Managing Potential Fiscal Liabilities of PPP Projects

PIMAC

Prepared by Kang-Soo KIM Executive Director, PIMAC, KDI

22 Jan 2015

Youngsob YOO

Deputy Director, PPP Policy Division Ministry of Strategy and Finance

Background

Public –Private- Partnership (PPP) imposes an obligation on the Public (governments) by definition Financial commitment in the form of payment, guarantee, subsidy, etc.

Risk (demand (revenue), foreign exchange, termination liabilities..) bearing produces obligations like guarantees

2

Government Financial Support and Risk Sharing

Measure

Construction Subsidy

Early Termination Payment Minimum

Revenue Guarantee (1999-2009)

Risk Sharing

Tax incentives

Land Acquisition

Background

Why do governments bear the risks ? To proceed and get the project done

To apply the best way of allocating risks

Why do the risks arise more often than they should ? Any fiscal costs come due only if particular events occur and involve

no immediate cost to the government.

Governments are facing incentives to ignore long-term consequences of projects and to absorb risks that the private sector could/ should bear

Capacities are not adequate to analyze possible risks and to manage the PPP related liabilities

3

4

0.60.650.7

0.750.8

0.850.9

0.95

500 2,000 3,500 5,000 6,500 8,000 9,500

Succ

ess

rate

of R

e-el

ectio

n

Total Cost of Transport Projects Implemented in a constituency (100 million KRW)

17th NA18th NA4th Local5th Local

Source: Hojun Lee and Jaehoon Kim (2013)

Effects of the Transport Project implementation on Re-election

Background

Background

Why is fiscal management for PPPs is important ? To prevent their misuse and to enhance efficiency.

Not to bypass expenditure controls and ensure that full life-costs of PPPs projects

To prevent the substantial fiscal consequences.

PPPs may have been a significant source of (un)expected increases in governments’ debt and contingent liabilities.

To make PPP system long term sustainable

The fiscal burden (specially from MRGs) has been criticized by politicians, mass media, and civil society. Without persuading critical taxpayers, PPPs with the long term fiscal risk cannot be sustainable.

5

How to manage the fiscal liabilities of PPP projects ? Key Factors for managing Potential Fiscal Liabilities of PPP Projects

Recognition and Analysis of Potential Fiscal Liabilities at the up-front stage

Approval of the PPPs ( Who and How ?)

Accounting and Reporting of Potential Fiscal Liabilities

Setting a Fiscal Rule (or regulation) for PPPs

6

Background

7

Source: KDI, Major Indicators of Korean Economy (November, 2014)

Background

Both the concession-type (BTO) and the service purchase-type (BTL) projects are implemented in Korea

PPP Projects by Procurement Scheme (As of Jan. 2014)

8

Procurement Scheme Number of Project Total Project Cost Average

Project Cost % %

Concession-type

BTO 202 31.42% 679,549 69.00% 3,364

BOO 7 1.09% 12,318 1.25% 1,760

BOT 4 0.62% 6,580 0.67% 1,645

Subtotal 213 33.13% 698,447 70.92% 6,769

service purchase-type BTL 430 66.87% 286,401 29.08% 666

Total 643 100.00% 984,849 100.00% 1,532

Unit: One hundred million KRW

Korea’s PPPs in Figures

9

Facilities Number of Project % Total investment %

BTO

Road 56 28.14% 38,618 59.86% Train 9 4.52% 13,307 20.63% Port 17 8.54% 6,284 9.74%

Environment 71 35.68% 4,999 7.75% Airport 14 7.04% 767 1.19% Garage 26 13.07% 316 0.49%

IT 1 0.50% 100 0.16% Culture 4 2.01% 100 0.16% Univ. 1 0.50% 20 0.03%

Sub-total 199 100.00% 64,511 100.00%

BTL

Education 194 45.75% 8,071 29.97% Environment 92 21.70% 6,687 24.83%

Military 71 16.75% 5,575 20.71% Train 4 0.94% 4,030 14.97%

University 15 3.54% 943 3.50% Culture 25 5.90% 851 3.16%

IT 4 0.94% 239 0.89% Social Welfare 10 2.36% 234 0.87%

Mixed use 4 0.94% 184 0.68% Science center 5 1.18% 112 0.41%

Sub-total 424 100.00% 26,925 100.00% (As of December 2013)

Korea’s PPPs in Figures

10

Classification FY2010 FY2011 FY2012 FY2013

□ PPP related gov’t expenditures(A) 2.3 2.8 3.7 4.3 ○ BTO - Land Acquisition - Construction Subsidy - MRG

1.5 0.2 0.8 0.5

1.5 0.3 0.7 0.5

2.0 0.6 0.7 0.7

2.4 0.8 0.7 0.9

○ BTL - Lease - Operation Cost - Land Acquisition Cost, etc.

