PPIAF data (316 projects, July 2008–February 2009): 95 reported delays; 9 projects canceled; 7 projects obtained finance only at higher cost.
  - June 2009 update (to March 2009): 107 out of 522 projects were delayed.
  - Country examples:
    - Korea: contract-signing volume fell sharply in 2008; contracts signed were less than 70 percent of the initial projection; a 10 percent decrease in annual port traffic was recorded in February 2009.
    - Canada: credit market capacity became a concern especially for projects over $500 million; long term loans for P3 more difficult to secure.
    - South Africa: government identified budget exposure to demand risk, residual value risk, exchange rate risk, renegotiation risk, early termination risk, and inflation risk; included as expected annual costs in the budget.
  - Survey of selected countries (responses from Canada, Colombia, Korea, Mozambique, Peru, Portugal, U.K., and South Africa):
    - Cost of borrowing and access to finance identified as main crisis transmission mechanisms affecting project pipeline.
    - Few countries were worried about exchange rate risk.
    - Most respondents confirmed linkages between PPP projects and the fiscal budget.
    - Most respondents reported PPP programs integrated within medium-term investment planning; more than half had formal guidelines for risk allocation and accounting; more than half made some effort to quantify government-exposed risks and include costs in the budget.
    - No country had updated estimates of the likely fiscal cost of any risks materializing in the context of the current crisis.
- Key implications:
  - Crisis began to affect PPP programs, especially the pipeline.
  - Private partners less willing to retain certain risks (e.g., interest rate risk, financial closure risk) and seek greater contributions or guarantees from government.
  - Some planned PPPs may proceed as publicly procured projects.
  - Governments can use contract provisions and crisis-specific measures to enhance attractiveness and shift risk-return balance (examples: sharing of interest rate risk, loan guarantees, direct loans).

