The World Bank recently started advising governments to assume the bulk of the risk in public-private partnerships, so as to attract more private-sector players. But in addition to introducing an unacceptable moral hazard, this guidance is creating a possible doomsday scenario for debt-saddled developing countries around the world.
OTTAWA – The World Bank and other multilateral institutions are increasingly promoting measures to “de-risk” infrastructure investments in developing countries, in order to make such projects more attractive for international finance. But “de-risking” is a misnomer: any project can be set back by external events, poor design, or mismanagement. At least some level of risk – whether stemming from human error and institutional weakness, or from earthquakes, hurricanes, and countless other sources – is inherent in all infrastructure investments.
So the question is not how to eliminate risk, but rather how to allocate it between participating parties. When the World Bank and others talk about de-risking infrastructure finance, they really mean reducing the risk for investors – and increasing the risk for governments.
The proposed risk-allocation provisions for public-private partnerships contained in the World Bank’s Guidance on PPP Contractual Provisions, 2017 Edition take this approach to a new extreme. In almost any contingency – from “force majeure” to performance failures on the part of the private party – the public party is directed to assume all or a significant part of the risk. Moreover, the Bank’s metric for determining the effectiveness of this unyielding approach is “successfully procured PPP transactions.” Missing is any measure of whether a project is actually providing the intended goods or services to citizens, and any mechanism for recourse if it is not.
This extreme approach to risk allocation could have far-reaching consequences. A major reason why governments use PPPs in infrastructure is so that they can list such projects as “off-book.” That means the financing of the project is neither counted as a direct government capital expense nor applied against government debt ceilings. And because a project’s costs are supposed to be paid out over time through direct user fees or operational funds furnished by the government, the capital expenditure is regarded as “free money” that governments need not account for.
But financial institutions such as the International Monetary Fund are now pushing back against this notion of “free money,” by pointing out that the higher the risk for a government, the less a project can be defined as “off-book.” Accordingly, the World Bank’s lopsided risk-allocation provisions should actually make it more likely that PPP projects will have to be categorized as on-book financing and debt. That would be a good thing in itself. By listing all infrastructure projects as on-book, governments will be in a better position to test whether they are delivering real value for money.
The problem is that these discussions are all happening behind the scenes. In the meantime, the World Bank has continued to promote PPPs as the only acceptable form of infrastructure financing for developing countries in cases where a private party can do the job. And governments have continued to accumulate ever more risk, on the assumption that it is off-book and thus not counted as a sovereign-debt obligation.
As a result, many developing countries are now heading for a doomsday scenario. The risks that governments have taken on will last 20-30 years in many cases. During that time, governments will face severe challenges in managing public expenditures, and they will incur unforeseen costs related to off-book commitments and excessive debt, raising the possibility of a default on all credit commitments.
Making matters worse, the World Bank’s current approach creates moral hazard: the less risk the private party in a PPP assumes, the less it has to lose from poor performance. The Bank’s guidance provisions stipulate that even a private-sector partner that has failed to deliver must be compensated in order for a government to terminate the contract. As a result, some private-sector contractors may not assume that they have to perform well; instead, they may constantly weigh the costs and benefits of doing mediocre or poor-quality work.
The current approach is also an open invitation for private parties to squeeze governments even further, by renegotiating active contracts. Faced with absorbing the full costs of a failed project or paying more to ensure that it succeeds, a government has little choice but to accede to a private-sector partner’s demands.
This is not a far-fetched risk. The World Bank and others have understood for years that private companies frequently initiate contract renegotiations in PPP infrastructure projects. And this is even more likely to happen when contracts are awarded in a context of imperfect competition, which creates opportunities for private companies to set unrealistic contract terms.
No doubt, the World Bank has good intentions. But pushing all of the risk onto governments is not the way to attract investment in developing countries. The Bank urgently needs to reverse course. That means promoting balanced risk allocations and ensuring that all infrastructure projects are assessed as if they were on-book. Guidance that is blind to its own consequences is not helpful. And when it is offered to developing countries that already have unsustainable sovereign debts, it is downright dangerous.