0.8 0.7 0.1

0.01

1.3 1.0 0.2

0.04

1.7 1.3 0.3 0.1

1.9 1.6 0.3

0.03

□ Net Budget Expenditure(B) 319.3 330.8 348.5 374.5

□ PPP expenditure ratio(%, A/B) 0.72 0.84 1.06 1.15

< PPP related gov’t expenditures FY2010~FY2013 >

(trillion KRW)

Korea’s PPPs in Figures

Up front budget Recognition and Analysis (1); Unified Framework

Competent Authority

Solicited project Unsolicited Project Private Sector →

Competent Authority

VFM Test VFM Test Competent Authority Review by PIMAC PIMAC

Selection of PPP Project Submission of Project Proposal

Designation as the PPP Project

Notification of Project Implementation Competent Authority Competent Authority →

Proponent

Announcement of RFPs

Evaluation and Selection of preferred Bidder and Negitiation

Construction and Operation

Competent Authority

Competent Authority

Concessionaire

11

Unified framework helps not to bypass expenditure controls and ensure that full life-costs of PPPs projects are taken into account at project approval stage !!

Fiscal regulation for project assessment with the same methods applied to Conventional Procurement is important to manage fiscal liabilities !!

Phase 1: Feasibility study (Decision to Invest) The cost- benefit analysis is conducted to determine feasibility of the

project from a national economy perspective.

Phase 2: Value for Money Assessment (Decision on PFI) The government payment of PSC (Public Sector Comparator) is

compared against that of PFI (Private Finance Initiative) to assess whether the PFI achieves VFM.

Budget recognition for all financial commitments, however, no risk or contingent liabilities estimation

Phase 3: Formulation of PFI alternatives Based on the results of phase 2, an appropriate PFI alternatives are

formulated The level of project cost, user fee, subsidy scale, etc. are suggested from

the government.

Up Front Budget Recognition and Analysis (2); Scope of a VFM Test

12

13

Distribution of Traffic Forecasting Errors

Optimism Bias in Traffic Forecasting

Up Front Budget Recognition and Analysis (3) ; Optimism Bias

Forecasting Fiscal Burden from MRG

14

Among operating 633 PPP projects as of end of 2012, 39 projects generated MRG payments. The payment is increasing from 2008 (366.3 billion won) and expected to be the highest at 2020 (1290.2 billion won)

Up Front Budget Recognition and Analysis(4) ; Excessive Fiscal burden ; MRG (1999~2009)

Up Front Budget Recognition and Analysis (5) ; Preventing Optimism Bias in Traffic Forecast

15

The role and function To review the over-estimation possibility

on the result of traffic forecast based on the expert's insight and experience, and the empirical results presented in a similar project case

Review Committee Members Experts with experienced and

professional expertise in order to review independently with balanced position and express own opinion

Equivalent or higher level of profess or Senior Fellow with having equivalent expertise and insight

Traffic Forecast Review Committee - Reflection of Outside View to Prevent Optimism Bias in Traffic Forecast -

Budget Authorization for PPPs by National Assembly and PRC National Assembly

Approves aggregate ceiling on annual total amounts of PPP project (BTL)

PRC (PPP Review Committee) Approves major PPP projects and monitors their implementation process

step by step. Reviews and approves the expenditures and contingent liabilities.

Recognition for the Long-Term Budget affordability Adopting Accrual basis accounting for PPP projects, instead of cash

basis accounting Incorporation into Medium-term expenditure framework (MTEF)

16

Approval and Reporting ; To Ensure Fiscal Sustainability

17

Class. 2006 2007 2008 2009 2010 2011 2012 2013

Central

94 1,299 3,468 5,204

1,291 3,131 5,928 7,969

Local

(supported by

Central)

7,222 9,096 10,162 11,308

계 94 1,299 3,468 5,204 8,513 12,227 16,090 19,277

Approval and Reporting ; To Ensure Fiscal Sustainability

• BTL Payment for FY 2006~ FY 2013 (100 million KRW)