### V. Box 5 — Government measures to reinvigorate PPPs (options, principles, and implementation)
- Country examples and context:
  - Canada:
    - Established in 2008, PPP Canada administers a $1.2 billion P3 Fund to further develop the PPP market.
    - The Corporation has not begun financing projects and is expected to issue an initial call for applications to the P3 Fund in 2009-10.
    - Provincial and municipal initiatives: Canada Line, Kicking Horse Canyon (British Columbia); Highway 30 (Québec); Edmonton ring road (Alberta); City of Ottawa established a PPP office.
    - Government of Alberta’s 2008 Budget Plan included approximately $6 million for the Alternative Capital Financing office.
  - Korea:
    - Government announced a fiscal stimulus package with more than 15 percent of the envisaged investment to be carried out through PPPs.
    - Package measures include:
      - lower equity capital requirements on concessionaires (5–10 percent);
      - for large-scale projects, higher ceilings on guarantees provided by the Infrastructure Credit Guarantee Fund (50 percent);
      - help in changing equity investors for some projects;
      - compensation for the preparation of proposals to encourage competition;
      - sharing of interest rate risk with concessionaires;
      - compensation for excess changes in base interest rates through grading of risks at concession agreement;
      - shorter periods for readjusting benchmark bond yields.
- Intervention measures (options to support PPPs) — purpose and conditions for use:
  - Conditions for considering options:
    1. extreme circumstances beyond the control of the private partner(s),
    2. they yield positive—and maximum, conditional on the crisis conditions—VfM,
    3. the government is compensated for accepting additional risk.
  - Measures (in order of increasing government risk exposure):
    - Concession extension: extends tenure to allow private partner to generate needed return.
    - Subsidy: output-based cash subsidies; alternatives include tax breaks or subsidies to private partners or direct users.
    - Grant: improves project attractiveness and reduces private partner exposure—should be conditional.
    - Minimum revenue guarantee: ensures private partners can cover repayment and servicing of debt liabilities; obviates a debt guarantee.
    - Exchange rate guarantee: protects private partner in case of significant domestic currency depreciation.
    - Debt guarantee: guarantees repayment of all or part of the debt.
    - Subordinated loan: government provides standing loan facility private partner can draw on if necessary.
    - Equity measures: guarantees for all or part of equity values or sale options to government at agreed price.
    - Step-in rights: government may step in and re-tender or take over operation in case of contractor failure, if fiscal space exists.
- Intervention principles (to limit fiscal and moral hazard risks):
  - Justify intervention on economic grounds (public good or positive externality).
  - Support wider fiscal policy stance; can be countercyclical if reducing PPP vulnerability to cycle.
  - Quantify measures and include in the budget framework; assess medium-term impact and future government liabilities.
  - Measures should be contingent on crisis conditions and temporary.
  - Access to public purse should come at a price to mitigate moral hazard:
    - charge fees for guarantees, contingent loans or other financing options;
    - public sector reducing private downside exposure should share in the upside.
  - Maintain VfM: private partner risk retention should remain sufficient to preserve efficiency incentives.
  - Public disclosure to avoid perceptions of arbitrary rule changes and mitigate moral hazard.
- “Trip switch” clauses (temporary, indicator-triggered interventions):
  - Purpose: ensure measures are temporary and automatically deactivate once economy exits crisis or indicators normalize.
  - Clauses should state mitigating steps, activation indicators (e.g., interest rate spreads and output measures), and deactivation indicators.
  - Types and examples:
    - Contract extensions: automatic extension by pre-negotiated period if revenue/profit temporarily falls below predetermined level; activation should require correlation with severe downturn indicators (example: a decrease in activity that exceeds two standard deviations, calculated with a moving window of 20 or 40 quarters).
    - Output-based subsidy and guarantees: activation requires correlation with severe economic contraction rather than idiosyncratic demand declines.
    - Revenue enhancement (shadow tolls): temporary partial shadow toll financed with debt; shadow toll scrapped post-recession and toll increases to repay debt.
    - Subsidy for interest rate increase: government pays grant covering excess over a defined “normal upper range” for interest rate movements; applies only for variable interest rate loans or short-term fixed-interest rate loans expected to return to normal; increase must not be due to idiosyncratic risky behavior by private partner; a normal upper range should be defined in contract.
      - Illustrative example: suppose average interest rate equals 8 percent, with a two standard deviation variation equal to three percentage points; a contract may state government will pay a subsidy to cover all basis points in excess of the 300 bps (i.e., when the interest rate exceeds 11 percent).
    - Government finance: government could finance some or all debt to address short-run difficulty; trip switch could give government option to sell its debt stake after two or three years, or if market indicators reach pre-crisis levels; debt stake can be sold in open tender process—use sparingly given significant increase in government exposure.
    - Debt-equity switch: contingency clause to convert some bond-financed debt into equity if revenue falls below servicing level; improves debt/equity ratio and de-leverages balance sheet but dilutes existing shareholders; reversible once revenue improves.
- Implementation considerations:
  - Ensure sufficient skilled personnel to negotiate and manage clauses.
  - If skilled personnel shortage exists, opt for clauses based on uncomplicated, straightforward indicators that are accessible, verifiable, and not manipulable (examples: interest rate spreads, total revenue earnings, total production figures).
  - Simpler indicators reduce negotiation time and cost.

*Source: Excerpt from _wp09144 - References .............................................................................................................*

### References .............................................................................................................

### _wp09144 - References .............................................................................................................

### I. INTRODUCTION
- The global economic and financial crisis generated challenges at all levels of economic policy decisions, requiring actions including bailouts of systemically or politically sensitive sectors, counteracting downturns in economic activity, and protecting vulnerable populations.
- These actions occurred amid falling government revenues and shrinking domestic and foreign financing, with medium to long-term consequences for budgets and debt.
- Anti-crisis packages in a number of countries included higher public investment, at times implemented through public-private partnerships (PPPs).
- PPPs can serve as counter-cyclical fiscal policy tools by supporting private sector recovery and generating employment, but growing PPP programs and their contractual structures may entail fiscal risks exacerbated by the financial crisis.
- Both existing and planned (pipeline) PPP programs could be affected through channels such as the availability and cost of credit, lower growth, and unforeseen exchange rate movements.
- Government interventions to maintain value-for-money (VfM) of existing projects should be:
  - aligned with broader fiscal policy objectives,
  - temporary,
  - transparent,
  - costed and budgeted.
- Empirical note: national PPP programs have grown; examples given:
  - Korea: total capital value of PPP equaled 6.7 percent of GDP at the end of 2008.
  - Portugal: 5.6 percent of GDP at the end of 2007.
  - South Africa: 1.7 percent of GDP for 2008.
  - Peru: 2.6 percent of GDP for 2008.
  - Canada: 1.4 percent of GDP for 2008.