OTTAWA – The World Bank and other multilateral institutions are increasingly promoting measures to “de-risk” infrastructure investments in developing countries, in order to make such projects more attractive for international finance. But “de-risking” is a misnomer: any project can be set back by external events, poor design, or mismanagement. At least some level of risk – whether stemming from human error and institutional weakness, or from earthquakes, hurricanes, and countless other sources – is inherent in all infrastructure investments.
So the question is not how to eliminate risk, but rather how to allocate it between participating parties. When the World Bank and others talk about de-risking infrastructure finance, they really mean reducing the risk for investors – and increasing the risk for governments.
The proposed risk-allocation provisions for public-private partnerships contained in the World Bank’s Guidance on PPP Contractual Provisions, 2017 Edition take this approach to a new extreme. In almost any contingency – from “force majeure” to performance failures on the part of the private party – the public party is directed to assume all or a significant part of the risk. Moreover, the Bank’s metric for determining the effectiveness of this unyielding approach is “successfully procured PPP transactions.” Missing is any measure of whether a project is actually providing the intended goods or services to citizens, and any mechanism for recourse if it is not.
This extreme approach to risk allocation could have far-reaching consequences. A major reason why governments use PPPs in infrastructure is so that they can list such projects as “off-book.” That means the financing of the project is neither counted as a direct government capital expense nor applied against government debt ceilings. And because a project’s costs are supposed to be paid out over time through direct user fees or operational funds furnished by the government, the capital expenditure is regarded as “free money” that governments need not account for.
But financial institutions such as the International Monetary Fund are now pushing back against this notion of “free money,” by pointing out that the higher the risk for a government, the less a project can be defined as “off-book.” Accordingly, the World Bank’s lopsided risk-allocation provisions should actually make it more likely that PPP projects will have to be categorized as on-book financing and debt. That would be a good thing in itself. By listing all infrastructure projects as on-book, governments will be in a better position to test whether they are delivering real value for money.
The problem is that these discussions are all happening behind the scenes. In the meantime, the World Bank has continued to promote PPPs as the only acceptable form of infrastructure financing for developing countries in cases where a private party can do the job. And governments have continued to accumulate ever more risk, on the assumption that it is off-book and thus not counted as a sovereign-debt obligation.
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As a result, many developing countries are now heading for a doomsday scenario. The risks that governments have taken on will last 20-30 years in many cases. During that time, governments will face severe challenges in managing public expenditures, and they will incur unforeseen costs related to off-book commitments and excessive debt, raising the possibility of a default on all credit commitments.
Making matters worse, the World Bank’s current approach creates moral hazard: the less risk the private party in a PPP assumes, the less it has to lose from poor performance. The Bank’s guidance provisions stipulate that even a private-sector partner that has failed to deliver must be compensated in order for a government to terminate the contract. As a result, some private-sector contractors may not assume that they have to perform well; instead, they may constantly weigh the costs and benefits of doing mediocre or poor-quality work.
The current approach is also an open invitation for private parties to squeeze governments even further, by renegotiating active contracts. Faced with absorbing the full costs of a failed project or paying more to ensure that it succeeds, a government has little choice but to accede to a private-sector partner’s demands.
This is not a far-fetched risk. The World Bank and others have understood for years that private companies frequently initiate contract renegotiations in PPP infrastructure projects. And this is even more likely to happen when contracts are awarded in a context of imperfect competition, which creates opportunities for private companies to set unrealistic contract terms.
No doubt, the World Bank has good intentions. But pushing all of the risk onto governments is not the way to attract investment in developing countries. The Bank urgently needs to reverse course. That means promoting balanced risk allocations and ensuring that all infrastructure projects are assessed as if they were on-book. Guidance that is blind to its own consequences is not helpful. And when it is offered to developing countries that already have unsustainable sovereign debts, it is downright dangerous.