Note: 1) Central government payment only (excluding payments by the local governments) 2) Individual statistics from central and local government payments for 2006~2009 not available

18

Classification 2014 2015 2016 2017 2018 Total

Central

Lease 5,830 6,730 7,840 8,164 8,159 36,724

Operation Cost 890 1,032 1,218 1,307 1,344 5,792

Subtotal 6,720 7,762 9,059 9,472 9,503 42,515

Local

(supported by

Central)

Lease 3,772 3,945 4,042 4,133 4,133 20,025

Operation Cost - - - - - -

Subtotal 3,772 3,945 4,042 4,133 4,133 20,025

Total 10,492 11,707 13,100 13,604 13,636 62,540

Note: 1) Central government payment only (excluding payments by the local governments) 2) For the approved BTL projects as of June 2014

< Estimated Government Payment for BTL projects 2014~2018 >

(100million KRW)

Approval and Reporting ; To Ensure Fiscal Sustainability

Fiscal Rule ; To Ensure Fiscal Sustainability

Budgetary Limits ; 2% limit rule for PPP Annual government payment PPP should be limited to less than 2% of

total annual government expenditure

Payments for PPPs / Net Government expenditure

PPP government payment: lease payment for BTL, land acquisition for BTO , construction subsidy, and MRG

(Trillion KRW)

19

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Net Gov. Expenditure(A) 324.0 319.2 330.7 339.8 374.3 392.1 406.0 420.7

PPP Expenditure(B) 2.8 2.3 2.8 3.7 4.4 5.9 5.0 5.1

-BTO 2.3 1.5 1.5 2.0 2.3 3.6 2.7 2.6

* MRG 0.5 0.5 0.5 0.7 0.8 1.0 1.1 1.1

-BTL 0.6 0.8 1.3 1.7 2.1 2.3 2.3 2.5

Ratio(%, A/B) 0.9 0.7 0.8 1.1 1.2 1.5 1.2 1.2

(Adequate) Risk sharing for PPPs is a key requirement for the implementation Public –Private- Partnership (PPP) impose an obligation on Public

(governments) by definition

Construction and operating risks are typically borne by the private sector, whereas the political, exchange rate, force majeure risks are generally borne by the public sector

Fiscal implications of PPPs should be properly accounted for and reported

To prevent their misuse and to enhance efficiency

To prevent the substantial fiscal consequences.

To make PPP system long term sustainable

Final Remarks

20

To manage fiscal liabilities and burden, it is important to

Recognize and Analyze Potential Fiscal Liabilities at the up-front stage

Account and Report Potential Fiscal Liabilities

Setting a Fiscal Rule (or regulation) for PPPs

(For sustainable PPPs in Korea) the fiscal management for PPPs is strengthened by (1) Establishing an Unified Framework for Budgeting ; It helps not to

bypass expenditure controls, It ensures that full life-costs of PPPs projects are taken into account at project approval stage

Though budget for all financial commitments is recognized, however, risks or contingent liabilities are not fully estimated due to the lack of capacities.

Final Remarks

21

(For sustainable PPPs in Korea) the fiscal management for PPPs is strengthened by (2) Establishing Multistage scrutiny system for approval and disclosing;.

National Assembly : Approves aggregate ceiling on annual total amounts of PPP projects (BTL)

PRC (PPP Review Committee) ; Reviews and approves the expenditures and contingent liabilities.

Adoption of Accrual basis accounting including PPP projects, instead of cash basis accounting

Incorporating (Future) Payment for PPPs into Medium-term expenditure framework (MTEF) for recognition of the Long-Term Budget affordability

Final Remarks

22

(For sustainable PPPs in Korea) the fiscal management for PPPs is strengthened by (3) Setting a Safeguard ceiling for PPPs ; Aggregate fiscal

commitment limited to a sustainable level for maintaining fiscal soundness and stability.

Annual government payment : 2% of total government budget expenditure

PPP investment : 10% to 15% of total public investment

Final Remarks

23

FY95-FY00 FY02 FY04 FY06 FY08 FY10 FY11 FY12

Total SOC Investment 72.4 17.2 19.1 21.3 24.3 27.2 26.6 25.5

Government Investment (A) 69.7 16.0 17.4 18.4 20.5 24.5 24.4 23.1

PPP Investment (B) 2.7 1.2 1.7 2.9 3.8 2.7 2.2 2.4

B / A (%) 3.9 7.5 9.8 15.8 18.5 11.0 9.0 10.3

Thank you