### II. PUBLIC-PRIVATE PARTNERSHIPS
- Rationale: PPPs are chosen over traditional procurement to improve VfM—maximizing the net present value of social benefits (benefits less costs) over the project life cycle.
- VfM tests typically involve a risk-adjusted comparison of the PPP and public procurement alternatives.
- Caution: PPPs have been used in practice to move borrowing off public sector balance sheets under the misconception that this creates fiscal space; fiscal space is only apparent because a PPP replaces debt incurred through traditional procurement with the present value of future service charges, which usually include a component to service the PPP debt.
- PPP phases and vulnerability to crisis:
  - Operational phase: negotiated, construction complete (if applicable), services provided by private partner(s).
  - Construction phase: negotiated, construction underway, services not yet commenced.
  - Pipeline phase: planned or tendered, but no financial closure and no physical works started.
- Definition of PPPs (Box 1) — characteristics used in this paper:
  1) Agreement between government and private partner(s) whereby private partner(s) undertakes to deliver an agreed upon quantity and quality of service.
  2) Private partner(s) receives either a unitary charge paid by government or a user charge levied by the private partner.
  3) Emphasis on a whole-of-life approach: private partner(s) usually responsible for construction and operational phases.
  4) Some degree of risk sharing determined by which party is best able to manage each risk to optimize VfM.
- VfM note: optimal option on a VfM basis is not necessarily the least expensive once quality and risk adjustments are made.

