Public-Private Partnership (PPP) project failures: Don’t put zombies on life-support
December 10, 2020 3:42 AM
Rather than repeated renegotiations to sweeten the deal for the private sector, allowing some PPP projects to be cancelled (or fail) is probably the only way to elicit more realistic bidding from the private sector
As per this database, 292 PPP projects (out of 8,295 projects, or 3.5%) failed in the period 1990 to 2020 in the developing world.
By Kumar V Pratap
Macroeconomic crises are an important reason behind Public-Private Partnership (PPP) project failures. A World Bank paper (Harris and Pratap, 2009) finds that the occurrence of a macroeconomic shock increases the likelihood of project cancellation (failure) from less than 5% to more than 8%, controlling for other variables. The Covid-induced macroeconomic shock will likely be similar in its impact on PPP projects, from the demand and the supply side. During the lockdown period in India, there was near total shutdown of road, rail and air traffic, and power consumption was drastically down in March-May 2020; all this has gradually eased from June 2020 onwards. The supply of labour and access to capital was also seriously affected during the lockdown period. Though the pace of recovery is much faster than anticipated (growth rate recovering from -23.9% in Q1FY21 to -7.5% in Q2), it is likely that there would be increased PPP project failures because of Covid in the future.
The PPP project failure rate in the developing world, as per the Private Participation in Infrastructure (PPI) database of the World Bank (ppi.worldbank.org), is below 4%, both by the number of projects and associated investments. As per this database, 292 PPP projects (out of 8,295 projects, or 3.5%) failed in the period 1990 to 2020 in the developing world. In terms of investments, the corresponding numbers were $71 billion out of $1.99 trillion, or 3.6%. This is much below the overall corporate failure rate and is attributed to concerns about service continuity (after all, almost all PPP infrastructure projects carry out erstwhile sovereign functions), possible termination payments, and negative publicity surrounding these perceived failures.
In a recent blog, Makhtar Diop, the World Bank’s Vice President for Infrastructure, talks about having used artificial intelligence to gauge Covid’s impact on infrastructure. He finds that, since February 2020, 256 private infrastructure projects in developing countries have been reported cancelled or delayed. For projects already under construction, the number of projects facing disruptions peaked in May and has since been decreasing. But, the sheer number of distressed projects (256) vis-à-vis the total number of cancelled projects (292) since 1990 should be deeply concerning and point to an increased number of cancellations in the near future. From this analysis, it can be safely inferred that India, with the second-highest number of PPP projects and associated investments in the developing world, is also likely to see increased project failures in the wake of Covid.
As per the PPI database of the World Bank, India’s project failure rate is fast catching up with the rest of the developing world—it was about 2% till 2011, but increased thereafter to 34 projects valued at $13 billion (out of a total of 1,103 projects valued at $275 billion, or 3.1% by number of projects and 4.9% by value of projects, respectively).
However, the increasing project failure rate in India is not necessarily bad. Commercial discipline and the “freedom to fail” are a big part of the rationale for turning to the private sector, and project failures should therefore be expected, since some projects or concessionaires will underperform. It must be realised that, as we move to a market economy, some underperforming firms will fail. Rather than going in for repeated renegotiations to sweeten the deal for the private sector, allowing some PPP projects to be cancelled (or fail) is probably the only way to elicit more realistic bidding from the private sector. The pain that the stakeholders (including private sponsors) may suffer because of increasing cancellations is probably the necessary price that needs to be paid for more realistic bidding by the private sector.
The government has taken a number of measures to ameliorate the impact of Covid on infrastructure projects. It has been accepted that Covid-19 would be considered a force majeure event. As per the Indian Model Concession Agreements, the remedy for a force majeure non-political event is extending the concession period to the extent of the force majeure period. To address immediate liquidity concerns, RBI allowed moratorium on debt payments for six months. Accordingly, deadline for fulfilment of contractual obligations of all government projects, including PPPs, which were due for completion on or after February 2020, were increased by upto six months in view of the Covid crisis.
However, while the importance of infrastructure in economic recoveries is well documented, the government would be well-advised not to save zombies, as trying to save each and every distressed firm would be extremely inefficient expenditure in these fiscally trying times. Asking the otherwise healthy public sector companies (like NTPC) to take them over (distressed coal based power projects, for example) is also logically flawed as sooner rather than later, these healthy PSUs would also become sick. Eighty-five percent of the failed infrastructure PPPs end up in the government fold in the developing world as efforts to reprivatise them do not generally find takers.
One only has to look at the wasted billions in the Dabhol Power Company (DPC, promoted by the infamous Enron) to realise the folly of trying to save each and every zombie firm. DPC is a 2,184 MW power project, taken over by a clutch of public sector sponsors (including NTPC and GAIL) in 2005 who formed a Special Purpose Vehicle, Ratnagiri Gas & Power Private Limited. While the acquisition price was `8,485 crore, now the total project cost has gone past Rs 13,000 crore, and the Maharashtra State Electricity Distribution Company Limited, the principal beneficiary of the project, terminated its Power Purchase Agreement in 2015. It would have been much better to allow the company to die and use the resources elsewhere.
Former joint secretary (Infrastructure Policy & Finance), ministry of finance, and currently, joint secretary (UT), ministry of home affairs