### III. TRANSMISSION MECHANISMS: THREATS, VULNERABILITIES AND RISK
- Conceptual framework:
  - Risk realization = ƒ(threat, vulnerability).
  - Threat: probability that a negative event occurs (e.g., channels identified below).
  - Vulnerability: PPP-specific or country-specific factors capturing preparedness to prevent or cope; includes lack of capacity and/or desire to manage risk and project outcomes.
  - Example: drop in traffic volumes is a threat to toll-road PPPs; risk exists only if vulnerability (e.g., lack of minimum revenue guarantee) is present.
- Channels of transmission: threats
  - Upward pressure on interest rates:
    - Policy rates in many developed economies decreased, but emerging markets saw increases in corporate and sovereign bond rates.
    - Spreads between corporate and sovereign rates increased since mid 2008 to levels not seen since the Asian crisis, the dotcom bubble, or the Argentine crisis (Figure 1).
    - Effect: increase in cost of borrowing affects pipeline projects and existing projects with refinancing needs (most likely construction phase) and/or variable interest payments.
  - Decrease in availability of credit:
    - Liquidity constraints affect both price and quantity of credit; banks ration credit regardless of price.
    - Downgrading of monoline insurers shrunk the bond market for infrastructure projects.
    - Banks may be unable to extend loans due to small capital (Abadie, 2008).
    - Project finance syndicated loans declined sharply in 1Q 2009 after a late-2008 peak, most notably in Western Europe (Figure 2).
    - Most affected: PPPs in the pipeline phase; existing PPPs may have residual refinancing needs.
  - Real effects of economic slowdown on revenue cash flows:
    - Lower demand for services reduces revenue cash flows—examples: landing fees in airports, toll-road revenues.
    - Mainly affects operational and pipeline phases; operational phase PPPs relying on user charges are particularly vulnerable.
  - Unforeseen exchange rate movements:
    - Private partners with sizeable, unhedged external debt can see balance sheet and debt servicing impacts.
    - In some emerging markets hedging is impossible due to absence of forward markets.
    - Increased cost of imported capital goods and operational inputs can affect projects under construction or operation.
    - Most affected: PPPs in operational or construction phase with unhedged external debt.
- Vulnerabilities: project-specific and partnership/institutional
  - Project-specific vulnerabilities: high unhedged external debt; overly optimistic revenue forecasts without guarantees.
  - Partnership vulnerabilities: contract structure, institutional framework, explicit contingent liabilities (e.g., exchange rate, minimum traffic, revenue guarantees) and implicit contingent liabilities (e.g., contractor failure, contract renegotiation).
  - Key elements to reduce partnership vulnerability:
    - Robust public investment planning: systematic investment planning, project selection and prioritization, framework for future budget implications.
    - Adequate distribution of risks between government and private sector: party best able to manage a risk should bear it to realize better VfM.
    - A sound legal framework: detailed legal framework provides parameters and assurance contracts will be honored, reducing risk premia.
    - Regulations limiting aggregate government exposure: e.g., (i) flow limits on annual total PPP-related payments and contingent commitments, and (ii) stock limits on overall PPP program size or total project liabilities, consistent with wider fiscal framework.
    - Good institutions: capacity to manage and assess risks, build government reputation, allocate responsibilities, ensure Ministry of Finance can veto unaffordable/wasteful projects.
    - Transparency in PPP finances: comprehensive disclosure of PPP-related risks and liabilities mitigates understatement of fiscal risks and prevents PPPs from bypassing expenditure controls.
- Risks classification and management
  - Risk types: commercial, macroeconomic, political (Figure 3).
  - Macroeconomic risks include aggregate demand risk, interest rate risk, liquidity risk, exchange rate risk; these can trigger other risks (e.g., credit risk).
  - Distinction: endogenous risks (can be actively managed by changing behavior) vs. exogenous risks (cannot be prevented by parties).
  - VfM requires allocating risk to the party best suited to carry/manage it by answering:
    1) Which party is best able to prevent an adverse occurrence?
    2) If no party can prevent it (exogenous), which party is best able to manage the outcome?
  - Crisis effects:
    - The financial crisis may exacerbate some risks, altering PPP attractiveness for different parties and reducing participation unless compensated.
    - Parties may refuse to enter new PPP agreements, refinance existing PPPs, or continue operating under agreements.
  - Risk management methods:
    - Risk avoidance: not undertaking the risky activity (e.g., opting for public procurement).
    - Risk prevention: reducing vulnerabilities (e.g., borrowing in domestic currency to avoid exchange rate risk).
    - Risk transfer: contractual transfer (e.g., minimum traffic guarantees).
    - Risk retention: a party retains risk and has incentive to reduce its cost implications (e.g., construction company managing design risk; government managing policy/regulatory change risk).
    - Risk insurance: financial coverage for loss from negative outcomes.
- Table 1 summarizes channels of transmission of the financial crisis, mapping threats, vulnerabilities, effects on private partners, and effects on government across:
  - Interest rates hike
  - Unavailability of credit
  - Decline in stock market prices
  - Exchange rate depreciation
  - Slump in domestic demand
  - (Table entries detail outcomes such as higher debt service, liquidity problems, lowered capacity to refinance, termination of projects, reduced investment, call of guarantees, contractor failure, pressure to renegotiate, increased external debt service, and counterbalancing factors such as switch from foreign consumption to domestic investment and increased demand for export-oriented services.)

*Source: Excerpt from _wp09144 - References .............................................................................................................*

### Box 2. Effect of a Crisis on PPP Partners

### Box 2. Effect of a Crisis on PPP Partners

### Parties potentially affected
- The relevant government department or agency
- The private partner(s) responsible for the construction of the asset
- The private partner(s) responsible for operating the asset and delivering the service
- The private partner(s) responsible for financing the project
- The special purpose vehicle, usually owned by one or more of the private partner(s)
- The direct recipients of the service (tax payers/users)

### Balance-sheet, leverage, and transmission effects
- The implications of the financial and economic crisis extend beyond the balance sheet of the Special Purpose Vehicle (SPV); assets, liabilities, income and expenditure flows of all partners can be affected to varying degrees.
- SPVs usually have rather high levels of debt—frequently in excess of 70 percent of capital—which means:
  - A drop in profit might negatively affect SPV equity value.
  - A drop in the profit of an SPV will also affect the balance sheet of its owners—more so if the owners also have a high degree of leverage.
- Leverage of private operators and financial institutions influences their ability to obtain credit and extend loans.
- The realization of downside risk on a PPP may run in several directions; transmission need not be only from the SPV outward.

### Endogenous vs exogenous risks and value-for-money (VfM) implications
- Allocating exogenous risks to the private partner(s) cannot increase VfM when the private partner cannot manage the risk responsibly.
- The private partner is normally expected to carry some macroeconomic risk such as weathering normal business cycle movements.
- Some risks may be exogenous to the private partner but endogenous to the government (e.g., the risk of expropriation).
- Where a risk is exogenous to both private partner and government, the private partner will only carry the risk if it can translate it into an expected cost that can be recuperated by the project.
- Risks that under normal circumstances are endogenous (and transferred to the private partner) might become exogenous in a global crisis; examples:
  - In a credit crunch where liquidity dries up and long-term risk premiums increase significantly, private partners may become unable to manage credit risk.
  - A global recession may have a large impact on demand, beyond what could be adequately managed by a private partner within normal operations, and consequently extend beyond the project to the partnership.
- Transmission of risk to the partnership is most likely to entail fiscal costs.

### Typology of risks affecting PPPs (categories highlighted in source)
- Commercial: Supply, Demand, Project risks (Design and construction risk; Operation; Maintenance risk; Input and output quality and quantity risks; Residual value risk; Contractor failure risk; Renegotiation risk; Early termination risk; Security risk; Technology risk)
- Political: Different investment preferences of alternating governments; Risk of expropriation
- Macroeconomic: Aggregate demand risk; Interest rate risk; Liquidity risk; Exchange rate risk; Idiosyncratic interest rate and liquidity risks; Expansionary anti-crisis policies raising the cost of financing; Force majeure
- Credit risks: of the SPV; of the construction and operating company; of the financial institution; sovereign risks
- Revenue structure: Private partner receives a fee from government and/or a user charge from the direct recipient; amount demanded may be fixed (specified in the contract) or variable

### Empirical evidence and observed effects during the 2008/9 crisis
- PwC survey of more than 20 of the leading banks in the UK PPP market found a marked shift away from long-term loans toward loans with a much shorter term to maturity.
  - Willingness to lend for long maturities depends on strong client relationships and strong refinancing incentives.
  - Some banks, due to limited capital, are unable to enter contracts with a relatively long maturity.
  - Longer term PPPs (concluded for, say, 20 years and over) might therefore only be able to secure loans for shorter periods, exposing private operators to more refinancing risk and future interest rate volatility.
- World Bank PPIAF data: Of the 316 projects surveyed between July 2008 and February 2009, 95 reported delays, predominantly due to the financial crisis.
  - In total 9 projects were canceled, while 7 projects that did obtain finance reported that they only did so at a higher cost.
  - South Asia (predominantly India) and transitional economies in Europe and Central Asia accounted for most delays; Eastern Europe and Central Asia also contained some projects that were canceled.
  - The largest delays were in the energy and transport sector. New projects and projects in excess of $250 million were also more likely to register delays.
- June 2009 update covering a larger sample to March 2009: 107 out of 522 projects were delayed (reported in source).
- Country examples and survey responses:
  - Korea: contract-signing volume fell sharply in 2008; contracts signed were less than 70 percent of the initial projection. A 10 percent decrease in annual port traffic was recorded in February 2009. Private partners reportedly less willing to take on interest rate risk.
  - Canada: credit market capacity became a concern especially for larger projects over $500 million; long term loans for P3 more difficult to secure as many foreign banks withdrew from the market; some negotiations shifted to design-build, fixed-price procurement.
  - South Africa: government identified budget exposure to demand risk, residual value risk, exchange rate risk, renegotiation risk, early termination risk, and inflation risk; these are treated as contingent liabilities and included as expected annual costs in the budget. New potential private partners hit by higher interest rates and lower access to financing; higher borrowing costs and lower expected returns on equity influenced VfM choices and risk allocation.
- Survey of selected countries (questionnaire to 20 countries; reported answers from Canada, Colombia, Korea, Mozambique, Peru, Portugal, U.K., and South Africa) found:
  - Cost of borrowing and access to finance identified as main crisis transmission mechanisms affecting project pipeline.
  - Some countries identified reduced demand, contractor failure, and project renegotiation as channels.
  - Few countries were worried about exchange rate risk, perhaps reflecting adaptation to past crises.
  - Most respondents confirmed linkages between PPP projects and the fiscal budget (payments to private partners or receipts from them).
  - Most respondents reported PPP programs integrated within medium-term investment planning; more than half had formal guidelines for risk allocation and accounting; more than half made some effort to quantify government-exposed risks and include costs in the budget.
  - No country had updated estimates of the likely fiscal cost of any risks materializing in the context of the current crisis.

### Key implications for PPP management and government response
- The crisis has begun to affect PPP programs, especially the pipeline of new projects.
- Private partners are less willing to retain certain risks (e.g., interest rate risk and financial closure risk) and are seeking greater contributions or guarantees from the government.
- Some planned PPPs may proceed instead as publicly procured projects.
- A minority of countries thought it more likely that guarantees would be called on existing PPPs.
- Governments can enhance attractiveness of PPPs and shift risk-return balance by using contract provisions and crisis-specific measures, examples identified in the source include:
  - Sharing of interest rate risk (example: Korea)
  - Loan guarantees (example: France)
  - Direct loans (examples: France and the U.K.)

*Box 2. Effect of a Crisis on PPP Partners — _wp09144*

### Box 5. Government Measures to Reinvigorate PPPs

### Box 5. Government Measures to Reinvigorate PPPs

### Country examples and context
- Canada
  - Canada did not have a formal PPP program until recently; prior partnerships were ad hoc.
  - Federal commitments and contributions to provincial and municipal PPPs include: Canada Line, Kicking Horse Canyon (British Columbia); Highway 30 (Québec); Edmonton ring road (Alberta).
  - Established in 2008, PPP Canada administers a $1.2 billion P3 Fund to further develop the PPP market.
  - The Corporation has not begun financing projects and is expected to issue an initial call for applications to the P3 Fund in 2009-10.
  - Provinces with concrete PPP steps: British Columbia, Ontario, Quebec—institutions and programs active in health and hospitals, roads, schools, and other sectors.
  - Government of Alberta’s 2008 Budget Plan included approximately $6 million for the Alternative Capital Financing office to explore alternative financing options for capital projects, including PPPs.
  - Municipal steps: City of Ottawa officially endorsed PPPs and established a PPP office.

- Korea
  - Government announced a fiscal stimulus package in response to the financial crisis with more than 15 percent of the envisaged investment to be carried out through PPPs.
  - Package measures to reduce financial burdens on PPPs, smooth interest rate changes, and shorten project implementation include:
    - lower equity capital requirements on concessionaires (5–10 percent);
    - for large-scale projects, higher ceilings on guarantees provided by the Infrastructure Credit Guarantee Fund (50 percent);
    - help in changing equity investors for some projects;
    - compensation for the preparation of proposals to encourage more vigorous competition during bidding;
    - sharing of interest rate risks with concessionaires;
    - compensation for the excess changes in base interest rates through grading of risks at the time of the concession agreement;
    - shorter periods for readjusting benchmark bond yields.

### Intervention measures (options to support PPPs)
- Purpose and conditions for use
  - Measures aim to facilitate access to finance and improve the risk-return balance.
  - Options should be considered only when three conditions are met:
    1. there are extreme circumstances beyond the control of the private partner(s),
    2. they yield positive—and maximum, conditional on the crisis conditions—VfM, and
    3. the government is compensated for accepting additional risk.
- Measures (listed in order of increasing government risk exposure)
  - Concession extension: extends the tenure of the agreement to allow the private partner to generate the return needed to ensure the viability of the project.
  - Subsidy: output-based cash subsidies are the measure most transparently linked to the ultimate objective of the PPP; alternatives include tax breaks or subsidies paid to private partners or direct users (possibly as vouchers).
  - Grant: extended to improve project attractiveness and reduce private partner exposure to risk—should be subject to conditions.
  - Minimum revenue guarantee: ensures private partners can cover repayment and servicing of debt liabilities; obviates a debt guarantee.
  - Exchange rate guarantee: protects private partner in case of significant domestic currency depreciation, protecting foreign currency earnings when the private partner is a foreign company.
  - Debt guarantee: guarantees repayment of all or part of the debt.
  - Subordinated loan: government provides a standing loan facility the private partner can draw on if necessary—may reduce cash-flow risks related to senior debt servicing.
  - Equity measures: guarantees for all or part of equity values (private partner can sell its equity stake to government at an agreed price) or other measures to ensure equity.
  - Step-in rights: in case of contractor failure, governments may step in and re-tender the PPP or take over operation, if there is fiscal space.

### Intervention principles (to limit fiscal and moral hazard risks)
- Intervention should be justified on economic grounds (public good or positive externality; delivery not entirely left to private sector).
- Interventions should support the wider fiscal policy stance; could support countercyclical budgetary stance if reducing PPPs’ vulnerability to the cycle.
- Measures should be quantified and included in the budget framework; medium-term impact and future government liabilities must be assessed.
- Government measures should be contingent on circumstances; as crisis subsides, perceptions and lending should resume at “normal” rates.
- Access to the public purse should come at a price to mitigate moral hazard:
  - charge fees for guarantees, contingent loans or other financing options;
  - public sector reducing private downside exposure should share in the upside.
- Intervention should seek to maintain VfM; private partner risk retention should remain sufficient to preserve efficiency incentives.
- Policy should be publicly disclosed to avoid perceptions of arbitrary rule changes and to mitigate moral hazard.

### “Trip switch” clauses (temporary, indicator-triggered interventions)
- Purpose: ensure measures are temporary and automatically deactivate once economy exits crisis or indicators normalize.
- Clauses should state mitigating steps, activation indicators (e.g., interest rate spreads and output measures), and deactivation indicators.
- Trip switches can be included in new and existing contracts and can limit renegotiation scope.
- Types of trip switches and associated measures:
  - Contract extensions: automatic extension by pre-negotiated period if revenue (or operational profit) temporarily falls below a predetermined level; activation should require correlation with severe downturn indicators (example: a decrease in activity that exceeds two standard deviations, calculated with a moving window of 20 or 40 quarters).
  - Output-based subsidy and guarantees: government pays output-based subsidy to ensure private partner can cover interest costs when revenue/profit falls below predetermined level; clause activation requires correlation with severe economic contraction rather than idiosyncratic demand declines.
  - Revenue enhancement (shadow tolls): temporary partial shadow toll (toll per user paid by government, not direct recipient), financed with debt; shadow toll scrapped post-recession and toll increases to repay debt incurred during recession.
  - Subsidy for interest rate increase: government pays grant covering excess over a defined “normal upper range” for interest rate movements; subsidy applies only for variable interest rate loans (of any maturity) where rates are expected to return to normal, or short-term fixed-interest rate loans; increase must not be due to idiosyncratic risky behavior by private partner; a normal upper range should be defined in contract.
    - Illustrative example provided: suppose average interest rate equals 8 percent, with a two standard deviation variation equal to three percentage points; a contract may state government will pay a subsidy to cover all basis points in excess of the 300 bps (i.e., when the interest rate exceeds 11 percent).
  - Government finance: government could finance some or all debt to address short-run difficulty; trip switch could give government option to sell its debt stake after two or three years, or if market indicators reach pre-crisis levels; debt stake can be sold in open tender process—use sparingly due to significant increase in government exposure, leaving only private partner equity at risk.
  - Debt-equity switch: contingency clause to convert some bond-financed debt into equity if revenue falls below servicing level; improves debt/equity ratio and de-leverages balance sheet but dilutes existing shareholders; reversible once revenue improves.
- Implementation considerations
  - Governments should ensure sufficient skilled personnel to negotiate and manage clauses.
  - If skilled personnel shortage exists, opt for clauses based on uncomplicated, straightforward indicators that are accessible, verifiable, and not manipulable (examples: interest rate spreads, total revenue earnings, total production figures).
  - Simpler indicators reduce negotiation time and cost.

*Source: Box 5. Government Measures to Reinvigorate PPPs (excerpts).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09144.pdf_